What is a common misconception regarding diversification in investment?

Investing in one asset class reduces risk is a common misconception because it overlooks the fundamental principle of diversification, which aims to spread risk across different types of investments. By concentrating on a single asset class, an investor may expose themselves to significant volatility and risk associated with that particular class. For instance, if an investor only puts money into stocks, they are vulnerable to market downturns specifically affecting that sector.

In contrast, investing in multiple asset classes—such as stocks, bonds, real estate, and cash—can indeed mitigate risk. The rationale is that different asset classes often perform differently under varying economic conditions, thus providing a buffer against losses.

Furthermore, the idea that diversification applies solely to equities can mislead investors into thinking diversification efforts should be limited to stock investments. In reality, proper diversification encompasses a broad selection of asset types to achieve a more robust risk management strategy.

The notion that all investments are equally risky fails to recognize that various asset classes have different risk-return profiles, and the level of risk can vary widely among them. Understanding that probability can lead to more strategic investment choices aligns with the true concept of diversification in a well-rounded investment portfolio.