What is diversification in investing?

Diversification in investing refers to a risk management strategy that involves mixing a variety of investments within a portfolio. The primary goal of diversification is to reduce the overall risk by not putting all of your eggs in one basket. By spreading investments across different asset classes, sectors, or geographical areas, the impact of a poor-performing investment is mitigated by the performance of others that might be doing well. This balance can lead to more stable returns over time, as the various investments may respond differently to market changes.

The concept emphasizes the importance of variety in an investment portfolio, which helps to protect against significant losses. When market conditions negatively affect one type of investment, others in different categories can offset these losses, thus promoting a healthier and more resilient investment strategy. This approach is particularly valuable in volatile market environments, where certain sectors may experience sharp declines while others thrive.

In contrast, focusing on a single type of investment would increase risk significantly, as it leaves the investor vulnerable to downturns specific to that investment type. Strategies or policies aimed at minimizing returns or mandating high returns do not align with the underlying principle of diversification, which is to balance risk and reward through a thoughtful mixture of investments.