DIVERSIFICATION
Back to GlossaryDefinition
Reducing risk by holding a variety of assets whose returns are not perfectly correlated.
Summary
Diversification is a fundamental risk management strategy that follows the principle 'don't put all your eggs in one basket.' By spreading investments across different types of assets, industries, or geographic regions that don't move in perfect sync with each other, investors can reduce the overall volatility of their portfolio. When one investment performs poorly, others may perform well, helping to smooth out returns over time. The key is that the assets must have low correlation - meaning they don't all rise and fall together.
Usage Context
Essential when learning about portfolio construction, risk management strategies, investment planning, and understanding the trade-off between risk and return in financial markets.
Common Confusions
- Thinking that owning many stocks automatically equals good diversification
- Believing diversification eliminates all investment risk
- Confusing diversification with asset allocation
- Assuming that more investments always means better diversification
- Not understanding that diversification works best during normal market conditions
