What is the main purpose of diversification in investing?

Diversification in investing is primarily aimed at reducing risks by spreading out investments across various assets or asset classes. By diversifying a portfolio, an investor can minimize the impact of poor performance from any single investment. This is because different assets often react differently to market conditions; when some investments are performing poorly, others may be performing well, which helps to stabilize overall portfolio performance.

The core principle behind diversification is that it can lead to a more favorable risk-return profile. This is especially crucial in volatile markets, where relying heavily on a single asset can lead to significant losses. Therefore, by spreading investments among different sectors, geographies, or asset types (such as stocks, bonds, and real estate), investors can achieve more consistent returns over time while reducing the potential for substantial loss.

In contrast, increasing the amount invested, combining different types of insurance, or attempting to maximize returns on a single asset do not effectively address the fundamental goal of risk management through diversification.