What does the term diversification refer to in investment strategy?

Diversification refers to the investment strategy of spreading investments across various assets in order to reduce risk. By diversifying a portfolio, an investor mitigates the impact of a poor performing asset on the overall performance of the portfolio. This tactic takes advantage of the principle that different asset classes often respond differently to the same economic event or market conditions.

For instance, if one asset class, like stocks, experiences a downturn, another class, such as bonds or real estate, may not be affected as severely or could even perform well during that period. Thus, the overall risk is lowered because the performance of the entire investment portfolio is not solely reliant on a single asset. This approach is widely recognized as a fundamental principle of investing, emphasizing the importance of a diversified portfolio to achieve better risk-adjusted returns over time.