Diversification — what it means, and why it’s important

Diversification of idle cash is an important strategy for your business, as you look to maximize your returns while minimizing risk. It ensures that your funds are not tied up with one institution, thus reducing your risk and exposure to a single point of failure. This keeps your business running smoothly, even if things were to go wrong with one of your banking partners. Here are some tips on how to diversify your cash effectively:

1. Understand the risks of holding cash: Holding large amounts of cash can expose your business to several risks, including inflation and loss of purchasing power. Inflation reduces the value of cash over time, meaning that the purchasing power of your cash will decrease if it is not invested effectively. Diversification allows you to mitigate these risks by investing in a variety of assets that can help protect against inflation and preserve purchasing power.
2. Determine your risk tolerance: Before you begin diversifying your idle cash, it’s important to determine your business’s risk tolerance. This will depend on factors such as your financial goals, cash needs, and overall financial position. Diversification means investing in a variety of asset classes, such as mutual funds, corporate bonds and treasury bills. If you have a low tolerance for risk, you may want to focus on low-risk investment options such as US Treasury Instruments. If you have a higher risk tolerance, you may want to consider other investment options such as corporate bonds or mutual funds.
3. Consider different institutions: Holding funds at multiple institutions is important for you as it helps to reduce the risk of loss or disruption to your financial operations. In the event of a financial crisis or other unforeseen circumstances, businesses that hold funds at multiple institutions may be better protected from the impact of any one institution’s failure. This is because your funds are not concentrated in a single location, reducing the impact of adverse events on your financial assets.
4. Consider different account types: Brokerage accounts hold securities such as stocks, bonds, and mutual funds and some cash. A bank account only holds cash deposits. A bank account lets you write checks and use a debit card. Some brokerage accounts also provide a debit card and allow you to write checks.
   As per FINRA, in virtually all cases, when a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm. Multiple layers of protection safeguard investor assets. For example, registered brokerage firms must keep their customers’ securities and cash segregated from their own so that, even if a firm fails, its customers’ assets will be safe.
5. Consider working with a financial advisor: Diversification can be complex, and it’s important to ensure that your investments align with your business’s financial goals and risk tolerance. Working with a financial advisor can help you develop a customized investment plan that is tailored to your business’s needs.

Diversification is an important strategy for businesses looking to maximize their returns while minimizing risk. By understanding the risks of holding cash, determining your business’s risk tolerance, considering different asset classes and institutions and working with a financial advisor, you can effectively diversify your idle cash and achieve your financial goals.