Portfolio Management and Diversification Flashcards

What is diversification in investing?

Answer: Spreading investments across different asset classes to reduce risk

Diversification involves spreading investments across various asset classes, sectors, and geographies to reduce the impact of any single investment's poor performance on the overall portfolio.

What is asset allocation?

Answer: The strategy of distributing investments among asset categories like stocks, bonds, and cash

Asset allocation is the process of dividing a portfolio among major asset categories such as stocks, bonds, and cash equivalents based on an investor's goals, risk tolerance, and time horizon.

What does rebalancing a portfolio mean?

Answer: Adjusting the portfolio back to its target asset allocation after market movements shift the proportions

Rebalancing restores a portfolio to its intended asset allocation by selling overweighted assets and buying underweighted ones after market fluctuations alter the original proportions.

What is systematic risk?

Answer: Market-wide risk that affects all investments and cannot be diversified away

Systematic risk, also called market risk, affects the entire market or a large segment of it and cannot be reduced through diversification — examples include recessions and interest rate changes.

What is the Sharpe ratio used for?

Answer: Measuring a portfolio's return relative to its risk, showing risk-adjusted performance

The Sharpe ratio measures the excess return earned per unit of risk (standard deviation), helping investors evaluate whether a portfolio's returns justify the risks taken.

What is dollar-cost averaging?

Answer: Investing a fixed dollar amount at regular intervals regardless of market price

Dollar-cost averaging involves investing a consistent dollar amount at regular intervals, automatically buying more shares when prices are low and fewer when prices are high.