The Easter season, with visions of children happily searching for brightly colored Easter eggs, brings to mind the adage: Don’t put all your eggs in one basket.
The origin goes back to the quote of Miquel de Cervantes in 1605 by Don Quixote: “It is the duty of a wise man to save himself today for tomorrow, and not to risk all his eggs in one basket.” In other words, don’t risk everything on a business, plan, idea, product or person and risk losing it all.
It is basically the concept of diversification to manage risk in the pursuit of yield or profit.
Diversification is usually discussed in the context of investing. However, understanding the importance of diversification in business can help illustrate the importance of maintaining a diversified portfolio.
In all areas of life, we tend to stick with what is comfortable and familiar. Although focusing on one thing may seem safe, we put ourselves at greater risk. For example, successful business people recognize the risk of depending on a single supplier or product or relying on a few big customers or a star employee. If a supplier has a disruption, a product has quality issues, or a customer or employee goes elsewhere, this narrow focus can be disastrous for the business. To manage risk, businesses and individuals need to place resources in different baskets, whether they are suppliers and customers or different asset classes.
Spreading your risk across different asset classes provides stability in volatile and unpredictable markets. Diversification allows you to enjoy strong returns on assets that might have been too risky on their own. It also provides a buffer against market declines, which reduces the stress, anxiety and time needed to monitor your portfolio.
A common investment mistake is investing too heavily in familiar and comfortable areas. Common areas include real estate, cash, and stocks. Investors often place too much security in real estate and fixed income securities, believing that the stock market is too risky. When real estate is no longer in vogue, interest rates are low or inflation is raging, this concentration leads to a loss of opportunity on the return potential of other types of assets. Alternatively, investing heavily in the stock market can be nerve-wracking and leave you unprotected against a stock market crash.
Ideally, you should create and maintain a diversified portfolio consisting of cash; obligations ; large, small and mid-cap stocks; international inventory; and real estate. Your asset allocation should respect your investment schedule, risk tolerance and financial goals. Create a portfolio that can withstand major market fluctuations and support your cash flow needs. Rebalance regularly to stay diversified.
A diversified portfolio places your money in different baskets to reduce risk and maximize return, consistent with your financial goals. If a basket falls to the ground, you will have other baskets to rely on.