Final answer:
To reduce risk in a portfolio, it is best to combine stocks with negatively correlated returns, which balance each other out. Diversification across various investments, such as through an index fund, is also crucial for risk management.
Step-by-step explanation:
In the context of portfolio theory, to reduce overall risk, stocks with returns that are negatively correlated should be combined in a portfolio. This means that when one stock's return goes up, the other's tends to go down, and vice versa, thereby stabilizing the portfolio's performance. Diversification is a key investment strategy that involves investing in a range of companies to mitigate the risks associated with any single investment. An index fund, a type of mutual fund, is an example of a diversified investment that seeks to track the overall performance of the stock market.