You are a risk-averse investor with a low-risk portfolio of bonds. How is it possible that adding some stocks (which are riskier than bonds) to the portfolio can lower the total risk of the portfolio?

Answer 1

Bonds and stocks have a low correlation. In some economic environments, stocks do well and bonds do not. During other times, bonds do better. Adding a small portion of stocks to a bond portfolio can actually decrease the volatility of the portfolio.