What are the theories in?

Answer 1

There are a lot, but Harry Markowitz's theory of diversification is one of the most important, and won him the nobel prize. It's based on the idea that if I invest in one company, I assume a certain amount of risk for a certain amount of reward.

But, if I invest in that same company and 1 other random company with a similar risk/reward ratio- then my risk is reduced while my reward is the same. Think about it. If I invest in a software comapny and a gas company, there is 50/50 chance that each one does well. So if one does bad, then I still have a 25% chance of the other one making that reward up. And I can continue to invest into different companies reducing my risk while keeping my reward the same. Investing in about 30 companies is statistically the best you can do, as far as risk vs. reward. After about 30 companies, the benefits are so minimal that most economist agree it is not worth it.

So by diversifiying my investments, I am keeping the same level of reward (which is income) while reducing my risk. When I reduce my risk, I can increase my investment, generating greater rewards.