Investing Lessons From the Race Track

LAKE GEORGE, N.Y. (TheStreet) -- The horses are back at Saratoga, and I've made my annual August trek up to the Adirondacks to spend time at my vacation house overlooking Lake George. It's the perfect place to enjoy some boating and take in the racing at the grand old thoroughbred race track in Saratoga.

Last year, in " Five Investing Tips I Learned at the Track," I highlighted some lessons and strategies that are applicable to both investing and horse-betting:

  • Don't Bet Every Race
  • Do Your Research
  • Eliminate the Losers
  • Not All Favorites Are Good Favorites
  • Be Aware of Derivatives
  • After nearly 30 years of going to the races, I still learn more about investing and betting with every visit. I would like to share three more lessons I've learned at the track.

    1. Stick With Your Strategy

    My colleague Mitch Rosen and I co-manage a Web site called Horsepicking.com. While Mitch is an excellent handicapper, my personal acumen is in figuring our how to bet the races. Similar to my trading models , I've developed a betting model that formulates a betting strategy based on Mitch's picks.

    When we deviate from our strategy, as Mitch sometimes likes to, we often miss out on opportunities. When we stick to our model, our expected return is always positive over an extended period of time. When it comes to investing, you need to do the same.

    A side lesson: Picking stock and learning how to buy and sell them are two separate and distinct talents. If you don't have them both, you need to work with a good partner.

    2. Understand the Downside

    Investing is not only about picking winners. It's also about generating returns on investments. Some favorites will return such low payouts that it is hardly worth money betting on them.

    There are people at the race track called bridge-jumpers who will bet huge sums of money on prohibitive favorites to show. Show bets will pay off if the horse runs in first (win), second (place) or third (show) positions. A typical bridge jumper bet will return $2.10 for every $2 wagered. Certainly a quick 5% return in short order sounds terrific. How often can you make 5% in two minutes?

    However, the downside risk is extreme. If the horse runs out of the money, then you lose the entire $2. That equates to an instantaneous 100% loss. For every loss, you have to hit a bridge-jumping bet 21 times to break even.

    Jim Cramer likes to look at investments in terms of upside vs. downside. When I seek out investments, I place a minimum of 20% expected return on an individual stock. Furthermore, I will stop myself out on a 20% decline just in case my investment thesis on an individual pick is incorrect. When you successfully pick more expected return winners than actual losers, your actual returns should outpace the market.

    3. Diversify

    You know the old adage "Don't put all of your eggs in one basket"? In investing, we call that diversification. At the race track, we diversify by picking several horses that could win a single race or consecutive races and bet them in combinations and permutations, called "boxing," in exotic (or derivative) bets such as exactas (first two horses in order), trifectas (first three horses in order), daily doubles (winner of two consecutive races) or Pick 3 wagers (winner of three consecutive races).

    As an individual investor, it is sometimes hard to pick the best stock in a sector. Let's say, for example, you want to play the biotech sector. Should you invest in Amgen ( AMGN)? Gilead ( GILD)? Genzyme ( GENZ)? Or you could put together a portfolio of representative stocks or even buy an exchange-traded fund such as the Biotech HLDRs ( BBH).

    Buying one stock in a sector, you take on stock-specific risk. Should you pick the wrong stock, in an index that is trading bullishly, then you will have guessed right as to the sector but will still lose money because of the individual stock pick. Nor do you want to buy stocks exclusively in one sector. If your thesis is wrong about the biotech sector, for example, then you could find yourself taking a beating. That is why investors diversify across sectors and asset classes.

    So the final lesson from the race track: diversify. Because, as with all investing strategies, applying lessons from the race track to your stock-picking endeavors requires discipline and risk management.

    If you plan on being at the Saratoga race track, drop me an email and perhaps you can bet alongside the professor.

    -- Written by Scott Rothbort in Lake George, N.Y.

    At the time of publication, Rothbort was long Apple, although positions can change at any time.

    Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele. He also is the founder and manager of the social networking educational Web site TheFinanceProfessor.com.

    Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

    Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

    For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.

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