Question

A financial planner is examining the portfolios held by several of her clients. Identify which of the following portfolios is likely to have the smallest standard deviation: A portfolio containing Microsoft, Apple, and Google stock A portfolio containing only Microsoft stock A portfolio consisting of about three randomly selected stocks from different sectors

Answer 1

Answer:

The answer is A portfolio consisting of about three randomly selected stocks from different sectors.

Explanation:

Standard deviation simply means the amount or the percentage that the portfolio may change in response to a shift in the market.

The best way to have a small standard deviation is by investing in different sectors rather than in one sector. This strategy is called diversification and it's a great way to mitigate risk.

Answer 2

Answer:

C. A portfolio consisting of about three randomly selected stocks from different sectors

Explanation:

Standard deviation helps measure risks. It determines market volatility or the spread of asset price from their average price. When the volatility of prices are rapid, standard deviation becomes high which in turn means investment is risky and vice versa. Diversification of investment tend to reduce risk. A portfolio containing a diversified randomly selected stock from three sectors would have a lower standard deviation (risk) than the other portfolios stated in the question.

Diversification is a form of risk management.