In investment portfolios, what does 'diversification' mean?

Diversification in investment portfolios refers to spreading investments across various assets to reduce risk. By holding a variety of asset classes—such as stocks, bonds, real estate, and commodities—investors can minimize the potential negative impact of a poor-performing investment on the overall portfolio. When one asset class is underperforming, others may be doing well, thus balancing the overall returns.

This strategy helps to mitigate risks associated with market volatility because different assets often react differently to the same economic conditions. For instance, while stocks might decrease in value during a recession, bonds may provide a stable return or even appreciate. Therefore, diversification not only helps in enhancing the stability of returns but also in achieving long-term growth by optimizing the risk-return profile of the investment portfolio.

The other choices do not capture the essence of diversification. Investing in a single asset class concentrates risk, maximizing returns from one investment focuses on a singular strategy without considering broader market fluctuations, and limiting exposure to market trends implies avoiding certain investments altogether, which isn't aligned with the principle of spreading risk across multiple asset types.