Compounding refers to the process by which investment earnings generate additional earnings over time. It’s the principle of earning interest on both the original principal and the accumulated interest from previous periods. This concept is a powerful wealth-building tool, especially in long-term investing, but it is not the same as diversification. Compounding increases the value of your investments exponentially over time, assuming consistent returns, but it doesn’t address the issue of risk spreading. An investor who only invests in one asset may still benefit from compounding, but that asset is still exposed to market-specific risks. Diversification, on the other hand, is about managing risk across a portfolio by spreading exposure. Confusing the two can lead to an overreliance on return growth without considering how to protect against potential downturns. Both concepts are essential in investing — but only diversification directly answers the question about reducing risk.