What is the main purpose of diversification in investing?

The main purpose of diversification in investing is to reduce exposure to collective losses. By spreading investments across a variety of assets—such as stocks, bonds, and real estate—investors can mitigate the risk associated with any single asset or market sector. When one investment performs poorly, others may perform well, helping to balance the overall portfolio performance. This strategy aims to smooth out returns over time and lower the volatility of the investment portfolio, increasing the likelihood of achieving more stable returns.

Investors who choose to place their money solely in one asset might experience significant gains, but also face higher risks, especially if that particular asset declines in value. Diversification protects against these risks because it limits the impact of any one underperforming investment on the total investment performance. Thus, by holding a diverse range of assets, investors can enhance their long-term financial stability and growth potential.