If you’re heading to Flemington to enjoy the Melbourne Cup action, take a moment to think about why the bookies always seem to win, while the punters generally come off second best.
It’s a no-brainer that bookies have better knowledge of various horses and their form than the once-a-year punters. But the big difference lies in the way bookies spread their risk while punters concentrate theirs.
Bookies continually change the odds in such a way as to encourage punters to back as many different horses as possible in each race.
If one horse, the favourite, is heavily backed, the bookie minimises exposure by backing it with other bookmakers. This way the bookie will have a mix of wins and losses. By spreading their risk the objective is their loses will be offset by their wins.
Punters on the other hand concentrate all their risk on one or two horses in each race – often without knowing much about any of them.
I often see the same approach taken to investing. Rather than spreading wealth across a range of decent asset classes – with good form, people often focus on one particular investment. If it does well, the rewards can be handsome. However if the asset performs poorly the investor can lose money.
To strengthen returns, you should ideally invest a little in a lot of different asset classes, rather than pinning your hopes on a single investment. Investors call this ‘diversification’, the bookies call it ‘hedging their bets’. They both mean the same thing; namely, not putting all your eggs in one basket.
There is a range of mainstream investments to choose from – quality shares, property, fixed interest securities and cash deposits. Even if you don’t have a lot of money to invest, it’s possible to diversify your portfolio through managed investment funds and your superannuation fund.
Diversifying doesn’t just offer protection against falls in one investment market. It also provides protection against things like legislative risk – the possibility that the government could change the rules affecting a certain asset class.
How you diversify depends on your age, income, family situation and so on. The younger you are the less diversification you are likely to have – being mostly invested in higher risk, ‘growth’ assets like shares and property makes sense. However, as you get older you should aim to diversify more, into more ‘conservative’ assets like cash and bonds as your wealth grows and retirement approaches. Over a lifetime it’s a proven investment strategy that provides decent, long term returns.