Why is a diversified portfolio's overall risk lower than the risk of its individual holdings?

Because the pieces don't all move together at the same time. When you combine assets that aren't perfectly correlated, their ups and downs partly offset each other, so the portfolio's overall swings are smaller than the average swing of its parts. This is the mathematical heart of diversification, often summarized by Nobel laureate Harry Markowitz's insight that diversification is 'the only free lunch in investing.'

In plain terms: a portfolio of many stocks bounces around less than any single volatile stock, and adding bonds (which often move differently) smooths it further. You get roughly the average of the components' expected returns but with less than the average of their risk. That's a genuinely free improvement, more stable returns for the same expected growth. It's why owning broad funds plus a bond allocation is more sensible than betting on a few holdings, no matter how promising they look.