What does diversification in an investment portfolio aim to achieve?

Diversification in an investment portfolio primarily aims to reduce risk by spreading investments across various assets. This strategy is based on the principle that different assets often react differently to the same economic event. By holding a mix of asset types—such as stocks, bonds, real estate, and commodities—investors can mitigate the impact of poor performance in any single investment or asset class on their overall portfolio.

For instance, if one asset class, like technology stocks, performs poorly due to market downturns, other asset classes, such as bonds or consumer staples, might perform better or remain stable. This balance helps to smooth out the overall volatility of an investment portfolio, leading to a more stable return over time.

Focusing on just one asset class would expose the investor to higher risk, as all their investments would be affected by the same fluctuations. While enhancing liquidity and seeking high returns are important considerations in investing, they do not encompass the primary goal of diversification, which is risk reduction.