Strategy Beginner: The Importance of Diversification

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1.
You have invested in a portfolio that has only two stocks. You observe that every time one stock goes up in price, the other goes down. The two stocks are _______ correlated.
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Negatively. Investments with prices that move opposite to each other are correlated negatively.
2.
Diversification among asset classes can reduce the overall return of a portfolio because _______.
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Diversifying among different asset classes means including less-volatile assets that have lower expected earnings. Returns are averaged among all the securities in the portfolio.
3.
What are the two most basic types of risk?
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Systematic and unsystematic. All other types of risk fall into these two categories.
4.
In investing language, what does it mean to diversify?
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To divide your investments among a variety of assets. This can mean different types of assets, different industries, different countries, etc.
5.
How does having a lot of money affect your risk tolerance?
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It can enable you to afford loss. If you have a lot of money, you can afford to lose some, and so your risk tolerance will increase.
6.
For a given investment return, there are optimal mixes of stocks, bonds, and cash that produce different returns with a minimum of risk.
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True. These portfolios are called "efficient." Their optimality has been demonstrated by analyzing returns over history.
7.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.