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Nearly everyone has heard the adage “don’t put all your eggs in one basket.” This, essentially, is the idea behind diversification.

With regard to investments, diversification means a portfolio of many, noncorrelated marketable securities. The object is to have securities that counterbalance one another, so when some of them fall in value, others increase or at least remain relatively unchanged. Thus, the overall portfolio value stays as even as possible. 

In business, diversification means having different lines of business or products. When one line does poorly, the other line does well, and overall revenue stays the same or grows.

Take the example of BH, Inc.  One division of BH is the high-end retail chain of department stores called Gold’s.  During a booming economy, Gold’s stores do very well.  But anticipating a downturn in the economy, BH created a chain of lower-end discount stores called P.H. General.  When the economy slips into a recession, P.H. General’s sales rise as customers seek lower priced goods.  Gold’s sales decline as consumers have less spending money to purchase high-end items.  The rise in P.H. General’s sales offset the decline in Gold’s, and BH has diversified its retail sales division.

Some analysts argue that diversification should be at the investor level, not at the company level.  Instead of being owned by BH, Inc., Gold and P.H. General could be separate companies.  If  investors wanted to diversify, they could own shares in each company. 

 

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