The basic concept of diversification is "not putting all your eggs in one basket." Diversification is for those who have already accumulated investments and want to manage them prudently to try to reduce market value risk. The primary method investment professionals use to combat risk is diversification among different types of asset classes.

Wise investors use asset allocation to diversify their portfolios among investments within the three broad categories of stocks, bonds and cash. With so many types of investments to choose from, one asset class may outperform all the others in any given year. By the same token, an asset class that does well one year may suffer a substantial downturn the next.

As we discussed above, the process of selecting the appropriate mix of risk and return for a customer's portfolio is known as asset allocation. Diversification through asset allocation helps minimize the customer's exposure to volatility. However, keep in mind, that diversification does not assure the customer a profit or protect against a loss in a declining market.