Question

If you have two assets that move in opposite directions, why does the portfolio&#x27;s total variance drop more than just by averaging the individual variances?

Accepted Answer

When two assets move in opposite directions, they act like a built-in shock absorber for your money. Variance is just a fancy word for how much an investment&#x27;s price jumps around or how risky it is. If you own two things that always go up and down at the same time, your total risk stays high because they both crash together. But when one goes up while the other goes down, they cancel each other&#x27;s bad days out. Imagine you are walking a tightrope while holding a heavy pole; if you lean left, you tilt the pole right to stay balanced. Because these assets move against each other, the big dips in one are smoothed out by the gains in the other. This effect is called diversification, which is just the act of spreading your money around so you aren&#x27;t relying on just one thing. By combining these opposite movers, the portfolio&#x27;s total ups and downs become much smaller than the average of the two parts alone. You end up with a steadier ride because the two assets are constantly fighting to keep your total value in the middle.

If you have two assets that move in opposite directions, why does the portfolio's total variance drop more than just by averaging the individual variances?

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If you have two assets that move in opposite directions, why does the portfolio's total variance drop more than just by averaging the individual variances?

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