What is the main goal of diversification in a portfolio?

The main goal of diversification in a portfolio is to reduce overall risk through varied investments. Diversification involves spreading investments across a range of assets, sectors, or geographical regions, which helps to mitigate the impact of poor performance from any single investment. By holding a mix of asset types that react differently to market conditions, an investor can lower the volatility of their portfolio and minimize potential losses.

For instance, if one asset class, such as stocks, experiences a downturn, other asset classes, such as bonds or real estate, may perform better during that same period, thus cushioning the overall portfolio's performance. This is a fundamental principle in finance, as it utilizes the benefits of negative correlations among various asset classes to achieve a more stable return over time.

Maximizing returns on each investment, focusing on high-risk assets, or increasing liquidity for all assets does not encapsulate the core purpose of diversification—it seeks to balance risk and return, thus emphasizing stability and risk management rather than concentrated gains or transactional speed.