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Why Risk & Return Do Not Move Linearly When Blending Funds

When combining two funds (e.g., a 50/50 split), the resulting portfolio’s risk and return will not always fall directly between the two on a risk line. This is due to correlation and diversification effects between the underlying assets.



  • This is a classic example of portfolio diversification and correlation effects.
    • When blending two funds, the portfolio’s risk and return do not move linearly between them due to the correlation and diversification effects.
  • The way the underlying holdings of the two portfolios interact can result in improved risk-adjusted outcomes:
    • In other words, since the underlying assets do not move perfectly in sync, their interactions can reduce overall volatility and improve the consistency of returns, leading to better risk-adjusted outcomes. 
    • Consequently, a combined portfolio may deliver more return for less risk than a simple weighted average would suggest—illustrating the fundamental principle that diversification enhances efficiency.
  • As is often said:
    • The whole can be greater than the sum of its parts.
    • Diversification is the only free lunch in investing.