What is the main purpose of diversification in investing?

Diversification in investing primarily serves to mitigate risk by spreading investments across a variety of assets. This strategy is based on the principle that different asset classes often perform differently under varying market conditions, which can buffer the overall portfolio from significant losses. By holding a mix of investments—such as stocks, bonds, and real estate—an investor can reduce the impact of a poor-performing asset or sector.

For instance, if one sector of the market experiences a downturn, investments in other sectors may still perform well, thus stabilizing the overall portfolio's performance. This balance helps to manage volatility and can lead to more consistent returns over time. Thus, diversification is fundamentally about managing risk rather than solely seeking high returns or concentrating funds in a single area or asset type.