What is the purpose of portfolio diversification?

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The purpose of portfolio diversification is to spread investments across various asset classes to reduce risk. By allocating funds to different sectors, industries, or asset types, investors can minimize the impact of a poor-performing investment on their overall portfolio. When one asset or sector underperforms, other investments may perform well, thus stabilizing returns and helping to mitigate potential losses. This strategy is based on the principle that different assets typically perform differently under varying market conditions, which can provide a protective effect against volatility.

The other options suggest strategies that do not align with the fundamental goal of diversification, and focusing investments heavily in one industry or restricting investments only to certain markets would expose an investor to higher risks. High returns typically come with increased risk, and it is unrealistic to expect to achieve them without some degree of market fluctuation.