Final answer:
To reduce investment risk, one should choose stocks with low positive correlation over those with high positive correlation, which helps in diversifying a portfolio and mitigating risk. Understanding the relation between stock returns is key to successful long-term investing, especially for younger investors who can bear more risk for potentially higher returns.
Step-by-step explanation:
To reduce your risk in stock market investments, you should select stocks whose returns exhibit a low positive correlation rather than a high positive correlation. When stocks have a low positive correlation, the rate of return on these stocks tends to move independently, meaning if one stock's return falls, it doesn't necessarily impact the other, thereby reducing the overall risk in your portfolio. On the other hand, stocks that are highly positively correlated tend to move in the same direction – if one goes down, the others are likely to follow, which can increase risk.
Correlation refers to how closely the returns of two stocks move together. By investing in stocks with a low positive correlation, an investor can better diversify their portfolio, which is a common strategy to mitigate risk. For young workers who have a longer time horizon, taking on more risk by investing in stocks might make sense since they can typically expect a higher return over several decades as the market fluctuates and eventually evens out. In contrast, a person nearing retirement might prefer investing in assets with lower risk and more certainty about income.