In Ethiopia, agriculture is the primary source of food and livelihood for many rural households, making it a dominant sector that seeks to reduce food/nutrition insecurity and poverty. Even if it is dominant, currently the sector is facing many challenges such as unexpected shock like drought and flooding, reduction in output mainly due to soil nutrient degradation and lack of capital to use improved agricultural technologies. Hence, rural households are compelled to develop strategies to cope with the increasing vulnerability associated with agricultural production. The current study therefore assessed rural households' participation in a combination of multiple livelihood diversification strategies and its impact on diet quality and welfare of smallholder farmers in Southwestern Ethiopia. As the average treatment effect on the treated result from multinomial endogenous switching regression model shows, an isolated participation in non-farm livelihood diversification results in a significant effect on smallholder farmers' welfare but, it doesn't have a significant effect on nutrition security measured in dietary diversity. Likewise, joint participation in off-farm and non-farm livelihood diversification results in a significant effect on rural households' nutrition security however it doesn't have a significant effect on welfare. The only livelihood diversification package that has a significant effect on both welfare and nutrition security simultaneously is off-farm livelihood diversification alone. As a result, policymakers and rural finance programs should shift their focus and place a greater emphasis in incentivizing smallholder farmers to invest on diversification strategies that can boost both welfare and nutrition security simultaneously, which is off-farm diversification.