What does "diversification" mean in investment strategy?

Diversification in an investment strategy refers to the practice of spreading investments across various assets or asset classes to reduce overall risk. By doing so, an investor aims to minimize the impact of any single investment's poor performance on the overall portfolio. This is based on the principle that different assets often behave differently under varying market conditions. For instance, if one asset class is performing poorly, others may be doing well, thereby balancing out the returns and mitigating potential losses.

In contrast, investing all funds in one asset can lead to higher risk because the entire portfolio is vulnerable to the performance of that single asset. Similarly, buying stocks only in emerging markets exposes an investor specifically to those economies, increasing risk through lack of diversification. Lastly, focusing solely on government bonds limits the potential for returns and does not provide the safety net that comes from a diversified portfolio. The aim of diversification is to achieve a more stable return on investment over time by leveraging the different performance patterns of various assets.