Certified Financial Planner (CFP) Exam 2026 – 400 Free Practice Questions to Pass the Exam

In the context of diversification strategy, the primary goal is to spread investments across various asset classes and sectors to reduce overall risk. A diversification strategy aims to eliminate or mitigate the impact of a poor-performing investment on the overall portfolio by including a variety of investments that respond differently to market conditions.

Investing in a single company does not contribute to the effectiveness of a diversification strategy because it exposes the investor to company-specific risks. If the company underperforms or faces adverse events, the entire investment is negatively impacted without any offset from other investments. This lack of variety concentrates risk rather than spreading it across different assets.

On the other hand, investing in stocks from multiple sectors, real estate investments, and bonds from different issuers each serve to enhance diversification by spreading investments across different categories. This broader approach helps to cushion against losses in any one area, as gains in some investments can help offset losses in others. By including various asset types, an investor can better stabilize their portfolio against fluctuations in the market.