Enter Values
| Asset | Weight (%) | Volatility (%) |
|---|
Enter your asset weights and individual volatilities above. The calculator computes Σ(wi × σi) automatically. Portfolio std dev (σp) is your actual portfolio volatility, which you can get from your broker or calculate from returns.
Quick Reference
- Lower ratio = Better diversification
- DR = 1 = No diversification benefit
- DR = 0.60 = 40% risk reduction
- Depends on asset correlations
Diversification Ratio Result
Formula Breakdown
Interpretation
Your diversification ratio of 0.54 means your portfolio has 54% of the risk it would have if all assets moved perfectly together. Diversification has reduced your portfolio risk by 46%.
Rating Guide
Lower ratios indicate better diversification. The ratio shows what fraction of undiversified risk remains.
| Minimal | Almost no diversification | |
| Low | Limited diversification | |
| Moderate | Some diversification benefit | |
| Good | Well-diversified portfolio | |
| Excellent | Highly diversified |
Understanding the Diversification Ratio
What is the Diversification Ratio?
The diversification ratio measures how effectively portfolio diversification reduces risk. It compares your actual portfolio volatility to what the volatility would be if all assets moved perfectly together (correlation = 1).
The formula is: DR = σp / Σ(wi × σi)
Where σp is the actual portfolio standard deviation and Σ(wi × σi) is the weighted average of individual asset volatilities.
Why Lower is Better
Unlike most financial metrics where higher is better, the diversification ratio works in reverse:
- DR = 1.0: No diversification benefit—all assets move together perfectly
- DR = 0.70: Good—30% of undiversified risk eliminated
- DR = 0.50: Excellent—half the undiversified risk eliminated
- DR → 0: Theoretical limit with perfectly negatively correlated assets
Calculating the Weighted Average
The weighted average asset volatility is calculated by multiplying each asset's weight by its volatility, then summing:
- 60% in Stock A (25% volatility): 0.60 × 25% = 15.0%
- 40% in Stock B (18% volatility): 0.40 × 18% = 7.2%
- Weighted Average = 15.0% + 7.2% = 22.2%
What Affects Diversification?
- Asset correlations: Lower correlations = better diversification
- Number of assets: More assets generally helps (with diminishing returns)
- Asset classes: Mixing stocks, bonds, commodities improves diversification
- Geographic diversification: International exposure can reduce correlation
Practical Applications
- Portfolio construction: Target a diversification ratio that matches your risk goals
- Manager evaluation: Compare diversification ratios across similar portfolios
- Risk budgeting: Understand how much diversification is contributing to risk reduction
- Asset allocation: Add assets that lower the diversification ratio
Consider using this calculator alongside the Beta calculator for systematic risk and the Sharpe ratio calculator for risk-adjusted returns.
Frequently Asked Questions
Disclaimer
This calculator is for educational and informational purposes only. The diversification ratio is a historical measure based on past volatility data. Correlations can change over time, especially during market stress when diversification benefits may decrease. Investment decisions should consider multiple factors including your risk tolerance, investment horizon, and financial goals. Always consult with a qualified financial advisor before making investment decisions.
