Diversification Strategies
Good risk management is essential in agriculture. Changing government policies, fluctuations of both input prices and commodity prices, and uncertain financial conditions are just some of the major risks faced by producers. In addition, producers face weather risks. These issues should be addressed when developing a risk management strategy. Many of these risks can be managed by the use of insurance, financial tools such as futures and options, contracts, and diversification.
One of the main tools used to manage risk is diversification. Diversification is a means to “to not put all your eggs in one basket.” In a financial setting, investors use diversification to minimize the loss or variability of returns in a stock portfolio. Agricultural producers use diversification to minimize losses and reduce the variability of farm returns. One type of diversification commonly used is enterprise crop diversification; the planting of more than one type of crop. If one crop has a bad year another crop may have not such a bad year which can help make up for the losses on the first. Off-farm income is another means agricultural producers are diversifying. Producers can use off-farm income for living expenses and farm income to maintain the farm. Thereby not having to rely solely on farm income to live and maintain the farm. There are numerous other ways to manage risk (see Table 1). Also included in Table 1 are issues to consider when considering a particular risk management strategy and links to additional information on the strategies. One relatively new risk management strategy is geographical diversification, which is producing crops in different locations in the U.S. and around the world.