What is the purpose of diversification in investing?

Diversification in investing serves the important function of reducing risk by spreading investments across different assets. This strategy helps investors mitigate the negative impact that the poor performance of any one investment may have on their overall portfolio. By allocating funds into various asset classes—such as stocks, bonds, real estate, and commodities—an investor can achieve a balance where the adverse effects of one investment can be offset by the potential gains in another, ultimately leading to a more stable overall return.

It's essential to recognize that while diversification reduces risk, it does not eliminate it entirely or guarantee returns, making it a prudent approach to managing investment portfolios. This strategy is based on the principle that different assets often perform differently under varying market conditions, which provides a cushion against volatility.