Diversification
Principles of Finance glossary · Risk, Return & Portfolio Theory
Definition
Reducing portfolio risk by combining imperfectly correlated assets.
Diversification in plain English
Diversification is the money version of "don't put all your eggs in one basket." If you own just one company's stock and it crashes, you're wrecked; but if you spread your money across many investments that DON'T all move up and down together, a bad day for one is often canceled out by a good day for another. The magic word is "imperfectly correlated" — it just means the investments don't rise and fall in perfect lockstep, so their bumps partly smooth each other out. The result is that your overall risk shrinks without you having to give up much expected return, which is about as close to a free lunch as investing offers.
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