In finance, diversification means reducing risk by investing in a variety of ass ets.

If the asset values do not move up and down in perfect synchrony, a diversi fied portfolio will have less risk than the weighted average risk of its constit uent assets, and often less risk than the least risky of its constituent. [1] Th erefore, any risk-averse investor will diversify to at least some extent, with m ore risk-averse investors diversifying more completely than less riskaverse inve stors. Diversification is one of two general techniques for reducing investment risk. The other is hedging. Diversification relies on the lack of a tight positi ve relationship among the assets' returns, and works even when correlations are near zero or somewhat positive. Hedging relies on negative correlation among ass ets, or shorting assets with positive correlation. portfolio diverfication Portfolio diversification is the means by which investor s minimize or eliminate their exposure to company-specific risk, minimize or red uce systematic risk and moderate the short-term effects of individual asset clas s performance on portfolio value. In a well-conceived portfolio, this can be acc omplished at a minimal cost in terms of expected return. Such a portfolio would be considered to be a well-diversified. Although the concepts relevant to portfolio diversification are customarily expl ained with respect to the stock markets, the same underlying principals apply to all types of investments. For example, corporate bonds have specific risk that can be diversified away in the same manner as that of stocks. Eliminate Specific Risk and Minimize Systematic Risk As was explained in Investment Risk and Return, it is assumed that all investors are rational and will therefore hold portfolios that are diversified to the poi nt where specific risk has virtually been eliminated and their only exposure to risk is to that which is inherent in the market itself. Thus, the residual risk of a portfolio should be equal to market risk, a.k.a. systematic risk, and syste matic risk can be reduced by investing over a broader market, i.e., a larger uni verse. International diversification provides a good example of the effects of

diversifying across asset classes. A portfolio invested 50% in domestic largecap stocks and 50% in international large-cap stocks would have approximately half the residual risk of a portfolio comprised solely of domestic large-cap stocks, assuming that the investments in each market were sufficiently diversified to el iminate specific risk. Some investors may choose to be exposed to specific risk with the expectation of realizing higher returns. But this is contrary to financial theory and such inv estors are therefore deemed to be irrational. Deliberate exposure to specific ri sk is unnecessary and is essentially gambling...unless you are trading on inside information, but we won't go there, as trading on inside information is a flagr ant violation of the securities laws.