Diversification is a way to minimize investment risk by spreading your investments amongst different financial vehicles such as real estate, stocks, bonds, foreign currency and mutual funds.
Diversification helps maximize investment return and minimize volatility on investment returns through asset allocation.
What is asset allocation?
Asset allocation is the process in which we decide how we allocate our investment funds in different asset classes or investment vehicles in order to increase potential returns. Ideally we want our investments to be negatively correlated so if one is going down then one is also going up.
What is volatility?
Volatility is a measure of the ups and downs of an investment. In more simple terms volatility is a measure of how far up or down the value of an investment moves. Some assets are more volatile than others. Example stocks are more volatile than bonds.
To decrease volatility we must diversify our investment portfolio across multiple investment vehicles.
Whilst diversification cannot stop volatility or risk it does soften their effects in a scenario our investments fail or lose value significantly.