What is Diversification? This is the first of a series of posts where I discuss the question of diversification in business, investments and income streams.
Having had a background as a financial planner I am very familiar with the word “diversification” in investment terms.
Let’s look at some definitions of Diversification.
From Wikipedia, What is Diversification?
In finance, diversification means reducing risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituents. Therefore, any risk-averse investor will diversify to at least some extent, with more risk-averse investors diversifying more completely than less risk-averse investors.
Also from Wikipedia – what is diversification?
Diversification is a form of corporate strategy for a company. It seeks to increase profitability through greater sales volume obtained from new products and new markets. Diversification can occur either at the business unit level or at the corporate level. At the business unit level, it is most likely to expand into a new segment of an industry that the business is already in.
In this series I discuss diversification in a broader sense than the two Wikipedia definitions which cater for investors and for corporate. I believe everyone should have more than one way they earn income. This applies to business, home based business owners, investors and employees. Why do I believe this?….. Because I have been burned twice by not being diversified and I learnt the lesson (pity I did not learn the first time). I will share those stories with you in later posts in this series.
For now let’s go back to the question ….. What is Diversification? What does it mean for investors, business and employees?
What is Diversification – Investors – the Wikipedia definition is simple enough to follow. We have all heard the sayings “Don’t put all of your eggs in one basket”, “spread you risk”.
I have heard people put forward the argument against diversification saying that you can only really understand one asset class well. For example if I love Residential Property and know how to be an astute investor in that area then I am better to stick with that rather than also have investments in stocks and shares.
The downside is if you pick any one type of investment in isolation there will be downturns. Diversifying can smooth out the overall ups and downs.
What is Diversification – Corporate/Business – again the Wikipedia definition is a good one. I will discuss my own experience and what not diversifying cost me in this series. A business that does not diversify is at risk. Products and trends change now at an ever increasing speed. We have seen many businesses who have not kept up with change become obsolete.
What is Diversification – Home Based Business – multiple streams of income protects the home based business owner in exactly the same way as having a conventional business.
What is Diversification – Employees – The days of job security are far behind us. We have witnessed this in a very large way through the Global Financial Crisis (GFC). It is also very difficult to create wealth and a secure future with just a job. It is important to build up other sources of income. This could be investments or a home based business.
One of the best alternatives for employees is to start a home based business part time. The income from this could then be used to invest in property, stocks or other assets. Many people with significant incomes from home based businesses started the business while they were an employee. I think this is a great strategy.
In Summary What is Diversification? – Diversification reduces our risk and also provides us with multiple options for our financial security.
In part two of this series on What is Diversification I will share with you my personal story of being a sole distributor and the lessons I learned. I tell these stories as I hope others can learn from my experiences.