Jay Vivian, former managing director of the IBM Retirement Funds, explains how diversification lowers risk in your portfolio. See more on how diversification lowers risk.
Diversification is a particularly good thing if you don’t have perfect knowledge as to how individual stocks are going to perform in the future. If you know what stock is going to perform the best, do not diversify. You should invest it all in that one stock that you’re guaranteed will do well. But I think it’s pretty unlikely you’re going to know that.
What diversifying does is it lets you spread the risk so that you don’t have any one stock that’s 2% or 5% or 20% of your portfolio to go down the tubes. So asset allocation, again, is the high-level asset class target weights that you’ve got. Diversification is the idea that within an asset class you want to be well-diversified so you’re not subject to the risk of any one of those investments in that portfolio going south.