What is diversification in investing?

Diversification in investing refers to the strategy of spreading investments across various assets to reduce overall risk. By diversifying, an investor can mitigate the impact of a poor performance from any single investment. If one asset underperforms, others may perform well, which balances the overall returns and reduces volatility in a portfolio.

This strategy is a fundamental principle in portfolio management because it aims to optimize the risk-return profile of the investment portfolio. For example, an investor might include stocks, bonds, real estate, and commodities in their portfolio. This variety can help protect against market downturns and unexpected events that might negatively affect a particular industry or asset class.

Investors employ diversification to ensure that their portfolios are not overly reliant on any one investment, which enhances the likelihood of achieving more stable returns over time.