What does 'diversification' refer to in investment strategy?

Diversification in investment strategy refers to the practice of spreading investments across various assets. This approach is designed to reduce risk by investing in a diverse array of securities, such as stocks, bonds, real estate, and other asset classes. The fundamental idea is that a well-diversified portfolio will yield higher returns with a lower risk compared to one that heavily concentrates investments in a single asset or type of asset.

By holding a variety of investments, an investor can mitigate the adverse effects of poor performance from any single investment. For example, if one sector of the market experiences a downturn, other investments in the portfolio might perform well and help offset those losses. This balanced approach is a cornerstone of effective investment management, as it recognizes the unpredictability of markets and aims for a more stable overall performance.