In an investment context, what is diversification?

Diversification in an investment context refers to the strategy of spreading investments across various assets to reduce risk. By diversifying a portfolio, an investor can avoid putting all their capital into a single asset or asset type, which helps mitigate the impact if one investment performs poorly. This approach allows an investor to take advantage of the performance of different asset classes, such as stocks, bonds, real estate, and commodities, which may respond differently to market conditions.

When various investments are included in a portfolio, the overall risk becomes more balanced because the performance of different assets can counteract one another. For instance, if one asset class suffers a decline, another may appreciate, softening the blow on the investor's total portfolio.

Risk management is a key reason for diversification, as it aligns with the fundamental investing principle that not putting all your eggs in one basket helps maintain stability and potential positive returns over the long term. Consequently, the idea of spreading investments can lead to a more resilient investment strategy overall, making it pivotal for any informed investor.