DISPARITY BETWEEN THEORETICALLY OPTIMAL DIVERSIFICATION AND ACTUAL PRACTICE

Portfolio diversification is the practice of spreading one’s money among many different investments. It is a common sense concept that has many parallels in popular language and Culture (for example “Don’t put all your eggs in one basket”). Its theoretical foundations were introduced in the normative work of Harry Markowitz (1952, 1959), and later confirmed by the work of William Sharpe (1964).

Despite documented benefits of diversification, many investors do not diversify their stocks in their portfolios. Average number of stock in individuals’ portfolio is about four. Degree of diversification depends on investors’ age, education, occupation and income. Various psychological factors, such as, overconfidence, excitement, familiarity with certain stocks, gambling instinct, etc., are various reasons of not diversifying. Many believe that a few chosen stocks, like a few lottery tickets provide a chance for becoming rich but a well-diversified portfolio of stocks, like a well-diversified portfolio of lottery tickets, only give mediocre results.