In risk management, what does 'diversification' refer to?

Diversification refers to the practice of spreading investments across various assets to reduce exposure to any single asset, which is why this choice is the correct answer. By investing in a wide range of assets—such as stocks, bonds, real estate, and other investment vehicles—investors can mitigate the impact of poor performance in any one investment. This strategy helps to manage risk because it is unlikely that all asset classes will perform poorly at the same time. Moreover, diversification can enhance potential returns while minimizing overall portfolio risk, leading to a more balanced investment approach.

The other options describe strategies that either do not align with the principles of risk management or are too extreme. For instance, suggesting the elimination of all forms of risk is unrealistic, as all investments carry some level of risk. Focusing solely on high-risk investments contradicts the fundamental principle of risk management because it increases overall exposure and potential losses. Lastly, avoiding investments altogether does not constitute a strategy for managing risk effectively; rather, it eliminates the opportunity for any returns. Thus, diversification is a well-established method for balancing risk and reward in investment portfolios.