When it comes to investing, one of the pillars of portfolio construction is diversification. Diversification is the practice of investing across a variety of assets classes, such as stocks, bonds, alternatives, or commodities to help mitigate and reduce risk, insulate and protect your portfolio against market volatility, and increase the potential for long-term returns.

Diversification works because different types of investments often perform differently under various market conditions and during different market cycles. For example, while stocks might experience a downturn during an economic recession, bonds, alternatives, or commodities like gold might hold their value or even increase in price. By holding a blend of assets, you reduce your reliance on any single investment, which helps to smooth out fluctuations in your portfolio’s overall value. Investors use diversification with the goal of building a portfolio that not only captures the upside when markets are up, but also offers downside protection when markets are down.

Diversification can be as simple or complex as you want to make it. It can go beyond just asset classes. It can also be done within each asset class. Whether that means investing in different sectors, industries, or geographic regions or owning individual stocks instead of mutual funds. For instance, instead of concentrating your equity investments solely in technology stocks within the U.S. market, you could include stocks from other sectors like healthcare, energy, or financials. Adding international investments is also a way to reduce your reliance on a strong U.S. market and economy. For more fixed income focused investors, looking to taxable municipal bonds vs corporates or tax-exempt municipals vs treasuries can be a way to diversify a fixed income only portfolio. For alternatives, it can be a mix of private equity, private credit, and private real estate or the funds and managers you choose to invest in to get exposure to each of those alternative asset classes.

But can you be over-diversified? Yes, absolutely. Over-diversification—spreading your investments too thin—can dilute returns and make it challenging to achieve meaningful growth. On the other hand, under-diversification can leave your portfolio overly exposed to the risks of a particular market segment.

The key is to find the right balance, but how? Regularly reviewing things like your investment time horizon and risk tolerance can help keep you on track and make sure that your portfolio is aligned with your financial goals and objectives.

Ultimately, diversification is about creating an all-weather portfolio that is resilient in the face of uncertainty. No one can predict the future of the markets with complete accuracy, but by spreading your investments wisely, you can mitigate risks and increase your chances of achieving long-term financial success. Whether you’re a seasoned investor or just starting out, understanding and implementing diversification is a key step toward building a strong and sustainable investment strategy.