Strategy Beginner: The Importance of Diversification

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1.
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.
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.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
5.
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.
6.
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.
7.
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.