What does diversification mean in investment terms?

Diversification in investment terms refers to the practice of spreading investments across various assets to reduce risk. By distributing investments among different asset classes, sectors, or geographic regions, an investor mitigates the impact that a poor performance in any single investment can have on their overall portfolio. This strategy is grounded in the principle that different assets often perform differently under various market conditions, thereby providing a buffer against volatility.

For instance, when some investments are underperforming, others may be doing well, which helps to balance out returns over time. Consequently, diversification can lead to greater stability in an investor's overall portfolio performance, making it a fundamental strategy in risk management.

Investing all funds into a single asset would expose the investor to high risk, as poor performance in that asset would lead to losses without any offsetting performance from other investments. Focusing solely on high-return assets can maximize potential gains but also increases risk, as those investments are likely to be more volatile. Concentrating on international investments may provide opportunities for growth but does not inherently reduce risk associated with portfolio volatility. Therefore, diversification stands out as the most effective method for managing investment risk.