It’s a common saying for a reason: don’t put all your eggs in one basket. And this timeless piece of advice is at the heart of a key investment principle—diversification.

At its core, this is the practice of spreading your investments across a range of asset classes, industries, and geographic regions. While it doesn’t eliminate risk or promise high returns, its primary goal is to help reduce risk and buffer your portfolio from the inevitable ups and downs of the market.

Consider what might happen if you invested solely in one company’s stock—a booming tech firm, for example. If the company performs well, your investment could grow significantly. But if it faces a setback, such as a scandal, a new competitor, or an industry downturn, your entire investment could be jeopardized. This type of vulnerability is known as concentration risk. Diversification can help lessen this risk by ensuring that if one investment underperforms, others in your portfolio may help offset the impact.

Key elements of a diversified portfolio

Diversification is more than just investing in a handful of different companies. A well-rounded portfolio typically includes three main layers:

1. Across asset classes
   This is the most basic level of diversification. A balanced portfolio typically includes a mix of stocks, bonds, and cash equivalents. These asset classes often react differently to market conditions. For instance, while stocks may be more volatile, bonds can offer greater stability. This mix helps balance risk and return over time.
2. Within asset classes
   Beyond selecting different types of assets, it’s also important to diversify within each category. For example, when investing in stocks, consider a variety of industries, such as healthcare, technology, and energy, as well as a range of company sizes, including small-, mid-, and large-cap companies. Including both domestic and international investments may further enhance your portfolio’s stability, as markets often respond differently to global events.
3. Through investment funds
   Building a diversified portfolio can be challenging for individual investors, especially when it comes to choosing a wide range of investments. That’s where mutual funds and exchange-traded funds (ETFs) can be helpful. These funds often include shares of many companies, allowing investors to achieve broader diversification through a single investment. For example, an index fund might provide exposure to hundreds or even thousands of companies across various sectors.

A long-term approach

Diversification is a strategy meant for the long haul. While a concentrated portfolio may outperform in a strong market, it can also be more vulnerable during downturns. In contrast, a diversified approach typically aims to reduce the impact of market volatility, which can make it easier to stay focused on your long-term financial goals.

Even in times of market stress, having a diversified portfolio tailored to your risk tolerance and objectives may help you remain steady and avoid impulsive decisions. While no strategy can completely shield you from losses, diversification can help create a more balanced and resilient financial plan.

As always, consider speaking with a financial professional before making investment decisions. They can help you build a portfolio that reflects your goals, timeline, and comfort with risk—and provide valuable guidance during changing market conditions.