Diversification

Spreading investments across assets to reduce exposure to any single risk.

Diversification is an investment strategy that involves spreading capital across a wide variety of assets, sectors, industries, and geographic regions. The primary goal is to reduce the overall risk of a portfolio by ensuring that the poor performance of any single investment is offset by the stable or positive performance of others. This practice is often summarized by the phrase "don't put all your eggs in one basket." To achieve effective diversification, investors look at how different assets behave relative to one another. By combining assets that have low or negative correlation—meaning they do not move in tandem—investors can smooth out the volatility of their total portfolio. For example, when stock prices fall, bond prices may hold steady or rise, cushioning the overall portfolio from severe losses. While diversification is highly effective at reducing unsystematic risk (the risk specific to an individual company or industry), it cannot eliminate systematic risk, which is the inherent risk of the entire market crashing due to macroeconomic events. A common pitfall for retail investors is over-diversification, sometimes called "diworsification." This occurs when an investor owns so many different assets that they cannot track them effectively, which dilutes their potential returns without providing any additional meaningful risk reduction.

An investor has $10,000 to invest. If they put the entire $10,000 into a single technology stock and that company goes bankrupt, they lose 100% of their capital. Instead, the investor diversifies by putting $2,500 into a technology stock, $2,500 into a healthcare stock, $2,500 into government bonds, and $2,500 into a real estate fund. If the technology stock goes bankrupt and its value drops to $0, the investor still retains the remaining $7,500 in the other three assets, limiting their total portfolio loss to 25% rather than 100%.