Certified Plan Sponsor Professional (CPSP) Practice Exam

Why is it important to maintain a diversified investment menu in retirement plans?

1. To concentrate investments in high-return areas

2. To reduce risk associated with market volatility

3. To fulfill legal requirements of plan sponsors

4. To outperform competitors' investment options

The correct answer is: To reduce risk associated with market volatility

Maintaining a diversified investment menu in retirement plans is vital primarily because it helps reduce risk associated with market volatility. Diversification involves spreading investments across various asset classes, sectors, and geographic regions, which can mitigate the potential adverse effects that a downturn in any single investment or market might have on the overall portfolio. When a plan offers a variety of investment options, participants can select those that align with their risk tolerance and investment goals. By diversifying, individuals can protect their retirement savings from significant losses that might occur if they were solely invested in a single asset or strategy that experiences a decline. This approach acknowledges that markets can be unpredictable, and no one can perfectly time market movements. Therefore, a diversified investment menu not only contributes to stability but also enhances the potential for long-term growth by balancing higher-risk investments with more conservative options. The essence of diversification is rooted in the principle that a well-rounded investment spread can lead to more consistent returns over time, ultimately supporting the financial security of retirement plan participants.