Spreading investments across different assets to reduce overall portfolio risk.
Diversification is the investment strategy of spreading money across different asset classes, sectors, geographies, and security types to reduce risk. A diversified portfolio might include U.S. stocks, international stocks, bonds, real estate, and cash. The logic: not all assets move in the same direction; when some decline, others may hold steady or rise. Diversification doesn't eliminate risk (called "unsystematic risk" or idiosyncratic risk), but it smooths out individual investment losses. Too much diversification ("over-diversification") can dilute returns and make portfolios hard to manage, so finding a balance is key. Index funds offer instant diversification, holding hundreds or thousands of securities. Diversification across asset classes, sectors, geographies, and market capitalizations offers the broadest risk reduction.