What does diversification in investing mean?

Diversification in investing refers to the practice of spreading investments across a variety of assets to mitigate risk. By allocating funds into different investments—such as stocks, bonds, real estate, and other securities—investors can protect themselves from significant losses that can arise if any single investment or asset class performs poorly. This strategy aims to lower the impact of adverse movements in any one investment, as gains in some areas can help offset losses in others.

For example, if an investor only holds shares of one company and that company's stock decreases in value, the entire portfolio is affected negatively. However, if the investor diversifies their portfolio by including stocks from various sectors, bonds, and other asset types, the overall risk is reduced because the different assets may respond differently to market conditions. This ability to smooth out volatility and protect against significant loss is a core principle of prudent investment strategy.