In investing, what type of risk does diversification mainly reduce?

In investing, diversification mainly reduces unsystematic risk.

Unsystematic risk is specific to a company, industry, or individual asset. Holding investments across different companies and sectors can reduce the effect of one business failing or one industry performing poorly. This is why a diversified portfolio is usually less exposed to a single issuer than a concentrated holding.

Diversification cannot eliminate systematic risk, also called market risk. Broad economic events such as recessions, interest-rate changes, wars, or major market shocks can affect many assets at once. Diversification may spread exposure across regions and asset classes, but it cannot guarantee a profit or prevent losses.

Harry Markowitz formalized modern portfolio theory in the 1950s, showing how portfolios can be evaluated by expected return and risk. In practice, diversification may be achieved through mutual funds, exchange-traded funds, or direct ownership of multiple assets.