What does it mean to have a diversified portfolio?

Having a diversified portfolio means that an individual holds a mix of different types of investments, which helps manage risk. Diversification involves spreading investments across various asset classes, such as stocks, bonds, real estate, and other financial instruments. This strategy is based on the principle that different assets respond differently to market changes; when some investments perform poorly, others may perform well. By doing so, the overall risk of the portfolio is reduced, as the chances of experiencing significant losses from any single investment are minimized.

This approach is particularly important for investors looking to achieve a balance between risk and return, allowing them to reduce volatility in their investment outcomes. A well-diversified portfolio is essential for long-term investment success, as it provides a cushion during market downturns, resulting in a more stable return on investment over time.

In contrast, concentrating investments in a few high-risk assets limits diversification and raises potential risk. A portfolio containing only stocks does not benefit from the risk reduction that comes from investing in different asset types. Focusing solely on assets with the highest returns can lead to significant risk exposure without considering the potential for losses, which is contrary to the principles of sound financial management.