Investment diversification is one of the basic building blocks of a solid portfolio. According to Ken Faulkenkenberry, investment diversification is a portfolio strategy that results through the combination of a wide range of assets with the aim of reducing the overall risk associated with an investment portfolio. A basic diversified portfolio might include various categories of investments which include a bond, cash and also stocks. The business person should allocate each of these assets based on his or her investment goals. Furthermore, the allocation should also be based on the individual’s tolerance for risk and the time horizon for the need to utilize the money. Ideally, the diversification of the investment should be based on the growth plans which has been prepared by the business individual. For example, one might use stock for mutual funds, ETFs, and private equity investment. This is important since it results in the building of a diversified portfolio. Diversification is a familiar term that has been used by several investors (Goetzmann & Alok, 2008, P. 67). It explains a phrase “don.t put all your eggs in one basket.” The phrase is significant because it provides the guidance on the practical implications of the role of diversification in business. Furthermore, it offers a clue on how the diversified portfolio has been created and its significance for the growth of the business. Ideally, the diversification in business is very significant since it reduces the risks which might affect the business. For example, an investment that consists of several diversified portfolios is in the position to address the problems that might face the business. Thus, a business that aims at growing and expanding should be in the position to have a diversified investment portfolio.
Modern Portfolio theory refers to a theory that explains how the risk-averse investors can construct portfolios to maximize or optimize the expected returns which are based on the available market risk. The theory emphasizes that the risk is an inherent part of higher reward. The theory is important because it explains how to create an efficient frontier for business. According to the theory, it is important for the business to create a diversified portfolio for it to survive the risks that might affect it. The theory was coined by Harry Markowitz, to advice businesses to undertake diversified portfolios for them to prosper in their endeavors. According to the theory, the investors should not view the characteristics of risks and returns alone but should also be in the position to evaluate the overall portfolios associated with such risks and returns (Elton & Gruber, 1995, P.56). Whether the business person is conservative or aggressive, diversification through the asset allocation is crucial for ensuring that the organization meets its requirements and demands. Arguably, diversification is regarded as an investment tactic which is aimed at reducing the risk through the spreading of such risks among various investments. Furthermore, it is important because it reduces the overall portfolio volatility. When other investments in the portfolio are declining, some others which are flourishing will counterbalance the declining investment.
Even though a well-diversified portfolio is significant in the business, many investors do not practice the diversification. Some of the business people argue that diversification is expensive since it requires a lot of money for it to get started. They argue that if someone would like to have a diversified portfolio, he or she should be in the position to part with a pretty penny (Markowitz, 2009, P.89). Thus, some investors shy away from building a diversified portfolio and engage in building a single line of business.
Furthermore, some investors also argue that diversification is a time-consuming exercise. They explain that it can be a full-time job that which requires an investor to stay updated with what is happening in all the investments. The majority of the investors argue that it is difficult to manage the diversified investment portfolios than the single line type of business. Additionally, some of the investors argue that diversification is time commitment since one should keep abreast of the major news and listen to conference calls also read quarterly reports (Statman, 1987, P.108).
Moreover, some investors argue that the diversification may make the investing activities more expensive. Some of them argue that rapid diversification has the tendency of consuming much money than is expected. Investors see that when they engage in diversification, they might end up paying higher premiums, and thus the business realize slow growth rate.
Additionally, some of the investors also argue that the diversification can be a tax nightmare. They it on the perspective that the more an individual has a lot of businesses, the more he or she will pay higher taxes (Statman, 1987, P.78). Thus, they fear paying a lot of taxes than they can pay when they operate a single line of business.
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