A process or strategy that is applied to investments for the purpose of lowering the overall risk involved. Diversification revolves around purposeful attempts to add more diversifiable risks, rather than concentrating all the investments in a single entity, industry, sector or asset. By so doing, it aims to mitigate risk and maximize returns.
Diversification can also be defined as the spreading of investments among and within different asset classes in order to mitigate different types of investment risks, including market volatility. Nevertheless, investors also diversify their portfolios so that losses in one vehicle, venue or sector can be limited or better yet made up by gains made in another. The main theme, in this respect, is avoidance of an all-out financial disaster. In addition to the above, diversification may also involve certain market techniques such as market timing, which can help reduce the likelihood of unfavorable events taking down a year’s work.
In a slightly different context, diversification may imply conscious attempts by an entity to entering into a line of business that’s outside its core business line in which it currently operates, for the purpose of encountering the effects of tough times (troughs of a business cycle). A trough occurs when a recession is over and economic recovery or expansion starts to pick up.
