In plain English
It is the idea behind “don’t put all your eggs in one basket”. Owning companies in different industries, sizes and countries means a problem in one area has a smaller effect on the total.
Example
If a portfolio holds one stock and its dividend is cut, income can fall sharply. If it holds 20 companies across different sectors, a single cut matters much less.
Why it matters
For dividend investors it also protects the income stream. Many high-yield stocks sit in the same few sectors, so a portfolio that looks varied can still be concentrated.
Limits
Diversification reduces the risk of a single holding failing, but it does not remove market risk. In a broad downturn, most holdings fall.
Common mistakes
- Owning many funds that hold the same stocks.
- Counting different share classes of one company as separate holdings.