The diversification strategy mixes multiple investments with a portfolio primarily to minimize the portfolio risks (Lin et al., 2022). The paper examines the diversification strategy in finance, how it is used, how it works and its importance in financing management.
Financial Investments and Diversification Strategy
Financial investment involves committing cash or money to buy a financial asset that it appreciates to generate more considerable money. These investments are faced with risks of losing money on investment if the asset depreciates or other related investment dangers leading to loss of capital by the investors. Possible financial risks include liquidity, credit, and operational risks (Lin et al., 2022). In this view, diversification strategy bridges the gap by guiding the investors to invest in different asset classes, including real estate, bonds, stocks or cryptocurrency. Investing in different classes of assets helps spread investment-related risks to different assets such that when one fails or makes a loss, the loss will be offset by the proceeds from the other investments (Oladimeji & Udosen, 2019). By so doing, the diversification strategy helps reduce the chances of experiencing significant losses. The investor is less likely to have the entire investment wiped out by one adverse economic event that impacts only one holding.
Within a financial investment portfolio, a diversification strategy works by balancing the risks and rewards of different financial assets investments such that in case of any significant economic disruption or recession, the entire investment does not collapse (Lin et al., 2022). For example, when the Great Recession of 2007-2009 collapsed the U.S real estate industry, the investors in real estate ran at massive losses due to huge depreciations that occurred. However, those investors who had invested in different financial assets, such as cryptocurrency, bonds or stocks, used the proceeds from these investments to offset the massive losses incurred in real estate investments (Chiţu, 2013). In this case, financial investment diversification helped the investors balance the risks and rewards, reducing their exposure to that economic recession. The strategy is designed to reduce the volatility of the investment portfolio over time.
Diversification strategy plays a critical role in helping financial market investors mitigate losses during periods of economic uncertainty. Looking at the holistic view of local, regional and global economics, different financial assets or classes perform differently at different times, and one portion of the economic market is affected at a time. For example, when the real estate sector is booming, stock financial markets might be undergoing a recession (Chiţu, 2013). In this case, an investor in both markets would use proceeds from real estate investment to offset the losses made in stock market investment. The overall scenario helps minimize the portfolio losses by ensuring that the investor does not lose in both investments.
The diversification strategy goes beyond mitigating or reducing the risk exposure to investors to helping ageing investors preserve capital for retirement (Oladimeji & Udosen, 2019). The approach would help them avert financial and economic challenges in their old age. It also helps investors increase their revenue streams by expanding their market share and reducing their dependence on a single source of income (Lin et al., 2022). Apart from the vast benefits of the diversification strategy in financial investments, it also has challenges as it requires considerable capital investment. The most important thing to note is that diversification does not eliminate risks but reduces the risk exposure to the investors.
Conclusion
Diversification strategy in financial investments allows the investors to invest in different asset classes, including real estate, bonds, stocks or cryptocurrency. The key benefits include reducing investors’ risk exposure, increasing the revenue streams and reducing the dependence on a single source of income. The strategy does not eliminate financial investment risks but reduces the risk exposure to the investors.
References
Chiţu, L. (2013). Was Unofficial Dollarisation/Euroization an Amplifier of the ‘Great Recession ‘ of 2007–2009 in Emerging Economies? Comparative Economic Studies, pp. 55, 233–265. http://dx.doi.org/10.1057/ces.2013.1
Lin, H. C., Huang, J. C., & You, C. F. (2022). Bank Diversification and Financial Constraints on Firm Investment Decisions in a Bank-Based Financial System. Sustainability, 14(17), 10997. https://doi.org/10.3390/su141710997
Oladimeji, M. S., & Udosen, I. (2019). The effect of diversification strategy on organizational performance. Journal of Competitiveness, 11(4), 120. http://dx.doi.org/10.7441/joc.2019.04.08
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