Advantage versus Investment Diversity. Can you have it all?

Most investors can only conceive of participating in “conventional” markets (stocks, bonds and real estate). The advantage of these investments is that there is plenty of public information available, they are highly regulated so you are less likely to get scammed, the friction costs of buying and selling stocks is very low (it is much higher for real estate) and you generally benefit from inflation (at least for stocks and real estate).

But the average investor is unlikely to get either an information advantage or a high level of diversity with this kind of portfolio. After all, low interest rates benefit both stocks and real estate, and increasing interest rates eventually tend to hurt investments in both arenas. If one owned Apple Computer, Exxon, Citibank, Allstate Insurance and Ford Motor and the overall market crashed one day by 20% don’t you think that each of these independent investments might do just as poorly? If the US stock market dropped by 20% one year, what do you think would happen to real estate prices?

On the other hand, if the law permitted you to operate a legal craps table and you only allowed pass line bets then you would have a 1.41% advantage on each and every wager. If you ran it yourself, never made a mistake on the payouts (your customers tend to point out mistakes in your favor more than mistakes in their favor), and had no other friction costs, this business would have a wonderful and rare combination of diversity and advantage. Each of the bets would have zero correlation with the other bets. Your small advantage would add up to steadily growing profits over the long run. The more reasonably sized bets that were made at your table, the more money you would make.

But these unique opportunities where you have both diversity and an advantage are hard to find and hard to retain. When you find such a prospect, the word tends to get out and new competitors undercut your advantage and increase your friction costs (for example advertising expenses).