Why is diversifying your portfolio across different stocks and industries so important? Diversification is a rather simple concept, but the reasoning behind it might be a bit more detailed and complex than you would have guessed. This course will take a deep dive into the importance of diversification for stock market investments and show you both conceptually and mathematically how it actually improves your rate of return and minimizes your risk!
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Stock Market: THE POWER OF DIVERSIFICATION
Why is diversifying your portfolio across different stocks and industries so important? Diversification isa rather simple concept, but the reasoning behind i...
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Table of contents
You will learn
The course project has two parts, the second being optional if you’re looking for a challenge!
- Identify at least 10 stocks or ETFs in which you have an interest to invest.
- Make sure these stocks or ETFs are in as many different sectors and industries as possible.
- You can take a look at my personal watch list that I uploaded here for examples. It already has the various stocks and ETFs I trade organized by their respective sectors and industries.
- Go to Yahoo Finance and download historical data for each of the stocks or ETFs you selected.
- Simply type in the ticker symbol for the stock or ETF and then click on “Historical Data”.
- I recommend setting the “Time Period” to span 20 years and setting the “Frequency” to monthly data.
- Click “Apply” and then download the historical data.
- Import the historical data into a spreadsheet (e.g. Excel, Google Sheets, or Numbers) like you saw in this course.
- Identify the percentage of money you would want to invest in each of the stocks or ETFs you selected.
- As you saw in this course, you do not need to allocate your money in the “optimal” proportions to take advantage of diversification.
- Simply spreading your money evenly across all stocks in your portfolio has a very effective impact.
- But I still leave it up to you here to figure out the allocations that make the most sense to you.
- Create another table in your spreadsheet that will be used to track your portfolio value across the same time period you chose for the historical data (you saw this in the last lesson of this course).
- Pick a starting value for your portfolio $1,000? $10,000? It doesn’t matter.
- For each allocation percentage you chose for the various stocks in your portfolio, multiply each percentage (as a decimal) by your starting value.
- For example, a 30% allocation in AAPL would mean multiplying your starting value by 0.3.
- Then for each of those results, divide the result by the share price of the corresponding stock or ETF from the first month in the historical data.
- This represents how many shares you will pretend to buy at the beginning of the time period.
- For each of the stocks you selected, multiply the number of shares calculated from the previous step by the share price of the first month and add everything together. Place the result in the first row of your new table.
- Make sure to do this by referencing the cells that contain the share prices, not the actual values they contain.
- I uploaded the spreadsheet you saw in this course here as well. Please take a look at the Portfolios table and click on the cells to see how I did these calculations.
- If you did this correctly, the final result that you placed in the first row of your table should be very close to your starting portfolio value (maybe off by a few pennies).
- Apply these calculations down your new table for all the dates included in your historical data.
- Repeat the process in Step 5 for each of the individual stocks in your portfolio as well.
- This will be much easier since the allocation percentages for these single-stock portfolios is simply 100%.
- Again, please reference my spreadsheet for guidance.
- Finally, take all the data in this new table containing the monthly performances of your diversified portfolio and the single-stock portfolios and plot them on a chart.
- Study the chart to see how your diversified portfolio held up against the individual stocks.
- My guess is your diversified portfolio won’t come out on top (and that’s not the point), but you will likely see that your portfolio did very well (solid return and minimal volatility) compared to the single-stock portfolios.
PART 2 (Optional)
- Create a portfolio optimization calculator like you saw in this course to calculate the optimal allocation percentages for your portfolio.
- I highly recommend you reference my spreadsheet and simply work your way through creating the same thing on your own.
- Keeping in mind the mathematical formulas you saw in this course, as you are building the calculator you will see how the math is being applied through the various Excel functions I used to create my own calculator.
- You can then use the solver that comes with Excel to perform the actual optimization calculations for you. Reference the “Optimal Portfolio” video in this course to see how to use it.
- If you do not have Excel, I can’t speak to what kind of “solvers” other spreadsheeting applications may or may not have, but at the very least, you will be able to use the calculator to calculate your entire portfolio’s expected return and monthly volatility based on whichever stock allocations you choose. Still very useful!
- NOTE: In order to create the calculator, you will first need to add a “Monthly Returns” column to each of your stock historical data sets. It’s very easy to calculate the monthly returns from the monthly closing prices. Again, just reference those columns in my spreadsheet to see how I did it.
Feel free to share your spreadsheets here to get help, feedback, or simply provide other students with examples!