Which of the following is a true statement about diversification?

Which of the following is a true statement about diversification?

A) Diversification allows you to eliminate all risks when investing in stocks.

B) The more correlated the stocks in your portfolio are, the more diversified you are.

C)The more correlated the stocks in your portfolio are, the less diversified you are.

D) The diversification benefits of adding a stock to your portfolio are the same if you own 2 stocks or 100 stocks.

Answer: C)The more correlated the stocks in your portfolio are, the less diversified you are.

Diversification is one of the risk management principles that minimizes risks associated with investment by investing in a system that comprises several assets or securities of different commodities. :Diversification is useful in minimizing an overall portfolio risk, given that the returns of the portfolio will not be as badly affected by a bad performing security.

Since the fundamental notion of utilizing diversified assets is to reduce the tendency for the stocks to move in the same direction, lack of diversification is evident when there are high stock correlations. This is because that one particular stock may perform poorly or well and the same can happen with the other stocks that are related to it and any risk diversifications are minimal. On the other hand, when the individual stocks in the portfolio have low or negative correlation, the portfolio becomes more and more diversified as the gains in one stock may be offset by the losses in the other, thereby reducing the general risk of the portfolio.