In finance, diversification means reducing risk by investing in a variety of assets.

If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituent. [1] Therefore, any risk-averse investor will diversify to at least some extent, with more risk-averse investors diversifying more completely than less riskaverse investors. Diversification is one of two general techniques for reducing investment risk. The other is hedging. Diversification relies on the lack of a tight positive relationship among the assets' returns, and works even when correlations are near zero or somewhat positive. Hedging relies on negative correlation among assets, or shorting assets with positive correlation.

portfolio diverfication Portfolio diversification is the means by which investors minimize or eliminate their exposure to company-specific risk, minimize or reduce systematic risk and moderate the short-term effects of individual asset class performance on portfolio value. In a well-conceived portfolio, this can be accomplished at a minimal cost in terms of expected return. Such a portfolio would be considered to be a well-diversified.

Although the concepts relevant to portfolio diversification are customarily explained with respect to the stock markets, the same underlying principals apply to all types of investments. For example, corporate bonds have specific risk that can be diversified away in the same manner as that of stocks.

Eliminate Specific Risk and Minimize Systematic Risk

As was explained in Investment Risk and Return, it is assumed that all investors are rational and will therefore hold portfolios that are diversified to the point where specific risk has virtually been eliminated and their only exposure to risk is to that which is inherent in the market itself. Thus, the residual risk of a portfolio should be equal to market risk, a.k.a. systematic risk, and systematic risk can be reduced by investing over a broader market, i.e., a larger universe. International diversification provides a good example of the effects of

diversifying across asset classes. A portfolio invested 50% in domestic largecap stocks and 50% in international large-cap stocks would have approximately half the residual risk of a portfolio comprised solely of domestic large-cap stocks, assuming that the investments in each market were sufficiently diversified to eliminate specific risk.

Some investors may choose to be exposed to specific risk with the expectation of realizing higher returns. But this is contrary to financial theory and such investors are therefore deemed to be irrational. Deliberate exposure to specific risk is unnecessary and is essentially gambling...unless you are trading on inside information, but we won't go there, as trading on inside information is a flagrant violation of the securities laws.