What is meant by a "diversified portfolio"?

A diversified portfolio refers to a strategy that involves holding a variety of different investments within the same portfolio. This approach is primarily aimed at reducing risk. By diversifying, investors can mitigate the potential negative impact of a poor performance in one particular investment or asset class, since the other investments may perform differently.

For instance, if one sector of the market is declining, gains in another sector can help to offset the losses, thereby lowering the overall volatility of the portfolio. This balance enhances the probability of achieving more stable returns over time. A diversified portfolio can include a mix of stocks, bonds, real estate, and other asset classes, which broadens exposure to various market segments and reduces the likelihood that the portfolio will suffer unduly from the performance of any single investment.

In contrast, a portfolio focused solely on one type of investment is more vulnerable to market fluctuations affecting that particular investment type, while a portfolio dedicated only to low-risk investments may miss out on higher returns that come with some level of risk. Similarly, investing exclusively in international markets does not guarantee diversification, especially if those markets are correlating strongly with each other.