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What Is Diversification and Why Does It Matter?

Written by Greg, founder of FTMarketWatch — a former licensed commodities trader, self-directed investor since. Not a licensed financial advisor.

Short answer: Diversification means spreading your money across different investments — companies, sectors, asset types, and sometimes countries — so that a poor outcome in any single investment doesn't sink your entire portfolio. It reduces company-specific risk, though it can't eliminate broad market risk.

Detailed Explanation

If you hold only one stock, your entire outcome depends on that one company. Diversification spreads that risk across many holdings, so one company's bad news has a much smaller effect on your total portfolio.

There are different layers of diversification: across individual companies, across sectors (technology, healthcare, energy, and so on), across asset classes (stocks, bonds, cash), and sometimes across countries. Broad index funds and ETFs are a common, low-effort way to get diversification across hundreds or thousands of holdings in a single purchase.

Diversification reduces the risk that's specific to individual companies or sectors, but it does not remove overall market risk — in a broad market downturn, a well-diversified portfolio can still lose value, just typically less dramatically than a concentrated one.

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