Any business, even the most successful one, cannot function unchanged for any length of time. However, there is an important technique that increases the sustainability of the business model and significantly reduces the risk of critical losses under the influence of changed circumstances. It's about diversification.
The external environment is changing, and any model is invariably tested for strength, forcing us to constantly be aware of new trends and adjust our business in accordance with economic trends and changes in the business climate.
What is diversification and why is it necessary?
Generally speaking, this concept the opposite of specialization. Namely, expanding the range of products and services, as well as developing new markets.
Now everyone should ask a basic question: why is this necessary?
The answer will be equally trivial: for the sake of diversification. If you have never heard this word, it can be explained like this: don't put all your eggs in one basket.
That is, in the event of temporary difficulties or a systemic decline in the profitability of one segment of activity, alternative flows must exist and function that will keep the entire system afloat or even compensate for losses in an area experiencing a decline.
Business diversification
First of all, let's look at the diversification of production in business. We are not talking about expanding the model range, since most risk factors will act to the same extent on different models of products of the same type.
The assortment should be as different as the production base allows, taking into account the reasonable level of investment required to master the release of a new product.
An example of production diversification is the Czech concern Česká Zbrojovka, which, in addition to specialized production of weapons, has mastered the production of parts for the automotive and aviation industries using its own equipment and using its own engineering technologies. That's an example horizontal diversification.
A diversification strategy is not only useful for large businesses. For example, you can choose different instruments and reduce the risks when investing.
But remember that any investment in the family budget should be based on financial goals. Diversification is just one way to minimize risks.
The range of services may be subject to a similar expansion. For example, a real estate office simultaneously begins to provide services in the field of insurance not related to real estate, since its material, technical and personnel base allows it.
Another important aspect is the diversification of sales markets. This may require bringing production and services into compliance with new standards or developing an appropriate legal framework, obtaining new certificates and licenses.
In any case, the goal remains the same: to reduce losses from complications in one business segment by creating and supporting its alternative segments.
Most investors are familiar with the two main classes of securities: stocks and bonds.
However, in addition to these two types, each of us can make investments in wider range of property classes, such as real estate, commodities, gold, and even certain alternative strategies such as currencies, etc.
As a result, each investor can focus his investment portfolio on safe(bonds) and risky financial instruments(stocks, raw materials, gold).
When talking about diversification with new investors, the answer is that most people get this issue wrong. For example, it is widely believed that if funds are invested in different shares of companies in the same country, then this is already diversification. Or that if you invest in bonds of two neighboring countries, this will also be diversification. However, most often this is not the case.
Well, the most wrong example is investing in investment funds from two management companies or banks that promote the same direction of investment. Yes, such a division can be called diversification between managers, but this is not the process we are discussing in its true understanding.
When it comes to truly diversifying an investment portfolio, there are three essential things to consider: risk, correlation, and return.
The process of diversification is a risk management technique in which a portfolio includes many different asset classes with different negative or close to zero correlation. It is best if the selected asset class should achieve positive returns in the long term, but in the short term the financial flow generated by them should not be correlated.
It is for this reason that it is proposed to include in the investment portfolio not only the standard classes of property - stocks and bonds - but also less common types of it, such as real estate, raw materials and precious metals. Thus, the main element of diversification is insignificant correlation of financial instruments.
Risk diversification
However, when talking about a diversified investment portfolio, you cannot expect its results to be too impressive.
The main goal of diversifying an investment portfolio is reduction of overall risk without compromising profitability. At the same time, the profitability of investments is only a secondary concern.
The point of risk diversification is to ensure that a threat to one part of the business or one of the assets does not affect other parts. The less our segments overlap in different risk zones, the greater the security.
Drawing up an investment portfolio of assets with uncorrelated results reduces risk, because while the profit on one asset falls, on another it is likely to grow.
Let's consider the option with securities. It can be argued that by investing in stocks, we contribute to the growth of the economy, but if the economy goes into recession, the prices of most stocks undergo a correction. At such moments bonds can help, on which constant interest is accrued.
But what to do if inflation suddenly begins to rise, currencies devaluate, the price of oil rises sharply, or a military conflict occurs in a certain part of the world? In such cases, owning only stocks and bonds is not the best alternative.
For example, when inflation rises, the real profitability of bonds is most often negative, stocks do not provide optimal insurance against sharp increases in prices, but if we allocate a certain part of the investment portfolio to real estate, raw materials or gold, then we can expect more favorable results.
Another example is the increase in fuel prices. Very often, this has a negative impact on the profitability of companies, as transportation and other costs increase, causing the stock prices of these companies to also fall. But if the investment portfolio contains energy resources, then their rise in price generates a counterweight negative changes in prices for shares of transport companies.
Finally, in situations where there are thoughts of a collapse of the financial system, currency depreciation or similar market cataclysms, most investors direct funds into gold for the purpose of diversification.
If you already have a successful business, then perhaps it's time to move online. For example, you can - the audience on the Internet and offline are different. Some call it market expansion, and some call it diversification, either way it's worth a try.
To assess the performance of a business and staff, we recommend using KPIs; you can read about these indicators.
If you are interested in financial analytics, then from the article at the address you will learn what EBITDA is and what this indicator is used for.
Conclusion
Business diversification allows it is relatively painless to endure temporary difficulties- interruptions in sales, a short-term decline in demand or prices for products - and in the event of a long-term crisis, alternative branches of the enterprise’s activities can come to the fore and become the basis for repurposing the company according to a new strategy.
At the same time, diversification, especially in the case of production, usually requires additional investments - in new equipment, technologies, personnel. The correct decision should be based on a comparison of such costs with the price of risk.
A well-diversified investment portfolio will not help avoid short-term losses, however, one thing is clear: with a portfolio of a wide range, i.e., broken down into different asset classes, you can expect approximately the same or slightly higher profitability, at the same time reducing the overall level of risk. This should be the starting point of every new investor.
Diversification is an investment approach aimed at reducing financial markets
Concept, basic methods and goals of diversification of production, business and financial risks in the currency, stock and commodity markets
Expand contents
Collapse content
Diversification is, definition
Diversification is an investment approach aimed at minimizing risks arising during production or trade, associated with the distribution of financial or production resources across different industries and areas. Diversification has become widespread in the foreign exchange and stock markets as a means of minimizing losses during trading.
Diversification is expanding the range of products and reorienting sales markets, developing new types of production in order to increase production efficiency, obtain economic benefits, and prevent bankruptcy. This diversification is called production diversification.
Diversification is the process of a firm's penetration into other industries. A diversification strategy is used to ensure that an organization does not become overly dependent on one strategic business unit.
Diversification is one of the forms of capital concentration. By diversifying their production, firms penetrate new industries and areas.
Diversification is expansion of the company's scope of activity to the production of different types of products or to different markets. Almost all firms are diversified to one degree or another: firms that produce only one product.
Diversification is one of the ways to reduce the risk of an investment portfolio is to distribute investments among the various assets included in it.
Diversification is distribution of capital between various investment objects in order to reduce the risk of possible losses (both capital and income from it).
Diversification is the process of expanding the scope of an enterprise’s activities or producing a diverse range of products, which, as a rule, do not correspond to the existing production profile.
Diversification is a self-organizing process of increasing diversity in a given local area of a broader whole; the process of expanding the structural features and properties or functional purpose (consumer qualities) of a manufactured product or the means of influencing it during its creation; enriching the content and nature of work through the growth of its internal diversity, increasing diversity in the field of culture and art, in recreational areas, etc.; expansion (extensive and intensive) of the profile of industrial enterprises and associations; spin-off of subsidiaries from the parent company or enterprise, association or concern with an increase in the range, volume and types of services. The science of change and stabilization of diversity - diatropics (Yu. V. Tchaikovsky).
Diversification is a marketing decision, a strategy that means an enterprise’s entry into a new market for it, the inclusion in the production program of products that do not have a direct connection with the previous field of activity of the enterprise.
Diversification is allocation of an investment fund among securities with different risks, returns and correlations, in order to minimize unsystematic risk.
General characteristics of diversification
The financial activity of an enterprise in all its forms is associated with numerous risks, the degree of influence of which on the results of this activity increases significantly with the transition to a market economy.
The risks accompanying this activity are identified as a special group of financial risks that play the most significant role in the overall “risk portfolio” of the enterprise. The increasing degree of influence of financial risks on the financial performance of an enterprise is associated with the rapid variability of the economic situation in the country and the financial market, the expansion of the scope of financial relations, the emergence of new financial technologies and instruments for our economic practice, and a number of other factors.
In the system of methods for managing financial risks of an enterprise, the main role belongs to external and internal risk neutralization mechanisms.
Internal mechanisms for neutralizing financial risks are a system of methods for minimizing their negative consequences, selected and implemented within the enterprise itself.
The main objects of use of internal neutralization mechanisms are, as a rule, all types of acceptable financial risks, a significant part of the risks of the critical group, as well as uninsurable catastrophic risks if they are accepted by the enterprise due to objective necessity. In modern conditions, internal neutralization mechanisms cover the majority of the financial risks of an enterprise.
The advantage of using internal mechanisms to minimize financial risks is the high degree of alternativeness of management decisions made, which, as a rule, do not depend on other business entities. They are based on the specific conditions for the financial activities of the enterprise and its financial capabilities, and make it possible to take into account to the greatest extent the influence of internal factors on the level of financial risks in the process of minimizing their negative consequences.
The system of internal and external mechanisms for minimizing financial risks involves the use of the following main methods.
Risk avoidance. This direction of neutralizing financial risks is the most radical. It consists in developing such internal measures that completely eliminate a specific type of financial risk. The main such measures include:
Refusal to carry out financial transactions, the level of risk of which is extremely high. Despite the high efficiency of this measure, its use is limited, since most financial transactions are associated with the implementation of the main production and commercial activities of the enterprise, ensuring the regular receipt of income and the formation of its profit;
Refusal to use high amounts of borrowed capital. Reducing the share of borrowed funds in economic turnover allows one to avoid one of the most significant financial risks - the loss of financial stability of the enterprise. At the same time, such risk avoidance entails a reduction in the effect of financial leverage, i.e. the possibility of obtaining an additional amount of profit on invested capital;
Refusal of excessive use of current assets in low-liquid forms. Increasing the level of liquidity of assets allows you to avoid the risk of insolvency of the enterprise in the future. However, such risk avoidance deprives the enterprise of additional income from expanding the volume of sales of products on credit and partially gives rise to new risks associated with disruption of the rhythm of the operating process due to a decrease in the size of safety stocks of raw materials, supplies, and finished products;
Refusal to use temporarily free monetary assets in short-term financial investments. This measure avoids deposit and interest rate risk, but generates inflation risk, as well as the risk of lost profits.
These and other forms of avoiding financial risk deprive the enterprise of additional sources of profit generation, and accordingly negatively affect the pace of its economic development and the efficiency of using its own capital. Therefore, in the system of internal mechanisms for neutralizing risks, their avoidance should be carried out very carefully under the following basic conditions:
If the rejection of one financial risk does not entail the emergence of another risk of a higher or unambiguous level;
If the level of risk is not comparable with the level of profitability of a financial transaction on the “return-risk” scale;
If financial losses for this type of risk exceed the possibility of their compensation at the expense of the enterprise’s own financial resources, etc.
Limiting risk concentration is setting a limit, i.e. maximum amounts of expenses, sales, loans, etc. Limitation is an important method of reducing risk and is used by banks when issuing loans, concluding an overdraft agreement, etc. It is used by business entities when selling goods on credit, providing loans, determining the amount of capital investment, etc.
The mechanism for limiting the concentration of financial risks is usually used for those types of risks that go beyond their acceptable level, i.e. for financial transactions carried out in an area of critical or catastrophic risk. This limitation is implemented by establishing appropriate internal financial standards at the enterprise in the process of developing policies for implementing various aspects of financial activities.
The system of financial standards that ensure limiting the concentration of risks may include:
The maximum size (share) of borrowed funds used in economic activities;
Minimum size (share) of assets in highly liquid form;
The maximum size of a commodity (commercial) or consumer loan provided to one buyer;
The maximum size of a deposit placed in one bank;
The maximum amount of investment in securities of one issuer;
The maximum period for diversion of funds into accounts receivable.
Hedging is used in banking, stock exchange and commercial practice to refer to various methods of insuring currency risks. In the domestic literature, the term “hedging” began to be used in a broader sense as insurance of risks against unfavorable changes in prices for any inventory items under contracts and commercial transactions involving the supply (sale) of goods in the future. A contract that serves to insure against the risks of changes in exchange rates (prices) is called a “hedge,” and the business entity carrying out the hedging is called a “hedger.”
There are two hedging transactions: upside hedging and downside hedging.
Upside hedging, or purchase hedging, is an exchange transaction for the purchase of futures contracts or options. An upward hedge is used in cases where it is necessary to insure against a possible increase in prices (rates) in the future.
Downward hedging, or sell hedging, is an exchange transaction involving the sale of a futures contract. A hedger who hedges down expects to sell a commodity in the future, and therefore, by selling a futures contract or option on the exchange, he insures himself against a possible price decline in the future.
Depending on the types of derivative securities used, the following mechanisms for hedging financial risks are distinguished: hedging using futures contracts; hedging using options; hedging using a swap operation.
Risk distribution. The mechanism of this direction of minimizing financial risks is based on their partial transfer (transfer) to partners in individual financial transactions. At the same time, that part of the enterprise’s financial risks is transferred to business partners for which they have more opportunities to neutralize their negative consequences and have more effective methods of internal insurance protection.
Diversification is the process of allocating capital among different investments that are not directly related to each other. Diversification is the most reasonable and relatively less costly way to reduce the degree of financial risk.
The following main areas of risk distribution have become widespread:
Distribution of risk between participants in the investment project. In the process of such distribution, the enterprise can transfer to contractors the financial risks associated with failure to fulfill the schedule of construction and installation work, the low quality of this work, theft of construction materials transferred to them, and some others. For an enterprise transferring such risks, their neutralization consists of redoing the work at the expense of the contractor, paying them amounts of penalties and fines and other forms of compensation for losses incurred;
Distribution of risk between the enterprise and suppliers of raw materials and materials. The subject of such distribution is, first of all, financial risks associated with loss (damage) of property (assets) during their transportation and loading and unloading operations;
Distribution of risk between participants in a leasing operation. Thus, with operational leasing, the enterprise transfers to the lessor the risk of obsolescence of the asset used, the risk of loss of technical productivity;
Distribution of risk between participants in a factoring (forfeiting) operation. The subject of such distribution is, first of all, the credit risk of the enterprise, which in its predominant share is transferred to the relevant financial institution - a commercial bank or factoring company.
Self-insurance (internal insurance). The mechanism of this direction of minimizing financial risks is based on the enterprise reserving part of its financial resources, which allows it to overcome the negative financial consequences of those financial transactions for which these risks are not associated with the actions of counterparties. The main forms of this direction of neutralizing financial risks are:
Formation of a reserve (insurance) fund of the enterprise. It is created in accordance with the requirements of legislation and the charter of the enterprise. At least 5% of the amount of profit received by the enterprise in the reporting period is allocated for its formation;
Formation of target reserve funds. An example of such a formation could be a price risk insurance fund; fund for markdown of goods at trading enterprises; fund for repayment of bad debts, etc.;
Formation of a system of insurance reserves of material and financial resources for individual elements of the enterprise’s current assets. The size of the need for safety stocks for individual elements of current assets (raw materials, materials, finished products, cash) is established in the process of their rationing;
The undistributed balance of profit received in the reporting period.
Risk insurance is the most important method of reducing risk.
The essence of insurance is that the investor is ready to give up part of his income in order to avoid risk, i.e. he is willing to pay to reduce the risk to zero.
Currently, new types of insurance have appeared, for example, title insurance, business risk insurance, etc.
Title is the legal right of ownership of real estate, which has a documented legal side. Title insurance is insurance against events that happened in the past that may have consequences in the future. It allows real estate buyers to expect compensation for losses incurred in the event of a court order disposing of the real estate purchase and sale agreement.
Business risk is the risk of not receiving expected income from business activities. The insured amount should not exceed the insured value of the business risk, i.e. the amount of business losses that the policyholder would be expected to incur if the insured event occurred.
Other methods for minimizing risk may include the following:
Ensuring the collection of an additional level of risk premium from the counterparty to a financial transaction;
Obtaining certain guarantees from counterparties;
Reducing the list of force majeure circumstances in contracts with counterparties;
Ensuring compensation for possible financial losses due to risks through the provided system of penalties.
Diversification in stock markets
Diversification of a securities portfolio is the formation of an investment portfolio from a certain set of securities in order to reduce possible losses in the event of a decrease in the price of one or more securities.
Also, diversification of a portfolio of securities on the stock market can be used not only for the purpose of protecting against a possible decrease in the value of some securities included in the investment portfolio, but also for the purpose of increasing the overall profitability of the portfolio.
Some securities selected for the portfolio in accordance with the investment strategy may demonstrate significantly better dynamics than other securities, which in general may have a positive effect on the overall profitability of the investment portfolio.
In the process of forming an investment portfolio on the stock market, the following questions arise: how many securities should be in the investment portfolio and what should be the share of shares of each issuer in this portfolio?
There is no definite answer to this question, because even 2 securities are already a kind of portfolio.
Some investors, such as W. Buffett, believe that an investment portfolio should not contain more than 3-5 shares of different companies.
Diversification, in their opinion, which includes investing in weak sectors, is likely to show mediocre results, close to the market average.
Diversification is most often seen as a way to reduce risks.
At the same time, this can significantly affect the rate of expected return on the portfolio - the more diversified the investment portfolio, the lower the overall rate of return on the portfolio may be.
Each time an investor adds another stock to an investment portfolio, the investor thereby reduces the overall average expected return across the entire investment portfolio.
Thus, while diversification protects our portfolio from certain risks, it also reduces the potential return of the entire portfolio of securities.
In addition, the more stocks included in an investment portfolio, the more closely you will have to monitor such a portfolio.
On the other hand, Peter Lynch, the famous manager of the Fidelity Magellan Fund, included about 1,000 stocks in his portfolio when forming and managing his investment portfolio.
The profitability of such a portfolio exceeded the market average.
Personally, I believe that it is worth forming your investment portfolio from shares of 8-12 issuers; this will be quite enough to diversify risks without significantly harming the potential rate of return on the portfolio.
If you think that you are capable of carrying out sufficiently high-quality and accurate
analysis of companies when forming an investment portfolio and you have sufficient experience and the necessary knowledge for this, then select the most promising shares of several issuers from the total in accordance with your investment strategy.
If you do not have sufficient knowledge, you can rely on the opinion of financial experts if they seem logically reasonable and justified to you, or build your investment portfolio from the most liquid securities included in the index.
Share of the issuer's shares in the investment portfolio
There is also no clear answer to this question.
There are several ways to determine the share of shares when forming an investment portfolio:
Proportional to the company's market capitalization;
Proportional to the free float of the company's shares;
Based on potential returns and forecasts of future stock prices;
Compiling a portfolio of shares from equal shares.
Each of these methods has its own specific subtleties and nuances.
It is up to you to decide which method of forming the share of shares of each issuer in the investment portfolio.
When forming an investment portfolio according to the principle of equal shares, the share of shares of each issuer in the portfolio has the same weight.
For example, this could be a portfolio of shares of 10 issuers with a corresponding share of the total portfolio of 10%.
In this case, when forming a portfolio, shares are selected that satisfy certain criteria in accordance with our investment strategy, for example, with the highest dividend yield or having the maximum potential profitability.
In this case, the portfolio is also rebalanced when it is more convenient for you, for example, once a quarter, and the shares of each stock in the total portfolio value are equalized.
At the same time, changes will periodically occur in our investment portfolio - those shares that no longer satisfy our investment strategy will be excluded from the portfolio, and new ones will appear in their place with the same share in the overall portfolio, satisfying our criteria.
And do not forget about the principles of diversification of the investment portfolio, and why diversification is necessary.
Diversification in foreign exchange markets
Risk diversification, or in other words risk distribution, is an integral part of trading on the Forex currency market.
As you know, the foreign exchange market very often moves due to unforeseen events and the human factor. Often a trader cannot predict in which direction prices will move in the near future. Thus, a trader needs to have a truly diversified portfolio of investment strategies. A trader must learn to sacrifice some of the potential maximum return of a net asset portfolio in order to preserve capital during periods of currency market fluctuations.
All traders understand that Forex trading carries a certain percentage of risk. While portfolio diversification may seem extremely easy, it is not. Since most novice traders lose a significant part of their funds.
Because all traders trade on margin in the forex market, it allows them to use enormous leverage with minimal requirements. The most commonly used leverage is 1:100. The trading leverage provided can be a powerful tool for a trader, but there are two sides to this coin. While leverage does contribute to the risk of a trader's position, it is a necessary measure to operate in the foreign exchange market. This happens solely because the average daily movement in the market is 1%.
It is precisely because the foreign exchange market is of this nature that every trader must diversify his risks within his trading accounts. Diversification can be achieved through the use of different trading strategies. As an option for diversification, transferring part of trading assets to the management of other traders can be used. The point here is not that another trader will have a better result than you, but that diversification will be achieved this way. Regardless of how much trading experience you have, you will still face periods of ups and downs. This is why having more than one trader will slightly reduce the volatility of the trading portfolio.
Naturally, in addition to the opportunity to transfer part of the capital to another trader for management, this is not the only option for diversifying risks in Forex. There are a huge number of strategies and trading theories, and there are also a huge number of ways to diversify the risks associated with Forex trading.
There are a sufficient number of different currency pairs on the foreign exchange market, each of which has its own volatility. For example, everyone’s favorite USDCHF pair is generally considered a safe haven, and, for example, GBPJPY is an unbroken stallion, galloping long distances in points, which indicates both high potential income and losses. Thus, “putting your eggs in two different baskets” - dividing the capital for trading into these two pairs, you can quite easily reduce risks if the trader prefers aggressive trading.
Technically, a diversified portfolio should consist of uncorrelated assets, i.e. unrelated (in practice, minimally related) assets. Therefore, it is quite difficult to diversify your assets in a single market. As for semantics, it would be more correct to talk about hedging risks in the Forex market, rather than diversification.
Diversification, like any other method of money management, has a significant disadvantage - as risks decrease, potential income also decreases. Therefore, people often speak negatively about diversification, believing that it is necessary to focus on one area - if you win, you will win a lot right away, and if you lose... The thought ends there.
In practice, competent diversification involves investing in the real sector of the economy (trading goods, providing services) and financial instruments, be it securities, deposits or trading on the foreign exchange market. It’s not for nothing that you can increasingly hear advice to invest as much as you can afford to lose. It is purely psychologically difficult to incur huge losses, realizing that this is the main asset and without it life will turn into slavery, therefore it is strongly recommended to cover your rear by having a constant source of income outside the foreign exchange market.
Diversification in commodity markets
Traded commodities are divided into five main groups: energy – which includes crude oil, petroleum products, gas; metals - in turn divided into industrial (copper, zinc, aluminum, steel, etc.) and precious (gold, silver, platinum); grains – wheat, corn, soybeans, rice, oats, etc.; food products and fiber - coffee, cocoa, sugar, cotton, orange juice, etc.; livestock farming – live cattle, pork, beef. Similar to stock indices, the overall performance of commodities can be tracked using commodity indices. The differences between the indices are mainly related to the weights of certain groups of goods included in the calculation of the index.
The main commodity market indices are: CRB index – the calculation takes into account 17 types of raw materials with equal weights; Dow Jones - AIG Commodity Index - the weight of each product is set depending on the volume of exchange transactions over the past 5 years; GSCI – weight corresponds to the share of each product in world production; RICI - reflect the share of goods in world trade. Low global economic growth and, as a result, fairly low inflation have not contributed to high returns on investments in commodities in the last two years - in fact, only soybean meal has outperformed the S&P 500 index over this period. However, an acceleration in economic growth and inflation rates in the near future will make raw materials a desirable investment.
The diversification strategy involves dynamic changes in the portfolio structure depending on market conditions. During periods of global economic growth, the emphasis is on fast-growing commodities (fertilizers, industrial metals, energy resources); during periods of crisis, defensive assets such as gold and silver are used.
Advantages of the strategy:
Raw materials are a real asset that will always be in demand on the market and have a certain value;
There is a long-term positive trend in the world market towards a reduction in supply and an increase in demand for raw materials, especially from the Asian region;
Investments in commodity assets are an excellent opportunity to hedge against global inflation and depreciation of the US dollar;
Some commodities, such as gold, have historically been used as a hedge against crises and inflation due to their low correlation with financial markets.
Capital management in the commodity markets of the world is the preservation and increase of capital and insurance of risks, and one of the main steps towards creating your own diversified investment capital.
Diversification of production
In economic practice, a large number of strategic alternatives for the development and growth of firms in market conditions can be proposed. One of these alternatives is diversification.
There are a large variety of definitions of diversification in the economic literature. But the difficulty is that diversification is a concept that cannot be clearly defined. Different people mean different things by it, so the important thing is to be able to recognize and interpret the concept in relation to your circumstances. Nevertheless, it is possible to give a fairly general, broad definition of diversification, but with some comments. This will provide some basis for further analysis. It is well known that from an economic point of view, diversification (from the Latin diversus - different and facer - to do) is the simultaneous development of several or many unrelated technological types of production and (or) services, expanding the range of products and (or) services produced.
Diversification allows firms to “stay afloat” in difficult economic conditions by producing a wide range of products and services: losses from unprofitable products (temporarily, especially for new ones) are offset by profits from other types of products. Diversification is: firstly, the penetration of firms into industries that do not have a direct production connection or functional dependence on the main industry of their activity.
Secondly - in a broad sense - the spread of economic activity to new areas (expansion of the range of products, types of services provided, etc.). Diversification of production and business activity, being a tool for eliminating imbalances in reproduction and redistribution of resources, usually pursues different goals and determines the directions for restructuring corporations and the economy as a whole.
This process concerns, first of all, the transition to new technologies, markets and industries to which the enterprise previously had no connection; in addition, the products (services) of the enterprise themselves must also be completely new, and new financial investments are always necessary.
Diversification is associated with the variety of applications of products manufactured by the company, and makes the efficiency of the company as a whole independent of the life cycle of an individual product, solving not so much the problem of the company’s survival as ensuring sustainable progressive growth. If a company's products have a very narrow application, then it is specialized; if they have a variety of uses, then it is a diversified company.
Diversified companies differ depending on the classification of their product range in relation to the technologies used and marketing features.
The classification shown applies only to currently released products or services and does not affect changes to the product or services. In market conditions, classifying an enterprise as one type or another is absolute at the moment and relatively in the long term, since over time a specialized enterprise can be transformed into a diversified one and vice versa.
The ideal activity of any company, as we know, is to prevent possible failures and losses in productivity, which can be obtained from various company forecasts regarding these particular indicators. The need for diversification can be identified by comparing the desired and possible levels of productivity and the level that was achieved as a result of the company's activities. For less successful companies that do not (or cannot) plan for the future, the first sign of such a productivity gap is often a shrinking order book or idle capacity.
In any given case, a number of reasons for diversification may play an important role, but the weaker influence of other reasons may ultimately lead to a different solution to the problem. I. Ansoff believes that the main reason is the lack of compliance with the required level of productivity and efficiency.
All reasons for diversification are caused by one thing - to increase the efficiency of the enterprise not only at the moment or in the near future, but also for the long term.
There is a diversification criterion. Establishing such a criterion is recommended only for an enterprise that is truly interested in its diversification. This first essential "cover" is invaluable, since it prevents various errors and, in addition, can serve as a safety program and good control.
The process of developing an assessment and diversification plan takes time, effort and careful consideration. A conclusion that was made in one evening cannot be the basis for market research, technical research of processes and products, financial analysis, even any meeting and services of external experts to provide any information. Indeed, it is necessary only as a basis in order to decide at the very beginning whether or not this problem should be dealt with seriously. An assessment may show that all this is really good, but not for this company.
Types of production diversification
The relationship between the financial position of a corporation and diversification of activities is quite simple, since the former determines the direction and effectiveness of the latter. Thus, the areas of diversification characteristic of the initial stages of development were based on an objective basis - alternative use of waste, production facilities, trade and commercial networks and were closely related to the financial capabilities of traditional production.
The difference between the following stages of diversification was the reduction of the role of the main production; it was not limited to expansion into its own or related industries and was accompanied by a complete separation of financial interests from the interests of production. With the development of both corporations and diversification itself, the goals of making a profit were achieved by expanding the opportunities for migration of resources beyond the boundaries of the industry, region, and national economy. Therefore, the two directions in the development of entrepreneurial activity can easily be explained by the evolution of the process from related diversification to unrelated or “autonomous”.
The classic definition given in the small explanatory dictionary of foreign words: “A holding company (holder company) is a company that owns a controlling stake in any other enterprises for the purpose of controlling and managing their activities.” It reveals the essence of the classical understanding of a holding (from an economic point of view) - there are shareholders who own shares, who either manage the holding structure themselves, or entrust the management of the general business to a management company.
Horizontal holdings are an association of homogeneous businesses (energy companies, sales, telecommunications, etc.). They are, in fact, branch structures managed by the parent company.
Vertical holdings are the association of enterprises in one production chain (extraction of raw materials, processing, production of consumer products, sales). Examples: associations involved in the processing of agricultural products, metals, and oil refining.
Mixed holdings are the most complex example. Such a holding includes structures that are not directly connected by either trade or production relations, such as, for example, Russian banks that invest funds in some enterprises. Their main task is to invest funds somewhere and then withdraw them profitably in a timely manner. Essentially, these are investment projects.
As for the types of holdings, it is necessary to clarify some concepts. The classification can be slightly transformed:
Diversified holdings (mixed) - a combination of unrelated businesses. (A typical example is when banks buy shares of various enterprises)
Sales holdings (horizontal). The really important thing about them is unified logistics: a single system of suppliers and many sales cells. If there are many cells, then a standard is needed to create a new sales point (and automation must support it). From a logistics point of view, the specificity of the holding is that the recipient is dispersed. There are always leftovers in the warehouses of sales cells and the task is to redistribute them. A unified policy regarding a specific type of product is possible (implemented in the form of discounts, gifts for customers, etc.). In this case, centralization of management plays an important role in the development of a general policy for the liquidation of residues.
If a holding wants to consolidate everything correctly (in terms of taxes and management accounting), then it must establish a single standard for document flow. This will allow, in particular, to conduct a unified marketing research directly in the sales process. (Particularly interesting results are obtained precisely when there are many sales points. It is possible to identify the dependence of demand on the region, location, and national specific preferences) With the proper use of this aggregated marketing information, it is possible to avoid leftovers and illiquid stock in warehouses. This is very significant for trading holdings. Thus, the advantages of a unified supply and sales network are that it becomes possible, firstly, to purchase goods from suppliers at lower prices (aggregate discount), secondly, to pursue a unified sales and marketing policy and, thirdly, to be flexible and quickly redistribute balances in warehouses, preventing the formation of illiquid stock (cost savings).
Concern-type holdings. They are characterized by a chain of processing processes that unites them from raw materials to finished goods. This case has its own characteristics:
Enterprises transfer their product to each other at cost (there is no point in profiting from each other);
It is necessary to ensure end-to-end quality management throughout the entire chain (up to the implementation of ISO 9000);
All enterprises of the concern must be balanced in terms of the level of equipment of production processes, personnel qualifications, etc.
That is, one of the most common ways to combine enterprises into diversified corporate associations is to organize a holding company. The implementation of this scheme makes it possible to clearly resolve all problems in the ownership structure and the system of relationships in the hierarchy of the corporation.
Thus, the most adequate response to economic globalization is business diversification and the creation of diversified corporate associations.
The main purpose of diversification is usually to ensure the survival of the organization, strengthen its competitiveness and increase profitability. Any commercial company tries to stay afloat and accordingly looks for how to achieve this. It is diversification and the search for new areas of effective activity that allows the company to accelerate its development, generate additional income and gain new competitive advantages.
It is generally accepted that diversification of a company - be it expanding its scope of activity by opening new production facilities or acquiring subsidiaries of various profiles by the holding - is a double-edged phenomenon. And in each specific case, management, when choosing directions for development, must consider both positive and negative consequences.
There are two main types of diversification - related and unrelated.
Related diversification is a new area of a company's activities that is related to existing areas of business (for example, manufacturing, marketing, supplies, or technology). There is an opinion that related diversification is preferable to unrelated diversification, because the company operates in a more known environment and takes less risk. If the accumulated skills and technologies cannot be transferred to another structural unit, and there are not so many opportunities for growth and development, it may make sense to take risks and the company should resort to unrelated diversification.
Unrelated diversification is expressed in the transition of a company to an area other than its existing business, to new technologies and market needs. It is aimed at obtaining greater profits and minimizing business risks. With the help of this strategy, specialized firms turn into diversified conglomerate complexes, the components of which have no functional connections with each other. Unrelated diversification is more difficult than related diversification.
As the organization enters a hitherto unknown competitive field, it must master new technologies, forms, methods of organizing work, and much more that it has not encountered before. That is why the risk here is much higher. An example of such diversification is the entire post-Soviet space. During the times of perestroika and cooperatives, many residents of the country were engaged in the production of clothing, everyday products and at the same time were engaged in the supply of products and goods from abroad. In this regard, it can be considered possible to assert that almost the entire population of the post-Soviet space has, to a greater or lesser extent, experienced the delights and burdens of unrelated diversification.
In practice, both large-scale, related or unrelated diversification, and local, experimental micro-diversification are widely used. The latter is implemented in the form of the introduction of individual elements of large-scale diversification, which can later form into an independent production unit. It is local, small experimentation that can subsequently give birth to a new large-scale production.
But it should be borne in mind that diversification is a very labor-intensive and complex process that can bring not only dividends, but also problems and losses.
Most companies turn to diversification when they create financial resources beyond those needed to maintain a competitive advantage in their original business areas.
Diversification can be carried out in the following ways:
Through the internal capital market;
Restructuring;
Transfer of specific arts between strategic economic zones;
Division of functions or resources.
Diversification through the internal capital market performs the same functions as the stock market. In the internal capital market, the main office plays the following main roles:
Performing strategic planning functions, consisting in determining the portfolio of the corporation’s strategic business area;
Defining financial goals and monitoring activities of the strategic management area;
Allocation of corporate capital among competing strategic business areas.
Under these conditions, strategic management zones are autonomous profit centers that are only under the financial control of the head office.
The restructuring strategy is one of the types of domestic capital market strategy. The difference lies in the degree of interference of the head office in the activities of strategic management areas. Companies that undergo turnarounds were usually poorly managed during the process of creation and development. The goal is to help them intensify their activities, change their behavior, develop new strategies at the SZH level and infuse new financial and technological resources into the company.
In the case where a strategy of transferring art or business experience is used, the new type of business is considered as related to existing agricultural activities (for example, in the field of production, marketing, supply, R&D). Typically, transfers of such arts are used that reduce costs in a diversified company.
Diversification through resource allocation is possible if there are significant similarities between one or more important functions of existing and new SBAs. The purpose of resource allocation is to realize synergies in the company’s activities using common production facilities, distribution channels, promotion means, R&D, etc. Thus, less investment is required in each SZH compared to an autonomous solution to this issue.
When deciding to diversify a company's activities, the cost of running such a company should be taken into account. These costs are determined by the number of SZHs and the need for coordination between them. Thus, management costs are higher in a company with 12 agricultural enterprises that have a certain synergy than in a company with 10 agricultural enterprises that do not have this quality. This is illustrated in Fig. 3. The unit costs of managing a diversified company with a high need for coordination (MHCN) are compared with those for a company with a low need for coordination (LMCL).
Let's assume that a company with a high need for coordination seeks to strengthen its position through SBA synergies. And a company with little coordination needs follows an internal capital market or restructuring strategy. As can be seen, at each level of diversification the corresponding values of direct MBCH are greater than the values of MBCL. If we assume that both companies have the same unit cost curves for managing MVA, the company with a low need for coordination has a management profitability greater than the company with a high need for coordination.
Unrelated diversification does not require coordination between SBAs. Consequently, management costs increase with the number of storage facilities in the company's portfolio. In contrast, companies with related diversification incur costs that increase with both the number of SBAs and the degree of coordination required between them. These increased costs can wipe out the higher returns from associated diversification.
Thus, the choice between related and unrelated diversification depends on a comparison of the profitability of diversification and the additional unit costs of management.
A firm should focus on related diversification where the company's core skills can be used in a wide range of industry and business situations, and management costs do not exceed those required to allocate resources or transfer skills. By the same logic, companies should concentrate on unrelated diversification if the skills of the basic agricultural sector are highly specialized and do not have external applications, and management costs do not exceed the values necessary to implement the domestic market strategy.
The opposite strategy to diversification may be the creation of a strategic alliance between two or more companies in the areas of cost, risk and reward associated with exploiting new business opportunities (for example, in R&D). However, there is a risk of the partner's access to key technology.
For a diversified company, its strategy must make it more than the sum of its BPA. It consists of actions to gain positions in various industries and improve the management of each agricultural sector and their entire complex.
Production diversification methods
Diversification methods are strictly dependent on business and management. Diversification requires such a degree of flexibility that no one should be excluded at the outset of planning activities. Each case of diversification requires an appropriate approach and analysis, but all possible methods must be considered at the same time. Diversification programs may contain one of the following methods.
All existing personnel as well as equipment should be used to achieve a greater variety of products and services in the future. This method is quite natural for companies whose staff are imbued with the spirit of research.
Increased productivity occurs due to an increase in the quantity of equipment and the quality of the organization, which, as a rule, leads to an increase in the range of products.
A firm engaged in a particular line of business is acquired through an acquisition, either for cash or stock, or a combination of both. Central corporate functions extend to both the new department and the management skills and experience of the acquired company and begin to work as a whole and for the newly formed company.
A merger of companies of approximately the same size and type of activity.
An interest in a company that manifests itself as direct participation or control over another company, but nevertheless the affiliated company continues to function as an independent structure.
The entire process of involving cash, management talent, technical skills, patents and other resources must proceed in such a way that the company can derive from it certain types of advantages, for example, guaranteed supplies of raw materials and returns on investments, certain benefits from cooperation with other firms. In some cases, companies may form a new corporation.
Supporting the operator or consumer to change diversification or expand their activities. By and large, the buyer's needs in a sanatorium-resort complex can be characterized as a significantly contributing factor to diversification.
It is impossible to present all the above options with all the details, since each diversification situation has different aspects. Diversification covers a wide range of possibilities, ranging from a fairly limited entry into a new area of production only within a given country ("narrow" diversification) to a broad entry into the production areas of other countries ("broad" diversification).
The first thing to do when considering this problem is to perform a fairly simple analysis of this spectrum. According to this, we have what is commonly called “vertical integration,” when a company uses part of its resources to form or acquire organizations that will supply the necessary materials and raw materials for this company and/or will provide markets for the products of this company .
Ways of diversification
The first way: development of new segments. We can predict with reasonable confidence that in the near future the structure of the Russian market will change significantly. Following the already ongoing structural changes in trade and distribution caused by the development of retail chains, structural changes in industry are beginning. Manufacturing companies are abandoning non-core operations and moving to outsourcing, and this stimulates the development of specialized companies that are ready to compete with inefficient internal divisions. For many companies, a unique opportunity is opening up to “catch the wave” and become a leader in emerging and rapidly growing markets.
The second way: alliances. In Russian practice, successful alliances with foreign companies are still rare. According to experts, not only Russian, but also Western managers often cannot formulate a strategically and economically understandable reason for their interest in an alliance with a specific company. For many Russian companies, the most realistic way to overcome the backlog is to enter into alliances with foreign partners and purchase licenses. It is clear that Russia is still a fairly attractive place for foreign companies in terms of cheap human and energy resources, and there are things that are interesting to us, that is, a mutually beneficial division of labor is possible.
The third way: foreign markets. The more specialized the company, the more clearly it senses the limited volume of the domestic market. Then the question arises: to diversify, develop new products in Russia, or to specialize, to expand the business to the foreign market? Typically, leading Russian companies choose diversification.
Managers usually point out the lack of a product that could be competitive in foreign markets. This is fair, but it hardly follows from this that there are no prospects at all. Rather, we need to focus on gradual movement towards the creation of such a product. Typically, the market of developing countries is considered as the main export market for Russian companies. But a number of entrepreneurs believe that it is realistic to develop the markets of developed countries.
It can be predicted that the process of specialization will actively develop in the coming years. And in the current situation, assessing the time available to them to make and implement restructuring decisions becomes critically important for companies.
Goals of production diversification
There are a number of motives and goals that most often serve as incentives for expanding the scale of activity.
Prerequisites:
Uneven development of economic sectors (law of uneven economic development);
The law of falling rates of profit in traditional production (the law of the tendency of the rate of profit to decrease);
Development of scientific and technological progress.
Motives:
Technical and technological. The desire to more fully utilize production capacity and maintain production potential. Alternative options for the use of raw materials, materials, technologies. Unemployment and underutilization of resources.
Economic. Re-accumulation of capital in traditional industries and the search for new areas of capital application. Expanding market share, conquering new markets, extracting synergistic effects. Economies of scale. Economic resource limitations.
Financial. Distribution of markets among large volumes of production. Financial stability.
Social. Retention of workers. Creation of new jobs. Satisfying other needs. Innovation policy of managers.
Strategic. Adaptation to market conditions. Countering market fluctuations. Insurance of the future enterprise. Antimonopoly legislation. Mergers and acquisitions. Government order.
Goals:
Economic stability and financial sustainability;
Profit;
Competitiveness.
All these motives can exist separately, but they can also be combined with each other - it depends on the specific circumstances in each company, therefore the choice of the form of diversification must be well justified and carefully planned in accordance with these circumstances.
In general, there are three types of diversification opportunities.
Each product offered by a company must consist of functional components, parts and basic materials that will later form a single whole. It is usually for the benefit of the manufacturer to purchase a large proportion of these materials from outside suppliers. One of the well-known ways of diversification is vertical diversification, which is characterized by the expansion and branching of components, parts and materials. Perhaps the most striking example of vertical diversification is the Ford empire during the time of Henry Ford himself. At first glance, vertical diversification may seem inconsistent with our definition of diversification strategy. However, the respective missions that these components, parts and materials must fulfill are significantly different from the mission of the entire final product. Moreover, the technology used to develop and manufacture these parts and materials is also likely to differ significantly from the technology used to produce the final product. Thus, vertical diversification implies both the acquisition of new missions and the introduction of new products into production.
Another possible option is horizontal diversification. It can be characterized as the introduction of new products when they do not fit in any way with the existing product range, and acquire missions that are consistent with the company's know-how and its experience in technology, finance and marketing.
It is also possible, through lateral diversification, to expand beyond the industry in which the company operates. If vertical and horizontal diversification are, in fact, restraining (in the sense that they limit the sphere of interests), then lateral diversification, on the contrary, contributes to its expansion. By doing so, the company declares its intention to change its existing market structure.
Which of the following diversification options should a company choose? Part of this choice will depend on the company's reasons for diversifying. For example, given industry trends, there are steps an airline can take to achieve long-term adoption goals through diversification:
The direction promotes technological progress of the currently existing type of production;
Diversification increases the coverage of military market segments;
The direction also increases the percentage of commercial sales in the overall sales program;
The movement stabilizes product sales in the event of an economic downturn;
The move also helps expand the company's technology base.
Some of these diversification goals relate to product characteristics and some relate to product missions. Each of the objectives is designed to improve some aspect of the balance between the overall product-market strategy and the environment. Specific goals set for certain specific situations can be grouped into three main categories: growth goals, which should help regulate the balance in conditions of favorable trends; stabilization goals designed to protect against adverse trends and predictable events, flexibility goals - all to strengthen the company's position in the event of unpredictable events. A diversification direction necessary for one purpose may be completely inappropriate for another.
The goals of production diversification directly depend on the financial condition and production capabilities of the corporation.
Problems of enterprise diversification
Assessing and planning for diversification takes time, effort and careful consideration. A thorough analysis of the enterprise is necessary in order to determine at the very beginning whether or not the enterprise should be diversified. Diversification is a very time-consuming and complex process that can lead not only to dividends, but also to problems and losses.
Diversification of production is usually characterized by a transition to new technologies, markets and industries; in addition, the products (services) of the enterprise themselves are completely new, so the risk is very high.
Diversification depends on the financial condition of the company. So weak or nascent companies are unlikely to be able to conquer new markets or enter the international arena. Also, the new product of the enterprise must be competitive. Diversification requires significant financial investment.
80% of the time spent brings only 20% of the results. Based on this, before implementation, it is necessary to analyze the most favorable types of possible diversification, which promise to bring maximum income with minimal expenditure of time, material and human resources.
From the above we can conclude that you need to think about diversification constantly. At any moment, both the market situation and the political situation may change: the introduction or cancellation of licensing; establishing or increasing customs duties; imposing bans on the production of certain products. All this will entail increased complexity of sales, increased competition, and the need to stop one or another type of activity.
Therefore, when starting production, you need to immediately think through new work options, types of goods, etc. So far, in practice, everything is happening exactly the opposite. Current activities often do not allow entrepreneurs to plan other areas of work. As a result, when enterprises face a sharp decline in sales, the only traditional measure is to reduce the number of workers, on whom years and money have been spent training.
Diversification of trading risks
Often, when creating trading strategies, traders are chasing the maximum profitability of the system. However, it is more important not to increase the expected profitability, but to reduce the possible risk, which is expressed in the maximum allowable drawdown.
A simple but relatively reliable way to assess the effectiveness of a trading strategy is to determine the ratio of profitability to the maximum drawdown of the system during the period under study, the so-called recovery factor. For example, if the system’s profitability is 45% per annum, and the maximum drawdown is 15%, the recovery factor will be equal to 3.
If we compare two systems with different values of profitability and drawdown, then the system with a higher recovery factor will be better. A system that gives 30% per annum with a drawdown of 5% will be better than a system with 100% per annum and a drawdown of 40%. Profitability can easily be adjusted to the desired value using margin lending, but the share of risk in the system’s profitability cannot be changed; this is an integral property of the system. By increasing profitability, we correspondingly increase risk.
However, you can reduce the risk of your overall portfolio if you use diversification, that is, trade not just one individual strategy, but a whole set, dividing capital between systems. In this case, the drawdown of each individual system does not necessarily coincide with the drawdowns of all other systems in the set, so in the general case we can expect a smaller maximum total drawdown, at the same time, the profitability of the systems will only average out. If the systems are sufficiently independent from each other (different trading strategies are used, different instruments are traded), then a drop in equity in one of the systems will most likely be compensated by an increase in equity in some other system. The more independent trading strategies and trading instruments are, the more the overall risk is eroded.
There may even be situations when it makes sense to add a strategy that is obviously unprofitable to the portfolio. Although the overall return of the portfolio will decrease slightly, it may be that the risk will decrease even more and the overall performance of the portfolio will increase.
Theoretically, if you add more and more strategies and instruments to your portfolio, you can get as little risk as you like, and, accordingly, as much efficiency as you like. However, in practice, such an intention will inevitably face the problem of correlation between different strategies and tools.
The main directions of possible diversification are as follows:
Diversification by trading strategies;
Diversification according to the parameters of trading strategies;
Diversification by trading instruments;
Diversification by market.
Diversification by trading strategies
Each trading strategy is based on some general property of the market or traded instrument that can be used to make a profit. For example, the ability of the market to form trends or the ability of prices to continue moving after breaking through a strong resistance level.
If there are several systems based on fundamentally different considerations, then diversifying capital between these systems can provide a significant reduction in risk. After all, in their internal essence, systems can differ greatly from each other as much as they like, and can weakly correlate with each other. If, for example, trend-following systems and systems on level breakouts are somehow similar to each other and often give similar equity, then trend-following and countertrend systems, on the contrary, will even show a negative correlation. Where the trend-following system is cut, the counter-trend system will show profit, and accordingly, the overall risk of the portfolio will significantly decrease.
Diversification of this kind, theoretically, has no restrictions on depth and depends only on the trader’s creative abilities to create systems. Therefore, it is important to constantly continue to search for new trading strategies, since it is in this direction that the most reliable path to increasing the efficiency and profitability of trading lies.
Diversification by parameters of trading strategies
Let's take a simple trend-following strategy based on a breakout of a price channel. Its main and only parameter is the number of bars by which the maximum and minimum prices are calculated. If the maximum is updated, we consider this a signal to the beginning of a trend and buy. We hold the position until the minimum is updated, which we consider the beginning of a downward trend and turn the position into short.
This simple strategy gives good results on instruments prone to trend movements. Let's say, for example, that this strategy gives satisfactory results in the range of parameter changes from 10 to 100 bars. Typically, traders limit themselves to determining the parameter at which the strategy shows itself most effectively, and begin to trade one separate system with this parameter. However, if you divide your capital and simultaneously trade the same strategy, but with different parameters, you can get more sustainable results.
For example, if you take three systems, with a channel length of 10, 30 and 100 bars, different systems will work out trends of different sizes. A system with a long channel will be good at taking long trends, leaving small ones without attention. A short channel system will work well with short trends. As a result, market volatility will be handled more efficiently, the equity of all three systems will be different, and therefore the risk of such a diversified portfolio will be lower.
In addition, by limiting trading to a single strategy with specific parameters, we increase the risk that it will fail simply because the market movements have developed in an unfortunate way for this system. By diversifying capital according to different parameters, you can expect results close to a certain average effectiveness of the strategy, without the risk of running into an unsuccessful combination of specific market circumstances.
If for some reason the system is strictly tied to the number of bars, and you cannot find a parameter that can be changed, you can try changing the timeframe.
As a rule, a successful strategy allows you to build profitable systems in a fairly wide range of parameters, which, however, is limited. Since transactions are not free and have their own price (broker commission, slippage, spread), it is not profitable to catch small market fluctuations, since the expected profit becomes commensurate with the transaction price. On the other hand, excessively long market fluctuations are unlikely to interest short-term speculators.
It turns out that diversification by parameters has its own limit of effectiveness, since the limited range of parameters means limited market movements from which a particular strategy can make a profit. And this efficiency will be higher, the better the idea underlying the trading strategy corresponds to the market behavior.
Diversification by trading instruments
It is logical to expect that the prices of different instruments will move differently. The price of shares is strongly influenced by internal corporate news and changes in the situation around the company. Of course, each company has its own situation, and it develops in a separate way. Therefore, it seems quite reasonable to divide the capital and trade the strategies available in the trader’s arsenal on various instruments.
On the other hand, there is a general economic background that causes different stocks in the same market to move more or less in unison. Events and trends in a particular economy similarly influence the sentiment of speculators and investors.
Of course, this correlation is far from complete, otherwise there would be no point in talking about diversification. However, such mutual dependence sets a certain limitation on the effectiveness of the entire portfolio as a whole.
In addition, each individual trading strategy can be traded on a limited number of instruments. For example, on the Russian market, possible instruments will most likely be among fairly liquid securities, of which, unfortunately, there are not so many. Trading the remaining securities may be prohibited by high overhead costs associated with their low liquidity.
And in a broader market, where the choice of shares is more diverse, the number of instruments suitable for a particular system will be limited in one way or another. It is hardly possible to create a profitable strategy that works on absolutely all market instruments.
Diversification by market
Modern technologies allow the private investor, not to mention financial institutions, to participate in trading in a wide variety of markets across the planet. The most accessible for the Russian trader is our domestic stock market. Flexible commissions and low prices for the most popular lots allow you to start trading with very little capital.
With sufficient capital, it becomes possible to diversify trading into other markets: FOREX, stock markets of the USA, Europe, other countries around the world, commodity markets. The undeniable advantage of such diversification will be that individual markets are usually very weakly dependent on each other, so systems traded on different markets will be well smoothed out.
Thus, diversification is the main way to get the most out of the trading strategies available to a trader. Even with only one fairly stable strategy, it is possible to increase trading efficiency significantly if you skillfully and consistently find more and more new areas of application for this strategy. And if you constantly search and find new strategies for playing on the market, the horizons of what is achievable will expand even wider. And on this path, the only limit will be the perseverance and creativity of the trader.
Diversification of investments
It would seem that the concept of “diversification” has already been worn down to holes - well, invest not in one asset, but in different ones, and you will be happy. But in fact, if the portfolio is scattered "anyhow", some - not entirely obvious - risks still remain. And although the circumstances that give rise to these risks must be quite large-scale, the history of even the last few decades shows that not a single generation is immune from them - remember, for example, the collapse of the Soviet Union or the last global economic crisis of 2008. All this happened before our eyes.
In order to understand these risks and learn to protect against them, let's look at the main types of diversification.
Instrumental diversification
This is the most common type of investment protection and risk insurance. In fact, this is exactly what you and I are accustomed to understand by “diversification” itself. In a nutshell, this implies the need to have investments not in one asset, but in several different instruments. And the riskier the assets, the smaller part of the portfolio you should trust them with. For example, if a portfolio contains several PAMM accounts and private traders, it can be considered instrumentally diversified.
The risk that such a measure protects against is a partial (or even complete) fall in price of one (or several) assets. We have already observed the benefits of instrumental diversification during the depreciation of an asset such as an investment in Devlani. At that time, I had already fully realized the risks inherent in this instrument, and kept only about 10% of my portfolio in it. As a result, despite the fact that my deposit there was reduced to a meager figure, I did not lose anything except the profit for the last few months, which, by the way, has already been fully restored by now (and I do not need to wait for the closure of the compensation account for this , like some). This happened because other assets in my portfolio continued to perform and generate profits.
But enough about the obvious - let's turn to what really few people think about.
Currency diversification
Already more interesting. Since you and I mainly deal with investing in Forex - the international over-the-counter foreign exchange market, we know that the exchange rates of various countries are unstable and in constant flux. This is due to the fact that the exchange rates of the main states and blocs have long been not tied to gold reserves or even the GDP or foreign trade balance of a particular country, but are in the so-called “free float” - their rates are determined by market mechanisms, demand and offer for a particular currency. This, in fact, is the essence of the FOREX market.
We also know that the main currency quotes at which most transactions are made on FOREX are US dollar rates: USDCHF, GBPUSD, EURUSD, USDJPY, and so on. There are much more transactions in which the US dollar appears on Forex than any other - both in volume and in quantity. Accordingly, traders open most trading accounts in this currency - although brokers, as a rule, offer a choice of euros and sometimes even more exotic currencies - the pound, for example, the Russian ruble or even gold.
Now let's imagine that we are invested in 10 managed accounts, all of which are denominated in US dollars. And suddenly, waking up one morning, we hear the following news: the United States has declared a technical default on its debt obligations - bonds with various maturities, treasury securities, etc. Does this seem unlikely to you now? Understand. And remember July of this year (2011) - even serious economists were seriously alarmed by the size of the US foreign debt, and Republicans and Democrats could not agree on raising the acceptable ceiling on public debt, and large state-owned banks (for example, China) began to slowly get rid of dubious debt US obligations. Even rumors about such events themselves have a powerful impact on exchange rates, not to mention the fact that the event had every chance of happening. And what do you think - the size of the US national debt has decreased since then? No matter how it is. The problem was hidden, but not solved. What is happening at this time in the Eurozone? Even those who are not interested in FOREX and politics have heard about the debt problems of Greece and other PIIGS countries that could sink the entire Eurotitanic, and primarily the single euro currency. As well as the inability of the government and influential financial circles of the European Union to coordinate their actions to quickly solve these problems.
But let's return to our hypothetical situation. As it turned out, our “well-diversified” portfolio of 10 PAMMs depreciated anyway - despite seemingly competent instrumental diversification... No, of course, the numbers on our balance sheet, in US dollars, remained the same. But the value of these dollars was equal to zero or so, which means we were still left with nothing.
Solution? Currency diversification involves creating assets in different currencies - this way you will be less dependent on their fluctuations, or on the risk of a catastrophic fall in a particular currency. Even if you divide your assets equally between the dollar and the euro, you will be ready for global disasters - since EURUSD is currently the most traded currency pair on Forex, a sudden and strong fall in one of these currencies will automatically lead to the growth of the other, so how large investors, central banks, hedge funds and other market makers will quickly begin to pump foreign exchange reserves to the other side, and this will lead to an increase in the volume of purchases of the second currency, and, consequently, an increase in its value. Moreover, most likely, this will happen even before the thunder actually strikes - as a rule, the people responsible for making such decisions in the above-mentioned organizations are well aware of upcoming events in advance.
Of course, in today's world neither the US dollar nor the euro can be considered stable currencies. The ideal assets for today are gold and the Swiss franc. Unfortunately, I have not yet seen PAMMs denominated in Swiss franc. But in gold, some accounts on Alpari have already been opened. The choice is still limited, but this type of account is gradually gaining popularity. As for the euro, one of the most famous accounts that has been trading in euros for three years is Invincible Trader, and among ruble PAMMs I recommend the scalper Baffetoff. By the way, he also has an account in euros, albeit with an identical strategy.
Institutional diversification
The words are becoming more and more scary, but don’t worry, we’ll figure this out now.
So, you and I have successfully dealt with the fall of one or more assets, and even provided for such a global event as the fall of world currencies. We distributed our funds across 10 Alpari PAMM accounts, opened in different currencies, and went to bed peacefully.
The next morning, when we wake up, we are surprised to learn that the Alpari company is ceasing to exist due to (for example) some legal proceedings with its market makers (liquidity providers), and payments on the company’s obligations are postponed indefinitely.
No, of course God grant the Alpari company long life, financial stability and prosperity, but if the obligations of the US state, which has existed for more than 200 years and has a high credit rating of AA+ (until recently, by the way, an even higher “AAA”) are in doubt, What can we say about the Alpari company, which is only 15 years old, and which exists in a country with one of the highest levels of corruption in the world.
So, we learn that although everything is in order with the exchange rates in which our assets are denominated, and traders work diligently and do not merge, we cannot withdraw our investments, and it is generally unknown when we will be able to.
To insure such risks, there is so-called “institutional” diversification, or the distribution of funds between different organizations.
So, let’s back up the theory with visual material: today, PAMM accounts are opened on more than a dozen platforms, and, thank God, their number is only growing from year to year.
Sources and links
coolreferat.com - Collection of abstracts
center-yf.ru - Financial Management Center
zenvestor.ru - Blog about investing
slovari.yandex.ru - Dictionaries on Yandex
ru.wikipedia.org - Free encyclopedia
dic.academic.ru - Interpretation of words
elitarium.ru - Financial management center
bibliofond.ru - Electronic library BiblioFond
revolution.allbest.ru - A selection of abstracts
bussinesrisk.ru - Business portal
ankorinvest.ru - Portal for investors
Evgeniy Malyar
#
Business Dictionary
Examples, types and characteristics
The concept of economic diversification can be expressed in simple words by remembering the saying “Don’t put all your eggs in one basket.”
Article navigation
- Diversification is a necessary measure in the economy
- Definition of the term
- Advantages and disadvantages
- Types of diversification
- What is differentiation
- Diversification of production
- Business diversification
- Diversification Strategies
- Diversification of the investment portfolio
- conclusions
The meaning of the word diversification seems clear to many. It is expressed by an English proverb that encourages “not to put all your eggs (or other fragile objects) in one basket,” but to distribute them among different ones. It is better to have several suppliers than to rely on just one. The same applies to types of products, sources of income or markets. What does this concept mean in economics? Where and when did it come from? What are the types of diversification? This will be discussed in today's article.
Diversification is a necessary measure in the economy
The advice about eggs and baskets is very old, but the real problem of finding economic alternatives arose in capitalist countries only in the middle of the last century. It was then that serious economic risks began to arise in the form of energy, oil and other crises, unprecedented before, and associated, first of all, with the collapse of the world colonial system.
The level of international competition has also increased significantly: “young dragons” have emerged in the form of Asian countries (Japan, South Korea, Malaysia, Indonesia). The offer of a high-tech product, previously produced almost exclusively in the USA and several other industrialized countries, made us think about safety measures. The specter of bankruptcy looms before many companies.
No fewer problems arose in the area of traditional sources of resources. Territories that previously served as “gas stations,” “sugar bowls,” or “teapots,” which seamlessly supplied cheap raw materials to Western markets, gained state independence. They were still ready to sell “colonial goods,” but at different prices.
That’s when the active development of diversification methods began, and this happened, as most often happens, forcedly. However, economics itself is the science of conducting economic activities in conditions of limited resources. Otherwise there would be no need for it.
Definition of the term
Without a clear definition, understanding any category is difficult. The morphology of the word partly reflects its meaning: the term comes from two Latin words diversus and facere, which together mean “to do different things” - this is what the word “diversification” literally means.
Now the official wording. Diversification is a set of measures to expand the range of products, sales markets, supply channels, investments and sources of financing, carried out in order to extract the greatest benefits and level out risks.
Diversification is also possible on a personal level. For example, girls sometimes “give advances” to two (or more) fans at once, and not always because of their frivolity. What if the relationship with one of them deteriorates? There will be a backup option. What is this if not diversification of matrimonial intentions?
An ordinary bank depositor can place his labor savings in one bank, but the sad experience of the bankruptcy of some financial institutions suggests that it is better to open accounts in several.
You can express what economic diversification is in simple words by recalling many examples and even popular sayings: from the already mentioned eggs in a basket to a straw laid in the place where a straw is supposed to fall.
It should be remembered that when expanding the range, markets and other financial and commodity flows, not only the goal of minimizing risks is pursued. This is done primarily to increase the profitability of an economic entity based on the complementarity of sources of profit.
Advantages and disadvantages
The diversification method is used to ensure the financial stability of an enterprise or state. It has a number of advantages compared to focusing on a single counterparty:
- an extensive market appears, where, if one buyer (seller) refuses to cooperate, another can be found;
- the risk of bankruptcy is significantly reduced;
- the potential of the enterprise is revealed wider;
- business survivability increases in the event of a decrease in demand for any product or product group.
At the same time, the method is not without its drawbacks. These include:
- increasing complexity of management and planning processes;
- reducing the concentration of capital in the primary, usually the most profitable direction;
- the likelihood of losses, direct and indirect, when developing new types of activities. In the initial period they are almost inevitable.
Despite these obvious disadvantages, focusing on only one supplier or buyer entails excessive threats. Successful examples of diversification of companies that started with a single product demonstrate the need for many options.
The Swedish company SAAB specialized in aircraft manufacturing, but after World War II it mastered the production of cars using aviation technology.
The Virgin Group holding includes a huge number of companies in different fields, such as film production, retail trade, air transportation, audio products, railway transport operation, financial activities, etc.
Agriculture is characterized by diversification of crop areas. By relying on only one crop, the producer exposes himself to the risk of crop failure.
By creating infrastructure for the delivery of hydrocarbons in the form of new pipelines, the Russian Gazprom provides a variety of export channels. The risk of blocking one of them cannot lead to a disruption in supplies.
Types of diversification
From the above examples, we can conclude that there are a variety of forms and types of diversification at all levels. The method is used in the following areas of activity.
National economy. The sovereignty of states with few sources of financial revenue is under threat. Economic diversification refers to the elimination of imbalances caused by one-sided development. Critical dependence on one (or few) industries creates conditions for external pressure (often political), of which there are many examples in the modern world.
Production. A drop in demand for any type of product produced by an enterprise can lead to complete ruin if it is the only one.
Activities outside the country. The potential benefits of geographic diversification include, first and foremost, the opportunity to take advantage of favorable tax laws. Cheap labor also encourages many firms to open production abroad. Other advantages may lie in the proximity of raw materials, energy sources, etc.
Debt insurance. The payment guarantee is provided by assets in the form of securities. The more types of liquid insurance reserves there are, the lower the risk of depreciation.
Investments in currency. Both ordinary citizens and entire states, when creating their foreign exchange reserves, take into account possible exchange rate fluctuations, but it is impossible to predict them with 100% certainty. Large inventories are most often stored in different monetary units and other types of values.
Labor reserves. Both employers and employees themselves are interested in universalizing personnel qualifications. The former have the opportunity to be interchangeable, while the latter have increased competitiveness in the labor market.
Investments. Investments in securities of various profitable enterprises increase the financial stability of the holder.
What is differentiation
These concepts are sometimes confused due to the similarity in the meaning of the roots of the words - they both mean some kind of separation. Enterprises actually use techniques such as diversification and differentiation. The differences lie in the essence of the processes. During differentiation, existing technological capabilities are separated into independent structures.
For example, one plant produced computer monitors and televisions. Many assembly elements of these products are the same, but during development, the company’s management decided to create an additional workshop designed to produce one of the types of products. At the same time, diversification as such did not occur: the range did not fundamentally change, sales markets and supply channels remained the same.
Differentiation can be made according to subject, detail, technological and functional characteristics. The purpose of such separation is to gain competitive advantages due to greater concentration of production resources, lower costs, increased productivity, etc.
One way to differentiate is to create a separate brand. Competitors, acting on the basis of the interchangeability of goods, attempt to replace the products of a particular manufacturer with their own goods (having similar qualities). At the same time, the company is interested in obtaining or maintaining its own monopolistic advantages, for which it is forced to constantly update its model range, fight for quality and take other measures to strengthen its position. Most often, without separating individual industries into independent structures, solving this problem is difficult.
Diversification of production
This is one of the most common types of diversification. Diversification of a company’s production means expanding the scope of the enterprise’s activities to include new areas. An example is Japanese zaibatsu or Korean chaebols (multi-industry corporations), the range of which is extremely wide - from large-tonnage ships to miniature radio equipment.
Such a combination and diversification of production presupposes the presence of general and auxiliary areas, some of which provide large profits in absolute terms, while others are characterized by high profitability with relatively low turnover.
Of course, such a strategy has a negative side effect, expressed in the forced diversion of assets to the development of less profitable and even adventurous programs. At the same time, diversification of business activities represents competition within the company itself: in order to receive financing, a project must prove its promise. In the course of the economic activity of the enterprise, resources are redistributed in favor of the most profitable types of products.
Business diversification
This concept goes beyond and includes production boundaries. Diversification of a company's business always begins with maneuvering in search of the most profitable product, and often leads to a radical change in profile. In some cases, the company's management becomes convinced of the relative unprofitability of the main strategy.
An example is the history of the American concern Westinghouse Electric, which completely abandoned the production of household appliances and radio electronics in the 1950s in favor of energy and precision instrumentation. Some companies successfully develop investment areas in parallel with hotel, printing or other businesses. In this sense, diversification is the development of activities that are in no way related.
Diversification Strategies
There are types of diversification strategy (three), and its types (also three). They should be considered in detail.
| Types of Diversification Strategy | a brief description of | Examples |
| Concentric | Also called centered. The technological base remains unchanged. New products are being produced and sales markets are expanding. | The engineering company produces specialized products, cooperates with the space agency and carries out defense orders. The Hilton premium chain builds hotels in an affordable price category. |
| Horizontal | The possibilities of the already conquered market and available technologies are used. The company produces new product samples aimed at its traditional consumers. | The company, which produced only televisions, is expanding its range to include satellite reception systems, DVD players, audio equipment and other consumer electronic devices based on complementarity. |
| Conglomerate | Also called conglomerative. It is considered the most difficult to implement. In contrast to centralized and horizontal diversification, it involves the production of fundamentally new products that were previously not characteristic of a given company. Requires significant expenditure of resources, attraction of qualified personnel, additional market research, advertising, management restructuring and other necessary measures. | Acquisition of an oil producing company by a media group. Other examples of conglomerate diversification: a bank creates a real estate agency, an airline absorbs a hotel chain, etc. |
Based on the listed strategies, the following types of diversification are distinguished:
| Types of Diversification Strategy | a brief description of | Situations |
| Unrelated | A conglomerate strategy is used for implementation. Both products and markets are becoming new. The use of old technological resources is excluded. | The takeover or acquisition of new assets most often occurs “on occasion”, at minimal cost. The priority selection criterion is the prospect of accelerated financial growth. |
| Linked (can be vertical or horizontal) | Vertical. Without changing the general technological principles, new associated capacities are being built up. For example, pellets produced by metallurgical corporations at their processing plants can be used in their own technological cycle or sold to third-party consumers. | Production (capacity) is acquired or absorbed for the production of other goods of a similar profile. |
| Horizontal. Companies that produce the same product, but in other regions and countries, are absorbed in order to expand markets geographically. | Expansion of horizontal diversification in the market most often occurs through the acquisition of competing companies. | |
| Combined | A combination of related and unrelated diversification. | Implementing a hybrid extension requires extremely powerful resources. Such diversification as a method is available only to transnational corporations. |
Diversification of the investment portfolio
An investment portfolio is a collection of securities owned by one owner. It, in turn, is divided into packages consisting of shares, bonds, currency or obligations, each of which is put into circulation by one issuer.
Obviously, the lower the number of types of securities in the portfolio, the higher the risk of investing in securities. The principle of diversifying investments is the same as in any other case, but the stock market has its own characteristics. It is advisable that the portfolio be divided into packages with the following characteristics:
- Profitability. In itself, diversity is of dubious value if the securities do not provide the holder with acceptable interest rates, that is, real profits.
- Industry diversification. Not only individual enterprises, but also entire sectors of the world economy (mining, ferrous or non-ferrous metallurgy, IT, mechanical engineering) are exposed to the influence of crises and other difficult-to-predict force majeure circumstances.
- Division by asset class. These could be stocks, bonds, mutual funds or other types of securities, including currencies. For example, with the onset of the global crisis in 2008, holders of many assets suffered, while owners of large sums of dollars, euros and precious metals benefited.
- Different territorial affiliation. Stock and currency rates may depend on the country of origin, the situation there and other circumstances, including, for example, natural disasters, mass unrest, wars, etc. Diversification of investments in the region means that securities are issued in different countries.
- Absence of mutual correlation. In other words, the safety of investments in projects with independent income is much higher than investments in related enterprises or industries. An example is the situation with a drop in activity in the new real estate market. Construction will slow down, which will lead to stagnation of firms producing brick, cement and other materials.
- Diversification of deposits. You should not keep all your funds in one bank, no matter how favorable conditions it offers.
Based on the above characteristics, we can conclude that high diversification of the investment portfolio is the process of the most rational allocation of funds in various types of income-generating assets. At the same time, there is a chance that a drop in profit from one package will be compensated by an increase in the cost of another.
The same principle is used by financial institutions when planning the issuance of borrowed funds. Diversification of the loan portfolio of a commercial bank in the Russian market involves dividing it into the following categories:
- Groups of borrowers. Most often, diversification is implemented by setting limits on the issuance of consumer loans in percentage or absolute terms.
- Accepted collateral. If the market price for one or another type of collateral (real estate, cars, etc.) falls, the bank may find itself in a difficult position when selling it.
- Interest rates. The flexibility of the accrual system serves as a tool for minimizing risks.
- Repayment terms. The financial institution diversifies loans in such a way as to maintain an evenness of incoming cash flows. Otherwise, problems with capital turnover may arise.
To make money trading securities, you need to risk something, buy something. Almost the entire difficulty of investing lies in professional risk management. There is a special concept of “risk diversification”. In this article we will look at this concept in detail, how to properly diversify your investment portfolio in order to minimize risks without limiting your income.
1. What is risk diversification in simple words
Sometimes it is also simply called diversification of funds, money, portfolio, etc. In fact, they are one and the same. I prefer to say that I diversify not risks, but funds.
There is a well-known saying that fully captures the essence of portfolio diversification: “don’t put all your eggs in one basket.”
2. Why is asset diversification needed?
Asset diversification allows you to reduce your investment risks by distributing funds between different financial instruments. For example, if you buy shares of only one super promising company, there is still a risk that their price may drop significantly (for example, due to the general situation on the market or internal problems). Instead of a double-digit income, the investor receives a loss. After some time, the company may restore its position and value, but it will have to wait, and possibly for a very long time.
Remember the main idea of investing: save and earn. Moreover, as much as possible and as stable as possible. Stability and profit margins are contradictory qualities. The lower the risk, the lower the return. And vice versa: a big risk gives the opportunity to get big money.
Every investor needs to find a reasonable compromise in the risk/return ratio. For example, what would you choose: a 7% return with zero risk, an average return of 12% with a 5% risk, or an average return of 15% with a 9% risk? Depending on the answer, there will be different approaches to compiling your investment portfolio.
3. Examples of diversification
So, to always make a profit, you need to invest in various instruments. For example, invest in stocks and bonds. The optimal ratio is considered to be 35%/65%, respectively. Thus, we are guaranteed to receive income from the coupon on the bond and have a good opportunity to make money from the growth of shares and also receive dividends.
This portfolio can already be called diversified, since it has relatively low risks and good income. In general, it is recommended to invest between 25% and 75% of your capital in stocks. The rest is in bonds. Naturally, in the case when 75% of funds are kept in stocks, the investor can receive maximum income in case of growth and maximum losses in case of decline in the market.
To maximize risk diversification, you should buy shares of companies from different sectors of the economy: financial, energy, telecommunications, etc. Often one sector can stagnate while another grows. To smooth out this situation, it is recommended to partially invest in everything. At the same time, it is important to buy only the leaders in your sector. On the contrary, it is worth getting rid of the weak.
The question “how to choose where to invest and how often to review your portfolio” is a huge topic. Gerald Appel wrote an entire book on "beating the financial market." This entire book has only one goal: to create an optimal portfolio and make money. I also advise you to pay attention to Graham Benjamin’s book “The Intelligent Investor”, it is old, but it has many points that an investor should know.
4. Classification of investment risks
There are many options for how investment risks can be classified:
- State(problems within the state and its relations with others, wars, conflicts, legislation)
- Economic (global and domestic crises)
- Investment Instrument Segment(crises in different segments of the economy: real estate, auto, finance, banking crisis)
- Companies (risks of an individual company)
- Raw materials (strong fluctuations in key raw materials: oil, gas, steel, etc.)
5. Diversification of non-correlated instruments
It is necessary to select financial instruments for diversification with a complete lack of correlation between them. For example, when investing in shares of Russian and American companies, there will be a strong correlation. If the American market starts to fall, then with 100% probability the Russian market will also fall. Therefore, in this case, there will be no portfolio diversification.
History has shown that American and Asian stocks do not correlate well, so you may want to consider partial diversification across companies in these two countries. In the future, the situation may change and it may be worth looking for other unrelated markets.
It makes sense to invest in reliable stocks (blue chips). For example, in the leaders of their industries. A strategy that works well is that after each quarter, funds are transferred to those companies that have shown the greatest growth. Thus, your portfolio will always contain only the strongest securities.
6. Diversification options - how to reduce your investment risks
Below we will consider all options for risk diversification, in which the invested funds will be evenly distributed. The ideal is to always maintain a balanced portfolio that is resistant to all types of risks.
Note
It makes sense to diversify risks only if you have “decent” savings. If the investment amount is small, then you can invest money only in one of the options listed below. The optimal investment amount should be at least 1 million rubles in each sector. If your entire amount is less than 1 million rubles, then there is little point in splitting it into small parts.
6.1. Purchase of securities
The group of securities primarily includes shares and bonds. Perhaps investing in these types of assets is the most common way among funds and investors to preserve and increase their funds. On average, the simplest “buy and hold” strategy brings 10-20% per annum. You can get more if you speculate on rates.
As a rule, it is worth investing in percentages from 30% to 50% in stocks, from 50% to 70% in bonds. If this proportion is violated, redistribute funds once a quarter.
Also, I would still evaluate trends. If the general trend is downward, then it is worth waiting out this quarter until better times. Drops in stock markets happen regularly and usually do not last more than 6 months. During crises, the fall can last up to two or more years. But such maneuvers will require trading knowledge.
Investments should be made in securities from different industries - this is an important point. As a rule, trends prevail in markets. If the entire financial sector is growing, this does not mean that metallurgists are growing. You can smooth out these situations by simply investing money evenly in different sectors.
Ordinary individuals do not have direct access to exchange trading. To purchase securities you need to create an account with specialized brokers. I recommend working with the following two:
They have the lowest commissions for trading securities, and have a complete list of MICEX assets. They occupy a leading position in terms of the number of clients. I recommend them for work.
6.2. Buying a property
Investing in real estate makes sense during periods of economic calm or growth. During crises it becomes cheaper. Therefore, you won’t be able to make money on this, but there is a great opportunity to purchase a piece of real estate cheaply, but it is worth remembering that at this moment securities are also very cheap, so it is sometimes difficult to choose what to buy.
It is best to buy several apartments to rent them out. We recommend investing only part of the money in real estate (no more than 50%), since this is far from the best option for making money.
In general, real estate over the entire period, taking into account rental income and rising prices, brings only 5-10% per annum. This is equivalent to profit from bank deposits. But on the other hand, it is a more reliable asset than keeping your fortune in fiat money.
There is a separate article about investing in real estate on the website:
6.3. Purchasing "strong" currencies
It makes sense to keep part of your savings in “large” currency. As practice shows, crises periodically occur in Russia when the ruble sharply depreciates (devaluation occurs). According to statistics, every 20 years the ruble falls to the dollar by half.
Simply storing money in foreign currency would be ineffective. After all, money should work. What options are there? Where to invest foreign currency? Maybe for a bank deposit? But the rates there will be only 1-2% per annum, which is negligible, but still better than nothing.
I recommend looking at options for investing in foreign stocks (yield 10-25%) or Eurobonds (5-7%). As you can see, the yield on these instruments is much higher.
For those who want to take a risk and get into trading, I recommend reading the following material:
6.4. Investing in mutual funds
Mutual funds (mutual investment funds) provide excellent opportunities to increase your capital. They are initially well diversified across a variety of assets. However, during periods of crisis they also fall.
It makes sense to invest here so as not to have to deal with your investment portfolio yourself. You can select the best mutual funds and invest in them. The main thing is to invest in several at once.
A small fee will be charged for managing your funds. Personally, it seems to me that this is not the best way to store money, since its profitability varies greatly. Mutual funds actually copy the stock market index, and you have to pay for their services. It is better then to buy the same securities yourself. At the same time, you will have flexibility in making decisions.
6.5. Bank deposits
Deposits have always been and remain one of the most popular options for saving money. It's better than keeping money under your pillow. However, rates are still lower than inflation, so the deposit is only an alternative option for saving.
It's also convenient that you can earn monthly interest on the account so you can live off it.
6.6. Investing in cryptocurrencies
Since 2015, a new direction for investing in “cryptocurrency” began to be introduced en masse. They are growing strongly in price and have every chance of occupying one of the most important places in the field of finance, so it makes sense to invest part of your funds in it.