Which of the following is a common reason investors diversify their portfolios?

Investors typically diversify their portfolios primarily to reduce volatility. Diversification involves spreading investments across a variety of asset classes, industries, and geographic regions. This strategy helps to minimize the impact of poor performance in any single investment or asset class on the overall portfolio.

By holding a mix of different investments, the overall risk is lower because different assets often respond differently to market conditions; when one investment may decrease in value, another may increase, balancing out the potential losses. This reduction in volatility leads to more stable returns over time, which is particularly important for long-term investors who seek to preserve their capital and reduce the unpredictability of their investment outcomes.

Maximizing short-term gains often involves higher risk and is not consistent with the foundational principle of diversification, which is aimed at stability. Concentrating investments in specific sectors can lead to higher risk, as poor performance in that sector could significantly impact the portfolio. Similarly, increasing risk runs counter to the purpose of diversification, which is fundamentally about achieving a more balanced and less volatile investment approach.