Strategy Beginner: The Importance of Diversification

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1.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
2.
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.
3.
The risk of the company in which you invest being destroyed by a passing tornado is an example of _______ risk.
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Unsystematic. A tornado is a natural disaster that is unlikely to affect all industries; hence, it is an unsystematic risk.
4.
An investor can diversify by investing in different regions of the world.
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True. One can diversify in many ways. Choosing different regions is one way.
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.
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.
7.
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.