Question

Which kind of stock would you expect to pay the higher average return: stock in an industry that is very sensitive to economic conditions (such as an automaker) or stock in an industry that is relatively insensitive to economic conditions (such as a water company)? Why?

Answer 1

If one has to buy a portfolio of stocks it is good idea to buy a diversified portfolio of different companies from different industries and located in different countries so that the poor performance of a single company or in an entire industry can be avoided and firm specific risks and market risks can be avoided.

It is a good idea to invest in different countries too because a slowdown of an economy will affect all the industries, all companies will experience low sales. Low profits and low stock prices, therefore to ensure a safe investment it is better to invest elsewhere in other countries as well.

In stock buying one should not put all the eggs in the same basket, higher returns come with higher risks therefore it is better to go for regular returns with lower risks.

Diversification reduces the risks although it does eliminate it.