I have talked before about diversifying your portfolio by targeting an asset allocation that is right for you. I also recommended a way to balance it across multiple accounts, with the goal of keeping as few funds in each account as you can. When you do this, each account by itself is NOT very diversified, and subject to a relatively large amount of volatility. However, if you take ALL of the accounts together, the overall volatility decreases without much sacrifice in the performance.
When it comes to choosing asset classes in your investment portfolio, most of us know that diversification leads to a better return vs risk profile by reducing volatility without sacrificing returns. That is the premise of investing in index funds instead of picking individual stocks. However, even among different index funds, depending on the asset class they represent, there can be high volatility as well (think emerging market or small cap funds). Thus, it is also important to diversify across different asset classes. I will show you my own personal asset allocation and how I decided on it.