What is the main purpose of portfolio diversification?

The main purpose of portfolio diversification is to reduce risk by combining uncorrelated assets. This strategy is based on the understanding that different assets often perform differently under various market conditions, and by holding a mix of assets that do not move in tandem, an investor can minimize the overall risk of the portfolio.

When assets are uncorrelated or negatively correlated, the volatility of the portfolio is reduced because gains in one asset can offset losses in another. This leads to more stable returns over time, enabling investors to achieve their financial goals with a lower level of risk than if they invested in a single asset or a concentrated selection of assets.

The other choices reflect misunderstandings of diversification's primary goal. Maximizing returns from high-risk investments suggests a focus on return rather than risk management. Achieving uniform risk across all assets is not achievable due to the inherent differences in asset characteristics and market behavior. Lastly, investing solely in domestic markets limits the potential for diversification, as it restricts the range of available assets that could help reduce risk. By opposing these limited strategies, diversification emphasizes a balanced approach to investment that focuses on risk reduction through variety.