Question

How does indexing compare to using the Markowitz procedure to achieving a diversified portfolio?

Answer 1

Markowitz procedure of achieving a diversified portfolio:

Markowitz diversification also known as the optimal diversification takes a different approach in creating a diversified portfolio. Here the focus is on finding assets where the correlation between them is not perfectly positive. This can help to minimize the risk in fewer securities which can also help in maximizing the return. In this approach, computers run complex models & algorithms that can help in finding an ideal correlation between the assets to minimize the risk & maximize the return.

Indexed approach:

Indexing is considered to be a passive approach to investing. This is usually done through ETF’s or mutual funds that can offer several benefits which includes diversification, low costs, competitive performance, tax efficiency etc. in indexing the funds are invested in several sectors. You can also invest in funds that track a sector, such as oil, technology, finance, consumer goods, and on and on. Whatever sector you can think of, someone has made an index for it, and someone else has created a fund that follows that index. An investor who thinks a particular sector is likely to outperform the general market can buy a fund that tracks that sector and still be diversified within the sector. For example if the oil fund isn’t doing well, there are chances that other index fund will. Hence we are diversified not only by different sector but also diversified by having money in different sectors,