What is the primary reason for portfolio diversification?

The primary reason for portfolio diversification is to minimize the risk of overall portfolio loss. Diversification involves spreading investments across various asset classes, sectors, or geographic regions, which reduces the negative impact that any single investment's poor performance can have on the entire portfolio. By holding a variety of assets that respond differently to market conditions, an investor can mitigate unsystematic risk, which is specific to individual investments or sectors. This risk mitigation occurs because while some assets may decline in value, others may remain stable or appreciate, thus stabilizing the overall performance of the portfolio.

Effective diversification aims to achieve a more stable return over time, as the various investments do not usually move in perfect correlation with one another. This means that even if certain investments do poorly, the overall performance of the portfolio may remain resilient. On the other hand, focusing solely on increasing returns, ensuring consistent dividend payments, or simplifying management may lead to high concentration in certain areas, which can amplify risk rather than reducing it.