Diversification is the practice of spreading investments across different assets, asset classes, and sectors to reduce the impact of any single holding's poor performance on the overall portfolio. The goal is not to maximize returns but to achieve more consistent returns with lower risk. A well-diversified portfolio tends to weather market downturns better than a concentrated one.

The Herfindahl-Hirschman Index (HHI) is a widely used measure of concentration. It is calculated by squaring the percentage weight of each holding and summing the results. A portfolio with one holding has an HHI of 10,000, the maximum. An equally weighted portfolio of 10 holdings has an HHI of 1,000. The U.S. Department of Justice uses the same index to measure market concentration in antitrust analysis.

True diversification goes beyond simply owning many holdings. If all your investments are in technology stocks, you are not diversified even with 20 positions. Spreading across asset classes like stocks, bonds, real estate, and cash provides protection because these assets often move in different directions during market stress. Adding international exposure further reduces correlation and improves portfolio resilience.