Strategy Beginner: The Importance of Diversification

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1.
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.
2.
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.
3.
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.
4.
In investing language, what does it mean to diversify?
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To divide your investments among a variety of assets. This can mean different types of assets, different industries, different countries, etc.
5.
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.
6.
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.
7.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.