Final answer:
The correct fill-in-the-blank answer is 'different' and 'steady,' implying that a diversified portfolio with investments that have varied returns is typically more stable over time. This reflects the principle of diversification in investment, where spreading risk across different asset types results in a smoother return trajectory.
Step-by-step explanation:
The question asks to fill in the blanks regarding the relationship between the diversity of returns in individual investments within a portfolio and the volatility of the portfolio's returns over time.
The correct answer is: The more different the returns of individual investments in a portfolio, the more steady the portfolio's returns are over time. This is because diversification spreads out the risks associated with individual investments.
The opposite is also true; similar or positively correlated investments will make the portfolio more volatile, as they are likely to move in the same direction at the same time.
Understanding why diversification affects volatility helps to comprehend the risk-return trade-off in investments. Stocks, which are generally more volatile, tend to offer higher returns than bonds, and bonds typically offer higher returns than a savings account.
However, stocks exhibit greater volatility in value, as evidenced by fluctuations in the S&P 500 in subsequent years, such as a 26% increase in 2009 after a 37% decline in 2008.
Bonds are affected by interest rates and thus, their value varies but usually less dramatically than stocks, while savings accounts change very little.
These statements highlight the misconception that high-risk investments must have low returns. Instead, it is generally accepted that higher risk is associated with the potential for higher returns. This concept is fundamental when considering investment strategy and portfolio management.