Strategy Beginner: The Importance of Diversification

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1.
A fall in price of one security in a diversified portfolio may be offset by an increase in price of another.
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True. Problems in one industry may lead people to seek the products or services of another in your portfolio.
2.
A portfolio with negatively correlated assets reduces volatility.
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True. When some assets fall in value, others will rise in value, and vice versa.
3.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
4.
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.
5.
The chance of experiencing inflation is an example of unsystematic risk.
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False. Inflation influences all companies as well as the entire economy. Diversification cannot eliminate the risk of facing inflation. Therefore, it is a systematic risk.
6.
Risk tolerance is the amount of risk with which you are comfortable.
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True. It determines your choices of investments, among many other things.
7.
Diversification helps to reduce risk because _______.
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Different investments perform differently. The idea behind diversification is that the changes in differently performing investments will cancel each other out.