How is "diversification" defined in an investment portfolio?

Diversification in an investment portfolio is defined as the practice of spreading investments across various assets to reduce risk. This strategy aims to minimize the impact of poor performance in any one investment or asset class on the overall portfolio. By holding a mix of different types of assets—such as stocks, bonds, real estate, or commodities—investors can manage their risk more effectively. If one asset performs poorly, others that may perform well can help offset the loss, thereby creating a more stable return over time.

This concept is fundamental in investment strategy, as it acknowledges the inherent uncertainties in the market. Diversification does not eliminate risk entirely, but it can significantly lower the chances of a major financial setback. In contrast to concentrating investments in a single type of asset, which could lead to higher risk and volatility, diversification encourages a balanced approach to portfolio management. This helps investors navigate market fluctuations with greater confidence.