Why is the marginal investor assumed to be diversified

The argument that investors can reduce their exposure to risk by diversifying can be easily made, but risk and return models in finance go further. They argue that the

7 Three stockholders, VCP, Safra and Grupo Lorentzen hold 28% each of the voting shares.

marginal investor, who sets prices for investments, is well diversified; thus, the only risk that will be priced in the risk as perceived by that investor. The justification that can be offered is a simple one. The risk in an investment will always be perceived to be higher for an undiversified investor than to a diversified one, since the latter does not consider any firm-specific risk while the former does. If both investors have the same perceptions about future earnings and cashflows on an asset, the diversified investor will be willing to pay a higher price for that asset because of his or her risk perceptions. Consequently, the asset, over time, will end up being held by diversified investors.

While this argument is a powerful one for stocks and other assets, which are traded in small units and are liquid, it is less so for investments that are large and illiquid. Real estate in most countries is still held by investors who are undiversified and have the bulk of their wealth tied up in these investments. The benefits of diversification are strong enough, however, that securities such as real estate investment trusts and mortgage-backed bonds were created to allow investors to invest in real estate and stay diversified at the same time.

Note that diversification does not require investors to give up their pursuit of higher returns. Investors can be diversified and try to beat the market at the same time, For instance, investors who believe that they can do better than the market by buying stocks trading at low PE ratios can still diversify by holding low PE stocks in a number of different sectors at the same time.

Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

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