What is the main purpose of diversification in an investment portfolio?

The main purpose of diversification in an investment portfolio is to manage risk. By spreading investments across a variety of asset classes, sectors, and geographical regions, an investor can reduce the overall volatility and potential losses within the portfolio. This concept is based on the principle that different investments typically perform differently under varying market conditions; thus, when one asset class is underperforming, others may be performing well, which helps to stabilize returns.

While including foreign investments, combining various asset types, and expanding beyond traditional asset classes are all valid strategies that can contribute to diversification, their primary objective is still centered around the overall risk management of the portfolio. The essence of diversification lies in the intention to protect the portfolio from the negative performance of any single investment, ultimately leading to a more consistent return pattern over time.