What is one risk of diversification?

What is one risk of diversification?

• A. It can lead to guaranteed losses
• B. It does not eliminate the risk of loss
• C. It focuses all investments into one sector
• D. It ensures higher dividends

Answer: (B)

Diversification is a strategy used to spread investments across various assets or sectors to reduce risk. While it is an effective way to lessen the impact of volatility in any single investment, it does not entirely eliminate the risk of loss. Even a well-diversified portfolio can suffer losses if overall market conditions decline or if correlations between different investments increase during market downturns. In essence, while diversification can mitigate specific risks, it cannot guarantee positive outcomes or prevent losses entirely. In periods of market stress, even diversified portfolios can see declines in value, proving that some degree of risk always remains, regardless of how diversified the holdings may be. This understanding is crucial for investment strategy, as it highlights the importance of not only diversification but also the management of other risk factors associated with market investing.

Diversification is a strategy used to spread investments across various assets or sectors to reduce risk. While it is an effective way to lessen the impact of volatility in any single investment, it does not entirely eliminate the risk of loss. Even a well-diversified portfolio can suffer losses if overall market conditions decline or if correlations between different investments increase during market downturns.

In essence, while diversification can mitigate specific risks, it cannot guarantee positive outcomes or prevent losses entirely. In periods of market stress, even diversified portfolios can see declines in value, proving that some degree of risk always remains, regardless of how diversified the holdings may be. This understanding is crucial for investment strategy, as it highlights the importance of not only diversification but also the management of other risk factors associated with market investing.