Which of the following statements is MOST correct concerning diversification and risk?
A) Diversification is mainly achieved by the selection of individual securities for each type of asset held in a portfolio.
B) Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category.
C) Large company stocks and small company stocks together in a portfolio lead to dramatic reductions in risk because their returns are negatively correlated.
D) Asset allocation is important for pension funds but not for individual investors.

Question

Quizplus · Accepted Answer

Diversification is mainly achieved by the asset allocation decision, not the selection of individual securities within each asset category. This is because different types of assets (such as stocks, bonds, and real estate) tend to have different risk and return characteristics, and holding a mix of these assets can help to reduce overall portfolio risk. Within each asset category, individual security selection can still play a role in diversification, but it is not as important as the overall asset allocation decision. Option A is incorrect because diversification is not achieved solely through the selection of individual securities. Option C is incorrect because the correlation between different types of stocks is not always negative, so holding a mix of large and small company stocks does not always lead to dramatic reductions in risk. Option D is incorrect because asset allocation is important for both pension funds and individual investors in order to manage portfolio risk.

Which of the Following Statements Is MOST Correct Concerning Diversification