diversification is a risk management strategy which involves the inclusion of a wide variety of investment instruments within a portfolio. The rationale behind this technique is that a portfolio consisting of different types of assets will, on average, produce higher long-term returns and reduce the risk of holding individual stocks or assets.
Diversification attempts to mitigate unsystematic risk events within a portfolio - the positive performance of some investments offsets the negative performance of others.
The advantages of diversification only hold if the assets in the portfolio are not perfectly correlated, i.e. they respond differently, often oppositely, to different market influences.
Studies and mathematical modeling have shown that maintaining a well-diversified portfolio with 25-30 different assets yields the most cost-effective level of risk reduction. Investing in more stocks generates additional benefits, albeit at a slower rate.
