What does diversification in portfolio management help to reduce?

Diversification in portfolio management primarily helps to reduce unsystematic risk, which is the risk associated with specific assets or companies. This type of risk stems from factors that can affect individual investments, such as company performance, management decisions, or sector-specific events. By holding a variety of different assets—such as stocks from different sectors, bonds, or other investment vehicles—investors can mitigate the impact of any single asset's poor performance on their overall portfolio.

When one asset underperforms, the diversity of the other assets can help to balance out the losses, leading to more stable returns over time. This strategy does not eliminate risk altogether, but it significantly lowers the volatility of the portfolio's returns that results from the performance of individual securities.

In contrast, systematic risk remains inherent in the market and cannot be mitigated through diversification alone, as it affects all assets within the market. An understanding of this distinction is crucial for effective portfolio management, highlighting the importance of strategic asset allocation to manage risk effectively.