Which of the following is the most effective way to maintain a balance between high-risk and low-risk investments in a portfolio?

• A. Diversify your investments across different asset classes based on your risk tolerance.
• B. Change your investment strategy frequently based on short-term market trends.
• C. Allocate all funds to low-risk investments to avoid any losses.
• D. Invest only in high-risk assets to maximize potential returns.

Answer: (A)

Verified step by step guidance

1. Understand the concept of portfolio diversification: Diversification involves spreading investments across various asset classes (e.g., stocks, bonds, real estate) to reduce risk and achieve a balanced portfolio.
2. Evaluate the risk tolerance: Assess your financial goals, investment horizon, and ability to handle potential losses to determine the appropriate mix of high-risk and low-risk investments.
3. Avoid frequent changes based on short-term market trends: Constantly altering your strategy can lead to higher transaction costs and may not align with long-term financial goals.
4. Recognize the drawbacks of extreme strategies: Allocating all funds to low-risk investments may limit growth potential, while investing only in high-risk assets increases the chance of significant losses.
5. Implement a diversified investment strategy: Based on your risk tolerance, allocate funds across different asset classes to balance potential returns and risks effectively.