What is the primary purpose of diversification in investment strategy?

The primary purpose of diversification in an investment strategy is to spread investments across a variety of financial instruments, asset classes, or sectors to reduce overall risk. By holding a diverse portfolio, investors can mitigate the impact of poor performance in any single investment. Different assets often react differently to market events; for example, when stocks are underperforming, bonds or commodities may perform well. This balancing effect can stabilize returns and lower the volatility of an investor's overall portfolio.

In contrast, maximizing potential returns without any risk is unattainable in the investment world; risk and return are inherently related. Concentrating investments in a single sector can lead to greater risk exposure, as a downturn in that sector can significantly impact performance. Lastly, while certain assets may provide a more predictable income stream, such as bonds, there is no strategy that can guarantee fixed income over time without any risk, especially given market fluctuations and inflation considerations.