A thoughtful Investors’ Checklist of Diversifiable Risks

I usually think about diversification as abstract dimensions,  what some people call stat factors:   they do not have discreet meaning individually, but collectively add it to measure the information / uniqueness in the portfolio.

Sometimes, I find it helpful to run the process in reverse.  By thinking about all the things that your portfolio constituents might have in common and then you can be mindful or deliberate to avoid such concentrations.   This is especially cool since much of these factors are latent factors which means they won’t often even show up in the data.

I think that this exercise is especially useful in Ultra-High-Net worth Investors (UHNW – those with net worth over 25 million) because of the likelihood of having multiple, accounts, custodians and operating companies, however, usually investors with portfolios over ~ 2-3 Million will often start having sufficient complexity that this thought exercise could prove one day to be invaluable.

This is generally the domain as my rule of thumb about ⅓ max:   Don’t let anything be more than ⅓ of your portfolio.   It’s a soft rule.    Run through this list of diversifiable risks and your stomach will likely tell you which ones need to be addressed.

Dimensions of Investment Diversification

1. Custody of the Accounts
   Assets held with a single custodian expose you to systemic risk if that custodian fails or faces operational issues. Diversifying custody across multiple institutions protects against these risks and ensures access to your funds during disruptions.  As of 2024, the standard FDIC insurance limit is $250,000 per depositor, per insured bank, per ownership category. (Different ownership types, such as individual accounts, joint accounts, and certain retirement accounts, are insured separately.)   So spreading your accounts around gives you more insurable coverage – and since the banks pay for this you get this benefit free.   Having greater diversity of your custodian banks then gives you another diversification free lunch since it increases your insurable base (once assets in any account exceed 250K).   The only downside is tax and reporting which the right accountant & fintech stack will address.
2. Geography of the Asset
   Geographic diversification reduces exposure to risks specific to a single country or region, such as economic recessions, geopolitical instability, or currency fluctuations. It allows you to benefit from varying growth cycles across global markets.   Countries have also been known from time to time to go to war,  sanction one another,  have trade wars, privatize companies or entire industries or impose un-capitalistic capital controls that can cause a capital flight (when investors and their money urgently flee the country and prices plunge). 
3. Counterparty Risk
   This refers to the risk that the other party in a transaction defaults on their obligation. Understanding counterparty stability ensures that your investments are backed by credible institutions or entities.  I am not a fan of most investors taking on ANY counterparty risk.   I believe that most investors who take on this risk are not equipped to understand it or appraise it, even if they are professionals.  When investors have counterparty risk failures, they are often catastrophic, with investors only recovering a pittance of their original investments,  and all for a risk that is likely incidental to the actual investment hypothesis.  Further, and not inconsequentially, never take on counterparty risk from a product that is being sold to you.  You are nearly guaranteed to be at an information disadvantage. BTW:  if someone wants to sell you a structured note, you have counterparty risk.   If counterparty risk hangs over much of your portfolio or net worth, you have a big problem. (call me)
4. Intrinsic Value
   Assets supported by future cash flows or tangible value are less speculative and typically more stable. Evaluating intrinsic value helps distinguish between risky bets and investments with long-term viability.
5. Source of Ideas
   Where an investment idea originates can indicate its reliability. A professional recommendation might have more research behind it than a tip from a friend or social media.   If you are getting all your ideas from one newsletter or influencer you have a serious problem.   Moreover consider this it’s not just about diversifying your sources of investment ideas but about diversifying the manner of those ideas maybe some should be discretionary but others systematic maybe some should be value-based but others momentum-based. Being deliberate about the mix of ideas is perhaps the most potent manner of deliberate sourcing of diversification investors can take on.   This diversification too will probably be wasted unless you are employing a diversification centric approach in your portfolio construction / optimization process such as Diversification Optimization (DVO) – which underpins all of our strategies.
6. Asset Class
   Diversifying across asset classes—like stocks, bonds, real estate, and commodities—spreads risk. Different asset classes often react differently to market conditions, reducing overall volatility and the chance of large losses.  This is low hanging diversification fruit.
7. Are the Investments of the Same Narrative?
   Investments driven by the same story or theme, such as “disruptive tech,” are likely to perform similarly under certain conditions. Balancing across different narratives avoids thematic overconcentration.
8. Are the Investments Subject to the Same Regulatory Oversight/Authority?
   Assets regulated by the same authority may share risks related to policy changes or enforcement actions. Diversifying across jurisdictions reduces exposure to regulatory shocks.  Maybe some regulatory agency is on the ball.   Maybe another is not.   
9. Are the Investments Distributed by the Same Broker/Promoter?
   Investments distributed by a single broker might indicate over-reliance on one source. Spreading across different promoters ensures varied perspectives and reduced conflict of interest.   See also Counterparty Risk and Custody of the Asset.
10. High Conviction vs. Low Conviction
    High-conviction investments reflect confidence but also carry concentrated risk. Balancing them with lower-conviction, diversified bets adds stability.    Investing Legend John Maynard Keynes famously said “the markets can stay irrational longer than you can stay solvent.”   High conviction is fine,  but it should not be for all things all the time.  Having low conviction investments could be very complementary, leading to more collective upside than just the basic diversification-aided variance reduction and Fama’s Diversification Return.  High conviction investors may want to double down, when the price moves away from them.  No problem.   But what if they get cut in half again?   Where is the money going to come from?   Is it going to come from other high conviction investments?  What if they are also down –  and unless you have gone through this exercise and made the necessary portfolio adjustments- it could be a big problem.  At what point does new information seep in?   High Conviction investing sounds good, but increasing your position with market perturbations is deleterious to diversification and can create a wealth catastrophe.  Accordingly,  as you consider,  a high conviction / low conviction split,   consider making low conviction the dominant allocation.
11. Are the Investments Generally of the Same Time Period?
    Investments tied to a single time frame (e.g., short-term speculative plays) may leave you vulnerable to cyclical risks. A mix of time horizons builds resilience against market timing issues and economic cyclicality.  In Gsphere, consider adding a profit taking policy if you are concerned about this dimension of risk.
12. Similarly, we want to diversify the timing of our investments. We know that dollar cost averaging helps investors diversify market timing matters from a market entry perspective.   This is most useful in situations where investors may have “found money”  such as an inheritance,  sale of a company, legal settlement,  cliff vesting,  lottery or YOLO windfall.   If you find yourself in this position, please take this diversification advice to heart and also consider stepping into the markets slowly.   Whether you employ a programmatic dollar cost averaging policy or just wade in with prudence and patience,  your virtues here are often rewarded.
13. Do the Investments Have Similar Fundamentals?
    Similar fundamentals, such as growth rates or debt levels, can lead to correlated performance. Including diverse fundamentals adds resilience.
14. Do the Investments Have Comparable Charts/Technical /Performance Histories?
    Identifying trends and correlations in performance history helps detect concentration risk. A mix of technical profiles ensures diversification in trading behavior.   If the plurality of your positions have the same looking charts and setup,  consider it a red flag.
15. Are the Assets Financial, Physical, or Operational?       Financial (stocks, bonds), physical (gold, real estate), and operational (businesses) assets behave differently. Including all three types creates a more balanced portfolio.   The considerable friction and illiquidity of these varying asset types should be of deliberate diversification.  It is not uncommon for 9+ figure family offices to lean up on stock market positions, if only to prop up operating companies that can not realistically be sold through a crisis.  This illiquidity, while never desirable, can be an asset at times. Operational assets often come with some serious taxes on your productive time and attention.   If you are not already into it, consider holding back on operational assets until your net worth is several million dollars.   This is one of my few instances where I suggest investors take deliberately less diversification.   If you are a high earner, keep your focus on scaling your earnings and let your money work for you,  not passively,  but programmatically. Automatically.