3 Reasons Why Diversification May Not Help Your Finances

Updated: May 14, 2009

Issue

Advice from financial professionals shouldn't be taken lightly. However, the pros' tips and tricks may not be the right strategies for your company. This is especially applicable when it comes to diversification. An old financial apothegm is "Diversify to minimize financial risk." That means dividing your money among many different types of investments, and choosing investments that run counter-cyclically to one another. For example, when stocks go down gold goes up, so you should keep some of your money in gold to counter dips in the stock market. Diversify to minimize the risk that any one investment category will tank.

But are you investing to minimize the risk of losing money, or to maximize the "risk" of making money? The fact is, diversifying reduces your risk of significant financial loss but also reduces your hope of significant financial gain by exactly as much. It's like a game of tug-of-war; some of your money is pulling against the rest. If you perfectly diversify to "minimize financial risk," you neither lose nor gain any money. So why diversify to minimize financial risk?

Considerations

1. Avoiding worry is one reason for minimizing financial risk. But as Max Gunther said in The Zurich Axioms,"Worry is not a sign of sickness but a sign of health. If you are not worried, you are not risking enough."

If the amount you have in a particular investment isn't worth worrying about losing, it isn't big enough to earn you any worthwhile return, either.

2. Liquidity has its financial risks and rewards. Every business occasionally needs a shot of cash in a hurry. Some of your money should be in a checking account to cover today's emergency. Money for a less pressing emergency can be kept in a savings account, mutual fund or other slightly less liquid asset. Minimize the financial risk of running short of cash.

When you have enough liquidity - whatever amount that is - put the rest in higher-yielding, longer-term investments such as CDs. Invest in stocks for the very long term, ignoring cyclical ups and downs with the faith that stock prices rise, on average, over the long haul. So goes the diversification theory.

But your faith that longer term investments will produce higher yields may be misplaced. Opportunities to "make a killing" come suddenly, peak and pass swiftly. If your money is tied up in long-term investments, you will miss these sudden spikes in opportunity.

3. Make money for your financial adviser. This is the real reason to diversify. You don't have the time or expertise to find viable investments in a dozen different categories, monitor their performance, then buy or sell them when appropriate. So you pay someone to juggle all those balls for you, while you attend to the business you know.

The Bottom Line

Diversifying your financial assets is smart, but only in some situations. Reasons abound for you to rethink this traditional investment strategy. Before withdrawing your funds and reinvesting them in high-risk projects, however, you'll need to be clear to your business's board and financial team about what you want to do. Working together, you can develop the best investment strategy for your organization.

For more information on business financial issues, check out the Financial Services Resource Center, where you'll find comprehensive research, topical research briefs and advice from Focus Experts.

Featured Research
  • Eight Ways You Should Be Using Contact Center Reporting

    Every day, your contact center collects critical data that can be used to drive strategic improvements to your efforts in the future. But that data is meaningless if you don’t know how to access and analyze it. The key to do doing both is using reporting features. By understanding how to use reporting tools, you will gain much greater insight from the data you are collecting. more

  • Is Your Phone System Stealing Profits?

    Having the wrong phone system can dramatically cut into your profits. Despite this, many businesses just sign up for a plan or platform that seems ‘good enough’. If you haven’t carefully considered your options and the included features, there’s a very good chance that you are leaving money on the table in some way. more

  • Best Video Conferencing Features for Business

    Most businesses are currently underutilizing their video conferencing software because they aren’t aware of the different ways it can be used. Understanding the different features of video conferencing software can be critical to getting the most out of your investment. These features often vary from one option to the next as well, so it's important to do your homework before choosing a specific service. more

  • Phone System Technology Showdown

    VoIP and IP telephony are often misconstrued as being the same type of phone system, but the truth is they operate on different technology and deployment methods. This guide will explain the differences between VoIP and IP, go into the pros and cons of both VoIP and IP-PBX, and give insight into which type of phone system will benefit your business the most. more

  • 8 Ways the Cloud is Changing ERP for the Better

    What if there was a tool available that allowed for you to save up to a quarter of your operational costs? Studies have shown that Enterprise Resource Planning (ERP) solutions enable businesses to access accurate, real-time information about daily operations which allow for the reduction of operational costs of up to 23% and administrative costs of up to 22%. more