The principle of diversification tells us that
A)concentrating a portfolio in three companies within the same industry will greatly reduce the overall risk of a portfolio.
B)concentrating a portfolio in two or three large stocks will eliminate all of a portfolio's risk.
C)spreading an investment across many diverse assets will eliminate all of a portfolio's risk.
D)spreading an investment across many diverse assets will lower a portfolio's level of risk.
E)spreading an investment across five diverse companies will not lower a portfolio's level of risk.

Question

Quizplus · Accepted Answer

The principle of diversification tells us that spreading an investment across many diverse assets will lower a portfolio's level of risk. It does not eliminate all the risk, but it helps to dampen the impact of any one particular investment's performance on the overall portfolio. Option A is incorrect because selecting companies within the same industry can actually increase risk if that industry is hit with a negative event. Option B is incorrect because it is impossible to completely eliminate risk. Option C is incorrect because diversification does not eliminate all risk. Option E is incorrect because spreading an investment across five diverse companies can still leave the portfolio exposed to risk if these companies are all in the same industry or subject to the same market forces.

The Principle of Diversification Tells Us That