Diversification
An investment strategy that spreads risk by allocating capital across different asset classes, sectors, geographies, and securities. It aims to reduce the impact of any single investment's poor performance.
Diversification is often called the only "free lunch" in investing. By holding a mix of assets that don't all move in the same direction at the same time, you can reduce portfolio volatility without proportionally reducing expected returns.
Levels of Diversification
- Within asset classes — Holding many stocks rather than just a few
- Across asset classes — Combining stocks, bonds, real estate, and commodities
- Across geographies — Including domestic and international investments
- Across time — Using dollar-cost averaging to spread purchase timing
Diversification reduces unsystematic risk (the risk specific to individual companies or sectors) but cannot eliminate systematic risk (broad market risk). A well-diversified portfolio typically holds assets with low correlation to each other. To learn how to structure a diversified portfolio, see our asset allocation guide.