This article examines livelihood diversification strategies of rural households using survey data from the Himalayas. We present and explore an analytical framework that yields different activity choices as optimal solutions to a simple utility maximization problem. By classifying the range of activities of rural households into a few distinct categories based on their profitability and by considering portfolios of farm and nonfarm activities, we provide novel insights into diversification behaviour of rural households. The evidence shows that while the poor are mainly agricultural labourers and work in the low-return non-farm sector, the better-off diversify in high-return nonfarm activities. As expected, we find strong evidence that education plays a major role in accessing more remunerative non-farm employment. A somewhat less intuitive finding is that larger household size is associated with higher probability of diversification into the high-return non-farm sector. The finding that the farm size is not a constraint to diversification in lucrative non-farm employment is also surprising. Geographical location plays a role in diversification behaviour of rural households indicating the importance of local context.