What is portfolio diversification?

Portfolio diversification is a risk-management strategy that involves spreading investments across various asset classes, sectors, geographies, and other modalities. The aim is to limit exposure to any one focus area of investment, reducing the overall risk of a downturn in one area negatively impacting an entire portfolio. 

By holding a mix of different asset classes like stocks, real estate and venture capital, for example, you don’t put all your eggs in one basket. While some of these investments might experience losses, others might provide stability or generate returns. This can mitigate the impact of those with poor performances, helping to keep a portfolio safer from inevitable market volatility.

The concept of diversification dates back to 1952. It was developed by American economist Harry Markowitz, who received the 1989 John von Neumann Theory Prize and the 1990 Nobel Memorial Prize in Economic Sciences.In a journal article, “Portfolio Selection,” published in The Journal of Finance, Markowitz emphasized the importance of combining assets with low or negative correlations to achieve a better balance between risk and potential reward. Today, his words seem to still ring true, and portfolio diversification is a widely implemented investment strategy.