Diversifying your portfolio

The subject of finance argues that by diversifying your portfolio, you can reduce risk but keep the same expected return. Thus, suppose you have a choice between these options, a 50% chance of getting $1000 and a fifty percent chance of getting nothing, or a certainty of getting $500. Most people would prefer the second, the certain $500. Both have the same expected value, but the first has more risk. Or if you could buy many different chances of the first option, you would get something close to the second option; this is the logic of diversification.

The intrade markets offer an interesting way to diversify your portfolio of happiness. When the election takes place, one side will be happy and one side will be unhappy. The expected value of happiness right now for both sides is about zero since the election looks like pretty much a toss up. To protect against the danger of emotional despair, each side should bet that the other side will win. Thus, if you want Obama to win, you should bet that McCain will win. Then if McCain does win, you will not feel so upset about it because you will be winning money. Of course, if Obama wins, you will not be so happy about it as you would have been if you had not placed the bet on McCain. But the risk is reduced. I wonder if anyone is actually doing this kind of diversification of the portfolio.

Alternatively, you might reflect on a lesson of life, that sometimes things that seem initially to be really bad turn out to be good, and things that initially seem to be really bad turn out to be really good. I always worry about young people who suddenly come into a large sum of money. Will it be good for them, or will it encourage them into decisions that in the long run will be unfortunate? Or consider a couple of workers, one of whom is let go and the other retained because a business has to cut back. Initially the one let go will be upset, but it may turn out that as a result he or she will find something that is far better than what they had, and they will look back at that misfortune as a blessing.

The same is true of politics. Sometimes you will be happy with the way an election turns out, but a few years later you will deeply regret the consequences. And other times you will be unhappy, but the end results may turn out to be very good.

As the saying goes, watch out what you wish for.