Certified Plan Sponsor Professional (CPSP) Practice Exam

Which of the following is a key feature of a diversified portfolio?

1. Similar asset classes

2. Negatively correlated asset classes

3. High-risk investments only

4. Fully allocated to equities

The correct answer is: Negatively correlated asset classes

A diversified portfolio aims to reduce risk and enhance returns by spreading investments across various asset classes. The presence of negatively correlated asset classes is fundamental to this strategy because it helps to mitigate risk and volatility. When asset classes are negatively correlated, their price movements tend to offset each other. For instance, if one asset class declines in value, another may increase, thereby providing a more stable overall performance. In this context, the idea is that by including negatively correlated asset classes, investors can achieve better risk-adjusted returns. This feature is essential in building a portfolio that can withstand market fluctuations and reduce the likelihood of large losses, making it a key principle of diversification. The other choices do not effectively contribute to the idea of diversification. Similar asset classes might lead to higher concentration risk, while focusing solely on high-risk investments or being fully allocated to equities exposes the investor to significant market risk without the benefit of diversification. Thus, having negatively correlated asset classes truly embodies a crucial aspect of a well-diversified portfolio.