If one of your stocks has a relatively high beta of 1.4 and is currently doing exceedingly well, why would you want a stock in your portfolio with a relatively low beta of 0.7 that has been recently under-performing? By diversifying your investments according to betas, have you entirely removed the potential risk of losses due to a declining stock market?
For the first question, the simple answer is that by diversifying your stock holdings, a more conservative approach is taken. A stock with a low beta at 0.7 is somewhat of a higher risk in losses. The tendency in this investment thought is that a recently under-performing stock, the future may hold the opposite, an increase in return. While the 1.4 beta stock has high returns, the potential for losses is greater than in the 0.7 beta stock. Having a myriad of investments in your portfolio can help to weaken the blow when the higher beta stock plummets.
For the second question, only by diversifying your investments due to betas, you have not entirely removed the potential risk of losses due to the decline in the stock market. The definition of risk backs up this claim that truly anything can happen.
If you are relatively risk adverse, would you require a higher beta stock to induce you to invest than the beta required by a person more willing to take risks? Explain. From the investment instruments in the simulation, is it possible to construct a portfolio that is risk free? Explain.
Seemingly, someone more conservative in the risk-taking department would tend to require a lower beta stock. This is explained in detail below, referencing an article on India's beta stock information.