Diversification is a risk management strategy that involves spreading investments across different asset classes, industries, geographic regions, and types of securities within a portfolio. Here's how diversification reduces investment risk:

1. Reduction of Unsystematic Risk: Unsystematic risk, also known as specific risk or company-specific risk, refers to risks that are unique to a particular company or industry. By diversifying across multiple assets, investors can mitigate the impact of adverse events affecting any single investment. For example, if one company in a portfolio performs poorly due to factors specific to that company, gains from other investments can offset those losses, reducing overall portfolio risk.

2. Smoothing of Volatility: Different asset classes and investments have varying levels of volatility. Diversifying across assets with low correlation helps smooth out portfolio volatility. For instance, when one asset class experiences a downturn, another asset class may perform better, cushioning the impact on the overall portfolio. This helps in reducing the magnitude of fluctuations in portfolio value over time.

3. Exposure to Multiple Growth Opportunities: Diversification allows investors to participate in multiple growth opportunities across different sectors and regions. While some investments may underperform, others may outperform, leading to overall positive returns for the portfolio. By spreading investments across various growth opportunities, investors reduce their reliance on the success of any single investment or sector for portfolio growth.

4. Enhancement of Risk-Adjusted Returns: Diversification can enhance risk-adjusted returns by improving the risk-return tradeoff. By combining assets with different risk profiles, investors can achieve a desired level of return for a given level of risk or minimize risk for a targeted level of return. This helps optimize portfolio performance while controlling downside risk.

5. Protection Against Event Risks: Diversification can protect against event risks such as geopolitical events, regulatory changes, or natural disasters that may disproportionately impact specific sectors or regions. By holding a diversified portfolio, investors reduce their exposure to the adverse effects of any single event or occurrence.

In summary, diversification reduces investment risk by spreading exposure across different assets, industries, and regions, thereby mitigating the impact of individual risks and enhancing the overall risk-return profile of the portfolio