What does diversification aim to achieve in investment management?

What does diversification aim to achieve in investment management?

• A. To increase investment concentration
• B. To reduce risk by spreading investments
• C. To guarantee high returns
• D. To engage solely in one industry

Answer: (B)

Diversification in investment management focuses primarily on reducing risk by spreading investments across various asset classes, sectors, and geographic regions. The underlying principle is that by investing in a diverse range of assets, an investor can mitigate the impact of poor performance in any single investment. For example, if one sector of the market experiences a downturn, the losses may be offset by gains in another sector, thereby stabilizing the overall portfolio's returns. This strategy helps in achieving a balance between risk and reward, as it ensures that an investor is not overly dependent on the performance of a single investment or market. Risk reduction through diversification does not eliminate the possibility of loss, but it can lower the overall volatility of the investment portfolio, making it a fundamental principle of sound investment management. Other options, such as increasing investment concentration or focusing solely on a single industry, contradict the essence of diversification, which is about spreading risk rather than concentrating it. The notion that diversification guarantees high returns is a misconception; while it can help in managing risk, it does not promise high returns.

Diversification in investment management focuses primarily on reducing risk by spreading investments across various asset classes, sectors, and geographic regions. The underlying principle is that by investing in a diverse range of assets, an investor can mitigate the impact of poor performance in any single investment. For example, if one sector of the market experiences a downturn, the losses may be offset by gains in another sector, thereby stabilizing the overall portfolio's returns.

This strategy helps in achieving a balance between risk and reward, as it ensures that an investor is not overly dependent on the performance of a single investment or market. Risk reduction through diversification does not eliminate the possibility of loss, but it can lower the overall volatility of the investment portfolio, making it a fundamental principle of sound investment management.

Other options, such as increasing investment concentration or focusing solely on a single industry, contradict the essence of diversification, which is about spreading risk rather than concentrating it. The notion that diversification guarantees high returns is a misconception; while it can help in managing risk, it does not promise high returns.