Certified Plan Sponsor Professional (CPSP) Practice Exam

According to modern portfolio theory, which portfolio is considered diversified?

1. A portfolio invested solely in stocks.

2. A portfolio invested equally in stocks, bonds, and cash.

3. A portfolio focused exclusively on international investments.

4. A portfolio that only includes cash assets.

The correct answer is: A portfolio invested equally in stocks, bonds, and cash.

A portfolio invested equally in stocks, bonds, and cash is deemed diversified according to modern portfolio theory. This theory posits that risk can be reduced through diversification, where different asset classes typically respond differently to market conditions. By holding a mix of asset types—equities, fixed income, and cash—investors can minimize the impact of any single investment's poor performance on the overall portfolio. In comparison to other choices, a portfolio solely invested in stocks lacks the risk-mitigating benefits that come from including bonds and cash, which can provide stability and reduce volatility. A portfolio focused exclusively on international investments similarly does not achieve diversification across different asset classes and could be subject to specific geopolitical or economic risks. Lastly, a portfolio that consists only of cash assets does not take advantage of potential returns from investments in other classes, which are necessary for growth. By incorporating a balanced mix of assets, the portfolio in question achieves a level of risk-adjusted return that is aligned with the principles of modern portfolio theory.