The formula for calculating the portfolio diversity score is:
\[ PD = 1 - \sum_{i=1}^{n} w_i^2 \]
Where:
Portfolio diversity, also known as portfolio diversification, is an investment strategy that involves spreading investments across various types of assets, industries, geographic regions, or securities to reduce risk and potential losses. The main idea behind portfolio diversity is not to put all your eggs in one basket. By diversifying, an investor can mitigate the risk of a single investment failing or an entire sector performing poorly. This strategy can help to protect the investor's overall portfolio value and potentially enhance returns over the long term.
Let's assume the following weights for a portfolio with three assets:
Using the formula to calculate the portfolio diversity score:
\[ PD = 1 - (0.4^2 + 0.3^2 + 0.3^2) = 1 - (0.16 + 0.09 + 0.09) = 1 - 0.34 = 0.66 \]
The portfolio diversity score is 0.66.
