Diversification Definition

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on January 11, 2021

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?

Investors looking to diversify their portfolios often first decide on a mix of asset classes, such as stocks, bonds, real-estate, ETFs, commodities, and currencies.

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

Diversification is a risk mitigation strategy in investing that involves mixing a broad variety of investments within a portfolio.
Investors looking to diversify their portfolios often first decide on a mix of asset classes, such as stocks, bonds, real estate, ETFs, commodities, and currencies.
Diversified portfolios are constructed of different kinds of assets that will yield higher average long-term returns and reduce the risk associated with any individual holding or security.
A drawback of diversification is that by mitigating risk, diversified portfolios also mitigate reward.