Advanced Diploma of Financial Planning (ADFP) Practice Test

What differentiates defensive stocks from cyclical stocks?

1. Defensive stocks lead to guaranteed profits

2. Defensive stocks are not influenced by economic cycles

3. Defensive stocks perform better in recessions

4. Defensive stocks have higher volatility

The correct answer is: Defensive stocks are not influenced by economic cycles

Defensive stocks are characterized by their performance that remains relatively stable regardless of the fluctuations in the broader economy. These stocks typically belong to companies that provide essential goods and services, such as utilities, healthcare, and consumer staples, which consumers continue to purchase even during economic downturns. This inherent stability is what differentiates them from cyclical stocks, which tend to follow the economic cycle closely and are significantly affected by economic conditions. By focusing on non-discretionary spending, defensive stocks demonstrate less sensitivity to economic upturns and downturns, making them a safer investment in times of economic uncertainty. This lack of influence from economic cycles is the key aspect that sets defensive stocks apart. The other options do not accurately capture the essence of defensive stocks. While defensive stocks often perform better during recessions, stating that they guarantee profits misrepresents the reality of market risks. Additionally, defensive stocks are generally characterized by lower volatility, contrary to the notion that they exhibit higher volatility.