What is the purpose of diversification across asset classes?

• A. Diversification guarantees high returns.
• B. It reduces overall risk by avoiding reliance on a single asset's performance.
• C. It concentrates investments in one sector.
• D. It eliminates all risk.

Answer: (B)

Diversification across asset classes aims to lower risk by avoiding dependence on how a single type of asset performs. Different asset classes—stocks, bonds, cash equivalents, real estate, and commodities—don’t move in lockstep. When one class underperforms, others can help cushion the decline, leading to more stable, smoother returns over time. It’s about balancing potential growth with risk management, not guaranteeing high returns. It also can’t eliminate all risk, and it’s not about concentrating in one sector, but spreading exposure across distinct types of assets to reduce vulnerability to any single market event.