Chartered Financial Analyst (CFA) Level I – Cypress Towne Lake Practice Test

A diversified portfolio is characterized by its composition of a variety of asset types, such as stocks, bonds, real estate, and other investment vehicles. This mix of assets serves to spread risk across different investments, which can help mitigate the potential impact of any single asset's poor performance on the overall portfolio. By holding a variety of assets, investors increase the likelihood that, even if some investments underperform, others may perform well, thereby providing more stability and potentially better returns over time.

This strategy aligns with the fundamental principle of diversification in finance, which aims to reduce unsystematic risk, or the risk specific to an individual asset, by combining various investments that react differently to market conditions. In contrast, portfolios limited to a single type of asset—such as only stocks or only bonds—fail to provide this risk mitigation, making them potentially more volatile and exposed to significant losses.

Thus, the essence of a diversified portfolio lies in its ability to balance and manage risk, providing a more resilient investment strategy over the long term.