In finance, what does "diversification" mean?

Diversification refers to the strategy of spreading investments across a variety of financial instruments, sectors, or asset classes to reduce overall investment risk. The fundamental principle behind diversification is that by not putting all investment capital into a single asset or type of asset, an investor can mitigate the impact of poor performance in any one investment. If one investment performs poorly, it may be offset by the performance of others that are doing well, thus balancing the overall risk and enhancing potential returns.

This approach is crucial in the field of finance because it helps to cushion against market volatility and unexpected events that can affect certain sectors more than others. For instance, if an investor only invests in tech stocks and the tech industry suffers a downturn, their portfolio could face significant losses. However, if they have diversified their portfolio to include stocks from various industries, bonds, real estate, and other assets, the negative impact of a downturn in tech could be softened by gains in other areas.

The other options depict practices that do not align with the concept of diversification; they either focus on concentration and risk assessment strategies, which do not contribute to the risk-reducing benefits that diversification provides.