Final answer:
The largest reduction in a portfolio's risk is achieved when the number of stocks is increased from 1 to 10. Diversification helps mitigate the volatility associated with individual stocks, and history has shown that high levels of concentrated risk can be detrimental, as seen in the 2008 financial crisis.
Step-by-step explanation:
The largest reduction in a portfolio's risk is typically achieved when the number of stocks in the portfolio is increased from 1 to 10. This initial stage of diversification greatly reduces the unsystematic risk, which is the risk specific to individual stocks or sectors. Adding more stocks to the portfolio beyond this range continues to provide benefits, but the impact on risk reduction becomes smaller as more stocks are added.
Diversification is an essential strategy in portfolio management. It helps mitigate the risks associated with individual securities. Someone can purchase stocks through brokerage accounts, which can be found at various financial institutions or online platforms. By spreading investments across various sectors and industries, the investor's exposure to any single security's volatility is reduced. This is partly why diversification is so vital for the long-term health of an investment portfolio.
Historically, high levels of concentrated risk have proven detrimental during market downturns. For example, during the 2008 financial crisis, average U.S. stock funds declined by 38%, significantly impacting those who lacked diversified portfolios, particularly those nearing retirement. In contrast, younger investors with a longer time horizon can often afford to take on more risk in anticipation of higher long-term returns.