What is the purpose of diversification in investments?

Diversification in investments is primarily aimed at reducing exposure to any single asset. By spreading investments across various asset classes, industries, or geographical regions, investors can minimize the impact that the poor performance of one asset could have on their overall portfolio. This strategy helps to stabilize returns over time, as the potential losses from one investment can be offset by gains in others.

For instance, if an investor holds a diverse range of stocks, bonds, and possibly real estate, a downturn in the stock market may not significantly affect the overall portfolio if other investments perform well. This protective mechanism is fundamental to sound investment strategy, as it aims to mitigate risk and enhance the investor's ability to weather market volatility.