The Theory Why and When Companies Should Diversify Christine Porter

Financial Management

Dr. Morrison

February 24, 2015

What is Diversification? It’s a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Although diversification does not guarantee against loss it is the most important component of reaching long-range financial goals while minimizing risk (investopia.com). Simply put, diversification can reduce risk. Using diversification as a strategy will help to develop a business in entering new production lines, or markets, and reduce the risk by spreading investments. However, can a business reduce its risk with the appropriate diversification techniques, and when is the right time to diversify, or not. We will begin to explore the ideology of diversification.
Through diversification some risks can be eliminated, however no matter how much you implement diversification, businesses never reduce their risk down to zero.
(Financial Management, Principles and Applications, Chapter. 8, pg. 221). Looking closer at the concept of diversification, the idea for a business, or investors is to create a portfolio that will include multiple investments in order to reduce risk. For example, Everything But Water sells swimwear, during the summer months business is booming. They invest 20% into swimwear, receiving 0% during the winter months. However they have implemented a leisure apparel line that now generates 20% of return year round so that there is no money loss. By combining products half on swimwear, half on the apparel line, you have completely eliminated risk. This is a prime example of how diversification is