Which statement best describes the purpose of diversifying investments?

Which statement best describes the purpose of diversifying investments?

• A. It guarantees profits regardless of market conditions
• B. It increases the investment in high-risk assets
• C. It reduces risk by spreading investments across sectors
• D. It simplifies the investment decision-making process

Answer: (C)

The purpose of diversifying investments is effectively captured by the statement that it reduces risk by spreading investments across sectors. Diversification entails allocating capital among various financial instruments, industries, or asset classes to minimize the impact of a poor-performing asset on an investor's overall portfolio. By distributing investments across different sectors or asset types, the investor seeks to avoid excessive exposure to any single market risk. For example, if an investor holds stocks in various industries — such as technology, healthcare, and consumer goods — a downturn in one sector may be mitigated by stability or gains in another, thereby reducing overall portfolio volatility. This strategy does not eliminate risk completely but helps to manage it, leading to a more balanced approach to investing. The other statements do not accurately reflect the essence of diversification. While it does not guarantee profits nor does it specifically increase investment in high-risk assets, it focuses on risk management rather than simplifying decision-making processes in investments. Thus, the emphasis on spreading investments to reduce risk is the core rationale behind diversification.

The purpose of diversifying investments is effectively captured by the statement that it reduces risk by spreading investments across sectors. Diversification entails allocating capital among various financial instruments, industries, or asset classes to minimize the impact of a poor-performing asset on an investor's overall portfolio. By distributing investments across different sectors or asset types, the investor seeks to avoid excessive exposure to any single market risk.

For example, if an investor holds stocks in various industries — such as technology, healthcare, and consumer goods — a downturn in one sector may be mitigated by stability or gains in another, thereby reducing overall portfolio volatility. This strategy does not eliminate risk completely but helps to manage it, leading to a more balanced approach to investing.

The other statements do not accurately reflect the essence of diversification. While it does not guarantee profits nor does it specifically increase investment in high-risk assets, it focuses on risk management rather than simplifying decision-making processes in investments. Thus, the emphasis on spreading investments to reduce risk is the core rationale behind diversification.