Diversification & Return on Investment
Ch15 LO7 covers more than the four investment vehicles (InvestmentVehicles) — it also lays out the risk-management mechanics of investing: how to spread risk across assets, how to mix them by life stage, and how to actually measure what an investment returns. These are exam-targetable formulas and concepts that don’t fit neatly into any other Ch15 page.
graph TD INV["Investment Decision"] INV --> RR["Risk-Return<br/>Trade-off"] INV --> DIV["Diversification<br/>Spread risk across<br/>multiple investments"] INV --> AA["Asset Allocation<br/>Proportions per<br/>investment type"] INV --> ROI["Return on Investment"] DIV --> DV1["Different companies"] DIV --> DV2["Different industries"] DIV --> DV3["Different countries"] AA --> AA1["Younger:<br/>70% stocks · 20% bonds<br/>10% money market"] AA --> AA2["Older:<br/>more bonds & money mkt<br/>less stocks"] ROI --> R1["Current Dividend Yield"] ROI --> R2["Capital Gain"] ROI --> R3["Total Return %"] ROI --> R4["Compound Growth"]
How It Appears Per Course
ADMN 201
LO7 (the finance side of investing) and LO8 (risk) overlap here. The textbook frames diversification and asset allocation as the risk-management answer to investing — practical strategies that an individual investor or financial manager applies to portfolios. The ROI formulas are the measurement layer underneath.
The Risk-Return Relationship
Every financial instrument sits somewhere on a risk-return curve:
| Risk Level | Typical Instruments | Expected Return |
|---|---|---|
| Lowest | Treasury bills, government bonds, money market funds | Low but stable |
| Low–Medium | Corporate bonds (investment grade), GICs | Modest |
| Medium | Mutual funds, blue-chip stocks, real estate | Moderate |
| High | Small-cap stocks, junk bonds, commodities | High potential |
| Highest | Hedge funds, crypto, futures on margin, derivatives | Very high — and very negative |
The rule: higher expected return demands higher risk tolerance. Investors at the extremes (all safe, all risky) almost always underperform. The middle is where most strategy lives.
Diversification
Diversification = holding many different investments so that one bad outcome does not sink the portfolio. Even if one stock collapses, others may rise.
A diversified portfolio spreads across:
- Different companies (don’t hold only Bombardier; hold Bombardier + RBC + Shopify)
- Different industries (banking + tech + energy + healthcare)
- Different countries (Canada + US + Europe + emerging markets)
- Different asset classes (stocks + bonds + real estate + commodities)
Why it works: It is statistically very unlikely that all your holdings will fall at once — they react to different economic forces. A recession may crush retail stocks but barely touch utilities.
Common misconception: “I bought 5 different bank stocks, so I’m diversified.” Correction: 5 banks all react to the same interest-rate moves — that’s not diversification, that’s concentration.
Asset Allocation
Asset Allocation = the proportion of funds invested in each alternative. Diversification is the what; asset allocation is the how much of each.
The textbook ties allocation directly to investor age:
| Investor | Stocks | Bonds | Money Market |
|---|---|---|---|
| Younger investor | ~70% | ~20% | ~10% |
| Older investor | Smaller stake | Larger stake | Larger stake |
Why age changes the answer:
- Younger investors have time to ride out market crashes — a 30-year horizon absorbs short-term volatility.
- Older investors need capital preservation — a market crash one year before retirement is a disaster they cannot recover from.
Exam trap: Don’t confuse diversification with asset allocation. Diversification = many different investments. Asset allocation = the mix proportions. You can be diversified within a single asset class (many stocks), or you can have a single allocation strategy (just stocks, just bonds).
Return on Investment (ROI)
Three formulas matter for Ch15:
1. Current Dividend Yield
The cash income a stock generates per year, as a % of its current price.
Current Dividend Yield = Annual Dividend ÷ Current Market Price
Example: Stock pays 35.67.
- Yield = 35.67 = 5.05%
This lets you compare a stock’s income to other investments (a 5.05% yield beats a 3% bond, before considering capital gains and risk).
2. Capital Gain
The increase in the dollar value of an investment when sold.
Capital Gain = Sale Price − Purchase Price
A stock bought at 30 = $10 capital gain per share. (Tax treatment differs from dividend income — only 50% of capital gains are taxable in Canada.)
3. Total Return %
Combines income (dividends or interest) and capital gain into a single % return.
Total Return (%) = (Current Dividend Payment + Capital Gain) ÷ Original Investment × 100
Example: Bought at 115 with $5 dividends received during the holding period.
- Total Return = (15) ÷ $100 × 100 = 20%
Total return is the only number that matters for comparing investments — yield alone or capital gain alone tells half the story.
Compound Growth
Compound Growth = interest (or returns) earned on previously earned interest. Each year’s gain is added to the principal, so the next year’s gain is bigger.
| Year | Simple Interest (5% on $1,000) | Compound Interest (5% on $1,000) |
|---|---|---|
| 1 | $50 | $50.00 |
| 5 | $250 | $276.28 |
| 10 | $500 | $628.89 |
| 20 | $1,000 | $1,653.30 |
| 30 | $1,500 | $3,321.94 |
The lesson: compound growth is non-linear. Time matters more than return rate. A young investor saving modest amounts beats an older investor saving large amounts late.
This is the Time Value of Money in action: a dollar today is worth more than a dollar in the future, because today’s dollar can be invested and compound.
For deeper PV/FV mechanics, see PresentValueMeasurement (ACC 926 reference layer).
Cross-Course Connections
RiskManagement — diversification is one of the four risk-handling strategies (specifically, risk avoidance through spreading)
InvestmentVehicles — mutual funds and ETFs are the practical wrappers used to achieve diversification
SecuritiesMarkets — these formulas are applied to the stocks and bonds traded there
LongTermFinancing — a firm’s capital structure is the corporate-side cousin of personal asset allocation
SelectionBias-SecuritiesMarkets — survivorship bias in fund track records corrupts return data; PHIL252 selection bias tools apply directly
PresentValue-LongTermFinancing — compound growth ↔ PV/FV/annuity formulas
Key Points for Exam/Study
- Risk-Return relationship: higher return demands higher risk; extremes underperform
- Diversification = many different investments across companies, industries, countries; reduces unsystematic risk
- 5 banks ≠ diversification — they react to the same forces
- Asset Allocation = the proportions in each asset class
- Younger: 70% stocks / 20% bonds / 10% money market; older: more bonds + money market, fewer stocks
- Current Dividend Yield = Annual Dividend ÷ Current Price
- Total Return % = (Dividends + Capital Gain) ÷ Original Investment × 100
- Compound Growth = interest on previously earned interest — time is the lever, not just rate
- Time Value of Money: a dollar today > a dollar tomorrow, because today’s dollar can be invested
Open Questions
- How does a financial advisor decide the exact stock/bond split for a 35-year-old vs. a 55-year-old? Is it just age or are there other factors?
- Does ETF investing (passive, index-tracking) effectively replace the need for explicit diversification decisions?