Diversification refers to the act of placing money in an assortment of investment vehicles. The primary goal of diversification is risk reduction, as investing in a single asset or type of asset could prove financially damaging should it lose value. Participating in a variety of options spreads out risk, as the likelihood of all ventures declining in worth at the same time is small.
A diversified portfolio may include investment in stocks, bonds, and short-term investments, while a portfolio that is not diversified may hold investment in only one. During an economic recession, such as the recession of 2008, stock values may drop sharply across the board. In an all-stock portfolio, this can spell financial disaster, while a diversified portfolio might weather the storm better due to the growth of other asset classes such as bonds or short-term investments.
Short-term declines may reverse, with stock prices eventually regaining or exceeding their original values. However, market fluctuations may prove stressful for some people. In the end, even if a diversified portfolio and a portfolio that is not diversified have the same final value, the individual(s) that hold the diversified portfolio may benefit psychologically from lower stress levels as a result of the portfolio’s lower volatility.