Final answer:
Diversification in an investment portfolio primarily mitigates nonsystematic or company-specific risk by spreading investments across a variety of assets, thus ensuring one is not overly exposed to the adversities faced by any single investment.
Step-by-step explanation:
The objective of diversification in an investment portfolio is primarily aimed at minimizing the nonsystematic risk associated with individual companies. By spreading investments across various assets, sectors, or geographies, an investor can reduce the impact of poor performance from any single investment. This strategy follows the proverb "Don't put all your eggs in one basket" and helps to smooth out the volatility in a portfolio by mitigating the extremes of individual asset performance.
Portfolio diversification involves buying stocks or bonds from a broad range of companies. If an individual company faces adversity due to market-specific conditions or managerial decisions, investors who are diversified will be less exposed to the risk of significant losses. While some companies may outperform, others might underperform. Diversification, therefore, helps to balance out performance and preserve capital.
It is important to note that while diversification can reduce nonsystematic risk, it cannot completely eliminate systematic risk, which is inherent to the market as a whole. Events impacting the overall economy or financial markets can still affect a diversified portfolio.