What is meant by "diversification" in investment terms?

Diversification in investment terms refers to the strategy of spreading investments across a range of different assets to minimize risk. This approach is predicated on the idea that a portfolio composed of different types of investments will, on average, yield a higher return and pose a lower risk than any individual investment. The rationale behind diversification is that different assets often respond differently to market conditions; when some assets are performing poorly, others may be performing well, thus smoothing out the overall investment return.

For instance, if an investor puts all their money into a single company's stock, the performance of that investment is heavily influenced by the company's specific performance. In contrast, by diversifying into various asset classes—such as stocks, bonds, real estate, and commodities—an investor can cushion against the volatility inherent to any single investment. This strategy is particularly important in protecting against risks that may affect particular sectors of the market.

In contrast to the correct choice, investing all funds into a single asset leads to higher risks, as poor performance can result in significant losses. Buying assets only in foreign markets restricts an investor's options and may not adequately safeguard against domestic market risks. While buying low and selling high is a general investment strategy aimed at profit, it does not inherently encompass the concept