Strategy Beginner: The Importance of Diversification

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1.
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.
2.
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.
3.
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.
4.
Financial advisors suggest diversifying because putting your money into different investments is often the best way to avoid losing large sums of money.
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True. Diversifying spreads risk among several investments.
5.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
6.
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.
7.
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.