The purpose of diversification is to minimize correlation risk within your investment portfolio. In a simplified example say you had two Investments A and B. If investment A went down 10% in a given year you don’t want investment B to be correlated to investment A such that it also goes down proportionally. Ideally you would want Investment B to be negatively correlated or at least correlated to a lesser degree such it doesn’t go down on a 1:1 ratio.
This should firstly be done by diversifying by asset class between investments such as stocks, bonds, real estate, private equity, and cash. Once you have divided your assets between such categories you want to ensure to look at the diversification of your assets between factors such sector, geographic region, and industry. Varying risk is also important component of diversification and you should take into account your short, medium, and long-term objectives as well as your overall risk tolerance in making that decision.
Asset allocation ETFs which provide a mix of variable and fixed assets can be a way of achieving target portfolio balance in a way that is both easy and low cost.
Lastly, it is key to regularly look at your portfolio and re-balance as required. When real estate prices or stock prices rally this can skew your asset allocation and increase portfolio risk to a level which is inconsistent with your objectives.