How can diversification reduce systematic risk?

Diversification is a risk management strategy commonly used in investing to reduce systematic risk, which is the inherent risk associated with the entire market or an entire market segment. By spreading investments across a variety of different assets, an investor can mitigate the potential impact of any single investment's poor performance on their overall portfolio.

When you diversify, the assets you invest in may not all move in the same direction at the same time. For instance, if one sector of the market is experiencing a downturn, other sectors may still perform well, thus balancing out the overall performance of the portfolio. By holding a mix of asset classes, such as stocks, bonds, real estate, or geographic exposure, the investor can cushion themselves against market volatility.

In contrast, concentrating resources in a single asset or type of investment—as suggested by other choices—can lead to greater exposure to risks associated with that specific investment. Likewise, limiting investments to domestic markets or increasing transactions within a single asset does not take advantage of the potential benefits of having a more balanced portfolio. Therefore, the idea behind diversification is that by spreading investments across various assets, systematic risk is reduced, leading to a more stable overall investment outcome.