What is "portfolio diversification"?

Portfolio diversification refers to the strategy of spreading investments across a variety of financial instruments, sectors, or asset classes to reduce risk. By diversifying a portfolio, an investor can minimize the potential negative impact of any one investment's performance on the overall portfolio.

When a portfolio is diversified, it is less susceptible to volatility associated with individual assets or sectors. For example, if an investor holds stocks in multiple industries and one sector performs poorly, the overall impact on the portfolio may be cushioned by the performance of other sectors that are doing well. This approach ultimately aims to achieve a more stable return on investment over time while mitigating risk.

In this context, the other options do not accurately depict the essence of portfolio diversification. Investing all funds into a single investment concentrates risk rather than reducing it. Similarly, concentrating assets to maximize returns contradicts the fundamental principle of diversification, which seeks to balance risk and reward. The use of financial derivatives to hedge investments is a different strategy focused on protecting against market movements, rather than spreading investments across various assets to create a robust portfolio.