Have you diversified your business to reduce risk? Business expansion via product diversification helps a business in reaching a wide variety of audiences as well as reduce the inherent risk involved in conducting business.
For instance, take Disney as an example. The company has an extensive portfolio, including films, parks, cruise ships, and children retailing. Now, it has entered the world of streaming services as well.
While exploring various portfolios has a fair share of advantages for businesses, managing portfolios can become challenging if you don’t play your cards right. In fact, if not done correctly, the business might experience a high portfolio risk.
There are two types of risk you must be aware of, systematic and unsystematic risk. Unsystematic risk is specific to the company division at hand. For instance, a labor strike in a factor can hamper supply, leading to losses.
On the other hand, unsystematic risk refers to the risk that prevails over the entire industry. For instance, COVID-19 has caused a loss of 314 billion USD in revenue in the global airline sector.
To minimize portfolio risk, you must manage both systematic and unsystematic risk. Here are some effective strategies that help in dissuading the risk attached to portfolio investments.
Invest in unrelated industries
Just because your primary mode of business pertains to one sector doesn’t mean that you should only stick to products within the industry. Instead, to best reduce risk, it is advised that you invest across industries.
You might have heard of the famous adage, “Never put all your eggs in the same basket.” By investing in different sectors altogether, you are reducing your systematic risk.
Let’s say you are a textile company. Suddenly, the industry is plagued with accusations regarding poor treatment of labor within the sector. This causes major changes in regulations that hamper optimum efficiency. Here, your supply and revenue are likely to experience a blow.
At the same time, had your company invested in a completely different sector, like IT, the effect of the change in consumer perception and regulation would not affect the revenue generated from this chunk of your business.
There are various examples of such diversified companies. According to Balance, Johnson & Johnson has to be the most diversified company present in the stock market.
Currently, it manufactures baby shampoo, band-aids, health products, over-the-counter drugs, medical devices, and instruments as well as has a sports performance research institute for all the athletes out there.
For the past 55 years, year after year, the company has managed to increase the dividend it pays out to shareholders, evidence of its consistent performance.
Therefore, make sure to create a portfolio that has products of various industries. Keep close tabs on their performance. You can take the help of tools like Ziggma to do so.
Use Put Option When in Doubt
Businesses don’t build portfolios from scratch. Instead, they invest in already existing business enough to partially own it.
For some businesses, the reason to do so is not to run the operations of the company but to reap profits by selling the shares at the right time. If your goal for investing in different companies is merely to boost your revenue, you must be careful.
There are times when stock prices plummet, leaving shareholders with a loss. To prevent this from occurring, one can make use of put options. Before using it, it is imperative to do a thorough financial analysis and be sure that the price of the said stock is likely to go down in the future.
Here, help from financial experts will come in handy. After such an observation is made, stocks can be bought or sold in put options, which gives you the choice of selling or buying the stock at a pre-decided price at a given time in the future.
For instance, let’s say you invest in an automobile company by purchasing 100 of its shares at $90 per share. After a year, the stock price rises to $110. Your analysis tells you that while the future seems excellent for the price, it is likely to decrease due to speculative investors.
Now, to protect your money and reap maximum profits, you can get into an agreement with a willing company to sell your stocks at $115 within six months. Even if the stock price decreases, the transaction will still be liable
This helps in mitigating both systematic and unsystematic risk.
Invest in companies that pay a dividend
There is no better way than reducing portfolio risk than by investing in stable companies. Generally, stocks that pay dividends account for a significant portion of the total return from the stock. Over time, you can effectively get all, and sometimes more than all, your money back if you invest in companies that pay dividends.
Additionally, various studies have showcased that businesses that offer their stockholders significant dividends tend to feature high growth in their earnings. This, in turn, leads to higher share prices, which generates better capital gains.
This continuous cycle helps in protecting a business’s portfolio by boosting the overall return you get from the company. Even if the stock price of the said investment is falling, the dividends provide a much-needed cushion to minimize volatility.
Moreover, companies that pay a dividend are better-off during inflation than those who don’t. But, note that such investments might not offer the same rate of return as high-risk businesses do. Managing portfolios is all about balancing both types of investments for optimum return and effective risk management.
Yes, the world of portfolios and investment is a murky one. There is always a possibility of facing losses.
But, if you follow these three essential strategies, you can reduce the probability of losses. Invest in unrelated sectors to avoid unsystematic risk as well as stable companies to cushion against systematic risk. Exercise put options when need be.
Do you think there are other strategies businesses can use to avoid portfolio risk? Let us know!