Define Diversification in Simple Terms
Diversification is a risk mitigation strategy in investing that involves mixing a broad variety of investments within a portfolio.
The investments are uncorrelated with each other, meaning that they respond in opposing ways to changes in the overall market.
The idea behind this technique is that portfolios constructed of different kinds of assets will yield higher average long-term returns and reduce the risk associated with any individual holding or security.
Diversification in Finance
They then decide on a mix of investments within each class.
Investors may also diversify by buying foreign stocks, which can provide a cushion in case of a downturn in their domestic stocks.
Drawbacks of Diversification
A drawback of diversification is that by mitigating risk, diversified portfolios also mitigate reward.
As such, investors must curate their portfolio carefully so that their opposing stocks provide a parachute during downturns but do not become an anchor during upturns.
Diversification Definition FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.