Diversification is the spreading of risk by choosing different financial products to invest in so not all your eggs are in one basket. The impact is to lower overall risk on the total investment portfolio by hopefully having different parts of the investments perform differently under a set of circumstances.
You can diversify your investments by picking investment that have different features such as:
- Types of investments: Include different asset classes, such as cash, stocks, bonds, ETFs, options, etc.
- Risk levels: Investments with dissimilar levels of risk allow the smoothing of gains and losses.
- Industries: Invest in companies from distinct industries. The stocks of companies operating in different industries tend to show a lower correlation with each other.
- Foreign markets: An investor should not invest only in domestic markets. There is a high probability that the financial products traded in foreign markets are less correlated with products traded in the domestic markets.
Look for information on asset classes that react differently under different economic conditions. For example, if there is high inflation, how do different financial assets perform? Lowest risk is probably government bonds so would you have some percentage of your investments in bonds, as well as other higher return assets like stocks?