Strategy Beginner: The Importance of Diversification

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1.
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.
2.
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.
3.
A slump in one industry can actually help other industries.
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True. In industries that meet similar needs, people may use the products or services of another industry if their preferred one experiences major problems. For instance, if there are problems in the airline industry, transportation needs may be met by driving or using trains.
4.
When a financial advisor says, "Let's talk about risk and how much you can deal with," he or she is talking about _______.
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Risk tolerance. Risk tolerance is the amount of risk with which you are comfortable.
5.
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.
6.
Which of the following can reduce volatility in investing?
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Negative correlation of securities. A fall in one type of security can be offset by a rise in another.
7.
How can you greatly reduce unsystematic risk?
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Diversify your investments among several companies. Unsystematic risks are specific to a company. You can reduce them greatly by investing in several companies.