Understanding Portfolio Diversification Impact on Risk and Return

Investors are constantly seeking strategies to minimize risk while maximizing returns in their portfolios. A key concept in portfolio management is diversification, which involves spreading investments across a range of assets. This strategy is based on the premise that a varied portfolio will yield a better risk-return profile than investing in a single asset class.

Consider an investment advisor who is constructing a diversified portfolio for a client with a medium risk tolerance. The advisor suggests a combination of stocks, bonds, and real estate. Each asset class has its own risk-return characteristics, and their performance can be influenced by different economic factors. However, the advisor emphasizes that while diversification can reduce risk, it does not eliminate it entirely.

Which of the following statements best describes the impact of portfolio diversification on risk and return?