Portfolio diversification simply means not putting all your investment ‘eggs in one basket’. Every investment carries risks and is subject to potential unforeseen changes. No investment, not even government bonds, is ever completely safe. If your portfolio is narrowly invested (e.g. in a limited number of assets), then an unexpected change in conditions affecting those assets could have a drastic impact on your returns. However, if your investment ‘eggs’ are spread across a wide variety of asset ‘baskets’, each with different characteristics and profiles, then the risk of your portfolio being impacted by inevitable change will be reduced.
This is because the negative performance of some investments will tend to be offset by the positive performance of others. Over the longer term, the entire portfolio will be expected to yield higher and less volatile average returns.
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