What does a diversified portfolio aim to reduce?

What does a diversified portfolio aim to reduce?

• A. Market volatility
• B. Tax liabilities
• C. Transaction costs
• D. Overall returns

Answer: (A)

A diversified portfolio aims to reduce market volatility by spreading investments across various asset classes, sectors, and geographic regions. The rationale behind diversification is that different assets react differently to the same economic event or market condition. For instance, while stocks might be performing poorly, bonds or real estate investments could be doing well. By including a variety of investments in a portfolio, the adverse performance of one investment can be offset by the better performance of others, leading to a smoother overall return and reduced risk. This strategy does not inherently target tax liabilities, transaction costs, or overall returns. While diversification can indirectly influence these aspects—such as potentially reducing transaction costs by holding fewer individual securities—it is primarily focused on managing and mitigating the risks associated with market volatility.

A diversified portfolio aims to reduce market volatility by spreading investments across various asset classes, sectors, and geographic regions. The rationale behind diversification is that different assets react differently to the same economic event or market condition. For instance, while stocks might be performing poorly, bonds or real estate investments could be doing well. By including a variety of investments in a portfolio, the adverse performance of one investment can be offset by the better performance of others, leading to a smoother overall return and reduced risk.

This strategy does not inherently target tax liabilities, transaction costs, or overall returns. While diversification can indirectly influence these aspects—such as potentially reducing transaction costs by holding fewer individual securities—it is primarily focused on managing and mitigating the risks associated with market volatility.