Diversification
The practice of spreading investments across different assets, sectors, and geographies to reduce the impact of any single investment's poor performance.
Diversification is the only "free lunch" in investing — it reduces risk without necessarily reducing expected returns. By holding assets that don't move in perfect correlation (stocks and bonds, domestic and international, large and small companies), losses in one area are often offset by gains in another. However, diversification doesn't eliminate all risk — during severe market crises, correlations tend to increase. The simplest way to diversify is through broad-market ETFs or index funds. Over-diversification (holding too many similar funds) can increase costs without meaningful risk reduction.
Example
An investor holding only tech stocks would have lost 33% in 2022. A diversified portfolio (global stocks + bonds + real estate) might have lost only 15% in the same period.
Related terms
Asset Allocation
The strategy of dividing investments among different asset classes — stocks, bonds, real estate, cash — to balance risk and return according to your goals and risk tolerance.
ETF (Exchange-Traded Fund)
A fund that holds a basket of assets (stocks, bonds, or commodities) and trades on a stock exchange like an individual stock.
Portfolio Rebalancing
The process of realigning portfolio weights back to a target allocation by selling overweight assets and buying underweight ones.