Diversification is the practice of not depending on any one thing. A portfolio spread across thousands of companies in many industries and countries can absorb any single company failing, any single sector slumping, or any single economy stalling. A portfolio concentrated in one stock cannot.
The reason it works is that different investments do not move together. When one part of the market falls, another may hold or rise, and the combination is smoother than any piece alone. A single broad index fund holds thousands of stocks and provides most of this benefit in one purchase. Adding international stocks and bonds adds more.
For people paid in company stock, diversification is the central financial question. RSUs vest into the same company that pays your salary, funds your bonus, and sponsors your health insurance. If that company stumbles, your job, your unvested grants, and your portfolio all fall at once. A common guideline is to keep any single stock below 10% of investable assets, and many people simply sell vested shares on a schedule and move the money to index funds.
Concrete numbers: someone with $600,000 invested and $240,000 of it in employer stock is 40% concentrated. A 50% drop in that stock, which happens to large well-known companies more often than people expect, erases $120,000, or 20% of everything.
The common mistake is holding on because the stock has done well, which is the story every concentrated position tells right up until it does not.