What does "diversification" in investing mean?

Diversification in investing refers to the practice of spreading investments across various financial instruments, sectors, or geographical locations to reduce overall risk. The rationale behind diversification is that different assets react differently to the same economic event; therefore, if one investment performs poorly, others in the portfolio might perform well, balancing out potential losses. By diversifying, an investor can potentially minimize the impact of volatility and achieve a more stable return over time.

Choosing to invest in only one type of asset would significantly increase risk because it lacks this protective measure against market fluctuations. Similarly, concentrating investments in high-risk stocks or placing all funds in bonds creates an imbalance that fails to leverage the potential benefits of diversification. Thus, the strategy of spreading investments is fundamental for building a resilient portfolio.