What is one reason an investor might consider adding high-grade bond funds to their portfolio?

• A. To maximize short-term capital gains
• B. To gain exposure to highly volatile assets
• C. To avoid earning any interest income
• D. To reduce overall portfolio risk through diversification

Answer: (D)

Verified step by step guidance

1. Understand the concept of portfolio diversification: Diversification involves spreading investments across different asset classes to reduce overall risk. High-grade bond funds are considered less risky compared to stocks or other volatile assets.
2. Recognize the characteristics of high-grade bond funds: These funds invest in bonds with high credit ratings, which are less likely to default and typically provide stable interest income.
3. Analyze the role of high-grade bond funds in a portfolio: Adding these funds can balance the risk associated with more volatile investments, such as stocks, thereby reducing the overall portfolio risk.
4. Evaluate the incorrect options: High-grade bond funds are not typically used to maximize short-term capital gains or gain exposure to highly volatile assets. They also do not avoid earning interest income; instead, they provide steady interest income.
5. Conclude why the correct answer is diversification: By including high-grade bond funds, an investor can achieve a more balanced portfolio, reducing risk and ensuring stability, which aligns with the principle of diversification.