DECA Financial Consulting Complete Practice Exam

Diversification reduces investment risk by spreading investments across various asset classes. This approach helps mitigate the impact of any single investment's poor performance on the overall portfolio. When an investor diversifies, they allocate funds to different types of investments—such as stocks, bonds, real estate, and commodities—each of which may react differently to market conditions.

For instance, if one asset class underperforms due to economic downturns, other asset classes may remain stable or even gain value, balancing out potential losses. This strategy helps create a more stable investment return over time, as the volatility associated with any single investment is less likely to affect the entire portfolio significantly. Essentially, by having a mix of investments, an investor can safeguard against the risk of significant financial loss.

This method contrasts with other options that focus on concentrating investments, limiting exposure to just one type of security or asset class, which would leave the investor more vulnerable to market fluctuations affecting that particular segment. By diversifying, investors can optimize their chances of achieving their financial goals while minimizing risk.