What investment strategy aims to reduce risk through diversification?

What investment strategy aims to reduce risk through diversification?

• A. Concentration
• B. Hedging
• C. Asset allocation
• D. Diversification

Answer: (D)

The investment strategy that aims to reduce risk through diversification is focused on spreading investments across various assets to minimize exposure to any single asset or risk. This strategy acknowledges that different assets often react differently to the same economic events; as a result, when one investment may perform poorly, another may perform well, thereby balancing the overall performance of the portfolio. While the concept of diversification itself is often discussed as a primary method of risk management, the correct answer emphasizes the importance of not just spreading investments randomly, but strategically selecting diverse assets that are not strongly correlated. This helps in achieving more stable returns and minimizing the impact of volatility in any one part of the investment. In contrast, concentration is a strategy that focuses on investing in a limited number of assets, which can lead to higher risk. Hedging involves using financial instruments or market strategies to offset potential losses in investments, rather than diversifying the investments themselves. Asset allocation refers to the process of dividing investments among different asset categories, which can include diversification but is broader in scope than merely spreading risks. Thus, the clarification of diversification as the targeted approach is crucial in the context of risk reduction.

The investment strategy that aims to reduce risk through diversification is focused on spreading investments across various assets to minimize exposure to any single asset or risk. This strategy acknowledges that different assets often react differently to the same economic events; as a result, when one investment may perform poorly, another may perform well, thereby balancing the overall performance of the portfolio.

While the concept of diversification itself is often discussed as a primary method of risk management, the correct answer emphasizes the importance of not just spreading investments randomly, but strategically selecting diverse assets that are not strongly correlated. This helps in achieving more stable returns and minimizing the impact of volatility in any one part of the investment.

In contrast, concentration is a strategy that focuses on investing in a limited number of assets, which can lead to higher risk. Hedging involves using financial instruments or market strategies to offset potential losses in investments, rather than diversifying the investments themselves. Asset allocation refers to the process of dividing investments among different asset categories, which can include diversification but is broader in scope than merely spreading risks. Thus, the clarification of diversification as the targeted approach is crucial in the context of risk reduction.