STRATEGY
DIVERSIFY
Lies Your Stockbroker Told You
HOW TO REALLY DIVERSIFY YOUR PORTFOLIO
by Steve Streetman
henever I hear a stockbroker saying that you should diversify
investments are truly diverse and when they are the same. There are several keys to under- standing diversification and entire books have been written on the topic, but here the focus is on three concepts: counterparties, counter- weights, and counters. Many investments rely on the performance of one entity COUNTERPARTIES to perform. The most obvious is stocks and bonds. They rely on the company issuing the stock or bond to make a profit. But if you own stocks and bonds from the same company there is no diversity. If the company goes bankrupt, both the stocks and
the bonds will become worthless. The key idea here is that one compa- ny goes bankrupt and all the assets that rely on that company become worthless. But counterparty risk is much more subtle than that. In the great recession, one company, America International Group (AIG), insured a huge number of loans that went into foreclosure. What investors in those loans didn’t realize was that if many of the loans became delinquent at once the insurance company couldn’t cover the losses. AIG was a hidden counterparty to mortgages that represented a risk to those invest- ments. And hidden counterparties
W
your portfolio by investing in stocks AND bonds, I’m reminded of the old Blues Brothers movie (the one with John Belushi). As the band arrives at a honky-tonk bar for their first gig, Elwood Blues asks the proprietor what kind of music they like. He responds that they like both kinds of music: country AND western. Just like country and western is the same genre of music, and only one among many, stocks and bonds are similar investments and only one among many. If you want to diversify your portfolio, you need to enlarge that universe and understand when
70 | think realty magazine :: october 2020
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