The effect of correlation
Diversi?cation works better when the investments in a portfolio have small correlations. To demonstrate this, suppose that returns on 500 Index Fund and Diversi?ed International Fund had the means and standard deviations we have given but were uncorrelated (ρWY = 0). Show that the standard deviation of a portfolio that combines 80% 500 Index with 20% Diversi?ed International is then smaller than your result from the previous exercise. What happens to the mean return if the correlation is 0?