What is the term for spreading investments across different asset types to reduce risk?

• A. Diversification
• B. Asset Allocation
• C. Hedging
• D. Speculation

Answer: (A)

Diversification is spreading investments across different asset types to reduce risk. The idea is that different assets don’t all move in lockstep, so when some holdings dip, others may hold steady or rise, smoothing overall performance. This targets unsystematic risk—the risk tied to a specific company, sector, or asset—while leaving market-wide risk (systematic risk) intact. For example, mixing stocks, bonds, and cash or other assets can cushion the portfolio if stock markets slump, since bonds or cash often behave differently in those times.

Asset allocation, while related, focuses on the overall balance among broad asset classes to achieve a desired risk–return profile, but it’s not the same as diversification within the portfolio. Hedging involves protective strategies to offset risk using instruments like derivatives. Speculation involves taking on higher risk in hopes of higher returns rather than reducing risk.