What does diversification help reduce in an investment portfolio?

Diversification is an investment strategy that involves spreading investments across various financial instruments, industries, and other categories to reduce exposure to any single asset or risk. The primary benefit of diversification is its ability to help mitigate systematic risk, also known as market risk. Systematic risk pertains to the inherent risk associated with the entire market or market segment, which cannot be eliminated through diversification alone. However, by investing in a diverse range of assets, the impact of market volatility and economic downturns on the overall portfolio can be lessened, as not all assets will react the same way to market events.

The other types of risks mentioned can be managed through different strategies, but diversification specifically targets the broader market risks associated with investments. Thus, by correctly employing a diversification strategy, an investor can protect their portfolio against downturns in specific sectors of the market, making systematic risk the appropriate answer.