Final answer:
The correct answer is option b. Diversification.
Step-by-step explanation:
The basis of any investment policy should involve several key principles to ensure a balanced approach to risk management and potential growth. The principles include:
- Prudence: This involves making decisions with careful consideration of risks and avoiding speculative investments that could endanger the capital.
- Diversification: This principle advises spreading investments across different asset classes and sectors to mitigate risks associated with any single investment.
- Preservation of Capital: This focuses on protecting the initial investment amount.
While aiming for investment returns greater than the S&P 500 is an ambitious goal, it is not a fundamental principle of investment strategy as it focuses solely on performance benchmarks without necessarily taking into account the level of risk involved.
Diversification is crucial because it helps to spread risk across different investments. When you diversify, you reduce the impact of poor performance from any single investment.
Mutual funds are an example of an investment tool that inherently applies the principle of diversification. By pooling together money from many investors to buy a broad portfolio of stocks or bonds, mutual funds offer a convenient way to achieve diversification easily.