Diversification primarily reduces which type of portfolio risk?

Diversification primarily reduces issue-specific risk, also known as unsystematic risk, which is the risk associated with a particular company or sector. This type of risk can arise from various factors, such as company management decisions, changes in industry conditions, or events specific to the company, such as a product recall or regulatory changes.

By diversifying a portfolio, an investor can spread their investments across a wide range of assets. This way, the negative performance of any single investment has a reduced impact on the overall portfolio's performance. For example, if one company's stock performs poorly due to an issue unique to that company, the losses can be offset by gains in other investments within the diversified portfolio. This strategy effectively mitigates the risk associated with individual securities.

In contrast, market risk, interest rate risk, and purchasing power risk are types of systematic risk that affect the entire market or economy and cannot be eliminated through diversification. Market risk pertains to factors that affect the overall stock market, such as economic downturns or political instability. Interest rate risk involves changes in interest rates that can affect the value of bonds and other fixed-income securities. Purchasing power risk, on the other hand, relates to inflation and the potential decrease in purchasing power over time.

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