What strategy is typically employed to manage investment risk?

Managing investment risk effectively often involves the strategy of asset allocation into various asset categories. This approach involves spreading investments across different asset classes such as stocks, bonds, real estate, and cash, which can help reduce the overall risk of the investment portfolio. By diversifying investments in this manner, an investor can minimize the impact of poor performance in any single asset category, as other categories may perform well and provide a buffer against losses.

This diversification is crucial because different assets tend to respond differently to market conditions. For example, when the stock market is down, bonds might perform better as investors seek safer investments. Thus, a balanced portfolio that includes a mix of asset types can enhance stability and reduce volatility, making it a foundational principle of prudent risk management in investing.