Quiz: Portfolio Diversification 4 questions · 80% to pass 1. Diversification reduces risk by:Guaranteeing positive returnsSpreading investments across assets that don't all move in the same directionOnly investing in government bondsHolding cash instead of stocksDiversification works because different asset classes respond differently to economic conditions. When stocks fall, bonds often rise. When US markets decline, international markets may not. Spreading across uncorrelated assets reduces portfolio volatility.2. Correlation between two assets measures:Which asset is more expensiveHow much their prices move together (-1 to +1)Which asset has higher returnsHow risky each asset is individuallyCorrelation ranges from -1 (perfect inverse movement) to +1 (perfect same-direction movement). The best diversification comes from combining assets with low or negative correlation.3. Owning 30 tech stocks provides:Excellent diversificationDiversification within one sector but concentration risk across sectorsNo diversification at allProtection against a tech downturnThirty tech stocks gives you company-level diversification but sector-level concentration. If the tech sector declines (as in 2000 or 2022), all 30 stocks likely fall together. True diversification requires multiple sectors and asset classes.4. Harry Markowitz called diversification 'the only free lunch in investing' because it:Costs nothing to implementReduces risk without proportionally reducing expected returnsGuarantees you never lose moneyEliminates the need for researchMarkowitz's Modern Portfolio Theory proved mathematically that combining uncorrelated assets can reduce portfolio risk more than it reduces expected return. You get risk reduction 'for free' relative to the return you give up. Check answers Retake quiz Back to lesson Next lesson →