A 3-minute guide to diversification

By Staci West on 29 January 2026 in Basics

Part of understanding diversification is understanding what it’s actually trying to do.

You’ve probably heard the familiar “don’t put all your eggs in one basket” cliché, which is fine as far as it goes — but it doesn’t really explain what kind of risk diversification is designed to reduce, or what it can’t protect you from.

What diversification can and can’t do

When we talk about diversification limiting risk, we’re not talking about avoiding market-wide shocks. Events like the COVID pandemic, global financial crises, or sudden changes in interest rates affect almost all investments. This is known as systematic risk, and it can’t usually be diversified away. If markets fall, even well-diversified portfolios will feel it.

That’s where many investors get confused.

Diversification works by spreading your money across different investments so that no single poor performer can dominate the outcome.

What diversification looks like in practice

In practice, that means owning shares in many different companies rather than relying on a handful of favourites. It means investing across regions instead of concentrating everything in one country. It can also mean combining different asset classes or including alternatives like infrastructure that behave differently from traditional markets.

Each of these decisions reduces the chance that one weak link pulls the whole portfolio down.

Of course, this doesn’t mean your portfolio won’t move. It will still rise and fall with markets, sometimes sharply. Diversification isn’t about eliminating volatility or preventing losses in the short term. What it does instead is limit the damage caused by individual investments that underperform, helping to smooth outcomes over time. So that one thing going wrong doesn’t do lasting damage to your portfolio.

Risk vs volatility

To understand that, it helps to separate risk from volatility.

Volatility is the natural movement of markets. Risk, in this context, is the possibility that poor concentration leads to long-term harm. Our guide on volatility versus risk. Explains why the two are often confused and why they’re not the same thing.

Diversification: protection against being wrong

A good way to think about diversification is as protection against being wrong.

No investor can know in advance which country will perform best over the next decade, which industries will fall out of favour, or which companies will disappoint. If your portfolio depends too heavily on a single answer to any of those questions, you’re taking on concentration risk.

Take geography as an example. A portfolio invested solely in UK shares is effectively a bet on the UK economy, UK politics and UK consumers all pulling in the right direction at the same time. Global diversification doesn’t stop markets falling, but it does reduce the risk that problems in one country dominate your overall outcome. If one region struggles while others hold up better, the portfolio isn’t relying on a single engine for growth.

The same idea applies at a company level and the types of investment you’re holding in a portfolio. While equities tend to offer the best long-term growth, they don’t perform well in every environment. Adding assets that behave differently, for example fixed income or alternatives, won’t prevent short-term ups and downs, but it can help cushion the portfolio during market stress.

The long-term purpose of diversification

Over the long term, diversification increases the likelihood that returns come from multiple sources rather than relying on a single bet being right. When one area struggles, another may hold up better, reducing the overall impact on the portfolio. This is how diversification quietly does its job, not by avoiding market swings, but by preventing any one investment from defining the outcome.

At its best, diversification is about making a durable portfolio. It’s about building a portfolio that can absorb setbacks, adapt to different market environments and stay invested for your long-term goals. And over time, that resilience can matter far more than trying to avoid volatility altogether.