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It is important to diversify across various industries as each industry has specific risks (Sub-prime crisis for example might affect one sector to under perform while another to over perform).
2) Geography As industries, a certain region can be affected by a war or crisis.
3) Various other variables such as financial asset types, investment terms and more.

How do we achieve a diversified portfolio then? We participate in many bets with changing variables with relatively low sums of investment:

1) Buy a large number of promising' stocks For diversification purposes one could buy a large number of stocks (over 10) in a portfolio. This method of diversification is not recommended. Many researches have shown beating market performance by choosing specific stocks is not easy. There is another disadvantage in buying many specific stocks as buy/sell commissions can be quite high.

2) Invest in mutual funds Mutual Funds are run by professional who do exactly what we are trying to achieve. Diversify. Mutual funds purchase many, thought to be promising, stocks and use them to diversify our investment in them. There are many types of mutual funds. Some specialize in certain markets while some are more general. Even though mutual funds diversify our investment we should still minimize specific risks and diversify our investment in mutual funds as well. Buying various mutual funds, with various specializations in industry and geography is a good way of diversifying.

3) Invest in ETF's mimicking market indices As aforementioned even professional brokers have a hard time beating market performance by choosing specific stocks as mutual funds do. Why not invest in market indices then? An ETF is a good way to do that and with lower commissions. There are many ETF's which mimic market indices (such as QQQQ for NASDAQ). Buying ETF's is easy and relatively cheap. As before further diversification is still required.

4) Invest in bonds and deposits Investing in bonds and deposits is a good way of diversifying as the source of return in these financial assets is debt and not ownership. When a market under performs corporations still have to pay interest on bonds.

To conclude, diversification is one of the most basic tools of investors. Diversification will enable your portfolio to minimize specific risk (Not to be confused with market risk of the portfolio), lower the portfolio's variability and change over time and help generate better return on investment.

Learn more about this author, Dorian Wales.
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