- April 25, 2014
- Posted by: essay
- Category: Term paper writing
Today, the diversification of portfolio is one of the important factors that affects the overall success of investments. For instance, investing in Nike solely, raises the problem of undiversified portfolio which raises such risks and threats as the risk of financial losses or failure caused by the decline of Nike or turmoil in the sports shoes and sportswear market, where Nike operates at the moment. In fact, the diversification of portfolio is a sort of insurance against downturns in the development of the target company and investors should diversify their portfolio to minimize risks and to maintain stable level of profits because losses caused by some companies will be compensated by benefits obtained from other companies.
In fact, the diversification of portfolio is essential in the contemporary business environment. The diversification of portfolio implies investments in diverse companies, instead of focusing on one company solely. At first glance, the investment in one, fast growing company seems to be attractive but, in actuality, such investment is quite risky. Instead, the diversification of portfolio contributes to the investment in different companies (James & Webber 2001). In such a way, investors diversify their investments and invest money in different companies.
One of the major advantages of the diversification of portfolio is the reduction of risks associated with investments. The diversification of portfolio decreases risks associated with investments because investors use their funds wisely. They invest in different companies, which may have different marketing and financial performance and operate in different industries. As a result, if one company fails, investors will count on profits from another company, and so on. Therefore, the more diverse the portfolio is the lower are risks. On the other hand, investors should avoid excessive diversification because they will just pour out their financial resources, while their profits will be too insignificant to cover their losses. The excessive diversification may discourage further investment activities. Instead, the diversification should be wise.
In addition, the diversification of portfolio increases the profitability and return on investments because multiple investments can bring more profits than one investment. Different companies may have different level of profitability and return on investments. Investors should diversify their portfolio to increase profitability. In fact, the diversification allows investors to invest in risky companies, which can bring considerable return on investments, and in stable companies, which have low risk but they will bring moderate but certain profits. Such diversification allows companies to obtain minimal profits, in case of the failure of risky companies. On the other hand, investors can receive high profits, if risky companies succeed. Often even one company, which has the high return on investments, can cover losses of other companies, if the portfolio is diversified enough. The diversification of portfolio balances investments. Investors can take reasonable risks and count on stable, minimal profit. The undiversified portfolio increases the risk of substantial financial losses.
At the same time, the diversification should be carefully planned. Investors should develop the careful plan and focus on several target companies (Best, 2004). To plan the diversification of portfolio, investors should define which industries are the most prospective and fastest growing, which companies are leaders or can become leaders in the target industries, what risks and expected return on investments for each company are. After that investors can develop the action plan and start investing into the chosen companies.
The diversification should include investments in companies operating in different industries which do not intersect in their business activities. For instance, it is possible to invest in Nike and Ritz Hotels, Boeing, and other companies (Kerin & Peterson 2006). Such diversification increases the profitability and decreases risks associated with investments. Often, the failure of a target company is accompanied by the crisis or turmoil in the industry, where the target company operates. Therefore, if investors chose companies from different industries, they minimize the risk that they will be affected by the crisis in certain industry.
Furthermore, the diversification of portfolio should be preceded by a careful and detailed analysis of target companies. The analysis should include the financial analysis and the analysis of the marketing performance of the target company. The financial analysis helps to understand the current financial position of the company, its liabilities and assets as well as other important financial issues. The marketing analysis will help to reveal the competitive environment in which the company operates. For instance, the tight competition decreases the probability of the fast success of the target company, whereas companies dominating in the market are likely to maintain a stable marketing performance.
Thus, taking into account all above mentioned, it is important to place emphasis on the fact that the successful investment depends on the diversification of portfolio. The diversification of portfolio is an essential condition of safe and reliable investments. Companies may face downturns and fast growth and investors will secure their investments, if they invest in different companies operating in different industries. The investment in one company solely, even such a behemoth as Nike, is risky because even the largest companies are vulnerable to the risk of downturns in their development.