Why is diversification important in asset allocation?

Diversification is a crucial strategy in asset allocation because it helps manage risk across a portfolio. By spreading investments across a variety of asset classes, industries, and geographical regions, an investor can reduce the impact of any single investment's poor performance on the overall portfolio. When different investments behave differently under various market conditions, diversification diminishes the portfolio's volatility.

For instance, when one asset class, like stocks, might be underperforming, another asset class, like bonds or real estate, might perform well, helping to cushion the overall impact on the portfolio. Therefore, an effectively diversified portfolio can lead to a more stable investment experience over time, as it aims to balance risks while pursuing returns.

This approach is essential for investors seeking to protect capital while still striving for growth, making risk management a primary goal of diversification.