Strategy Beginner: The Importance of Diversification

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1.
Why does diversifying across different classes of assets help reduce risk?
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Different classes of assets respond differently to economic events. Each type of asset (stocks, bonds, cash, real estate, etc.) has its own risks that may not exist for other types of assets.
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.
Investment portfolios can be called efficient when they ________.
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Contain the best possible mixes of assets for a specific risk level and return. Efficiency is relative to the kind of objective that you are trying to fulfill.
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.
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.
6.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
7.
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.