What does portfolio diversification aim to achieve?

• A. Maximize profits from a single asset
• B. Reduce risk by spreading investments
• C. Increase the number of trades
• D. Focus on one market sector

Answer: (B)

Portfolio diversification aims to reduce risk by spreading investments across a variety of assets. The core principle behind this strategy is that different assets often react differently to the same economic events, which can help to mitigate the overall risk of the investment portfolio. By diversifying, an investor can minimize the impact of poor performance from any single investment, as gains in others can offset losses.

This approach allows investors to achieve a more stable and consistent return over time, which is especially important in volatile markets. Rather than concentrating their investments in one area—whether that be a particular asset, sector, or market—a diversified portfolio includes a mix of asset classes such as stocks, bonds, and perhaps real estate or commodities. This balanced strategy helps to ensure that the overall risk is managed effectively, which is the fundamental goal of diversification.