Legally, hedge funds can be marketed only to people with net worths of at least a million dollars. Feel left out? You shouldn't.

Not all hedge funds have impressive returns, and few use secret techniques that you can't. So rather than watching from the sidelines, you should learn from hedge funds to improve your own investing.

Here's the easiest lesson: Diversify. How to cut your risk

Hedge funds often invest in exotic securities in order to get an investment return that will behave differently from either the stock market or the bond market. That way, the fund can generate part of its return from an asset that doesn't duplicate or reinforce a broader market risk. Even if both the stock market and the bond market weaken, this asset may do well.

Individual investors can do the same through diversification.

"You have to think about the process of diversification from a macro standpoint," says Leo Harmon, a senior director of Fiduciary Management Associates, an institutional money manager in Chicago. Harmon explains that we all need to look at our investments from the broadest possible perspective.

From his point of view, investors should consider diversification beyond the usual mix of U.S. stocks and bonds. He points to international stocks, foreign-currency certificates of deposit, residential and commercial real estate, art and possibly even sports tickets -- for their resale value. What are your options?

Aggressive strategies for diversification are common in the hedge-fund world. A few hedge funds have gone so far as to invest in soccer players, signing young players to long-term contracts in hopes that the player will develop in a way that makes the contract profitable for the fund. If the player learns to bend it like Beckham, the fund can make millions.

At the best funds, each asset has a different risk-reward profile. Some assets will be slow and steady growers; others will offer a big hit one year and then do nothing for a few in between. Some will generate dividend income while others offer capital gains.

"You want to spread the risk," says Steven M. Ricchio, a senior vice president at Whitnell, an investment adviser in Oak Brook, Ill.

What does this mean for you? Let's look at the value of your house -- perhaps the biggest investments you may have. When should you cash out?

If you have a conventional mortgage, a house provides shelter at a predictable price, and that's an important aspect of its value.

Its value as an investment, however, will fluctuate depending on the strength of the U.S. economy and on interest rates. So if most of your net worth is tied up in your home, you should consider diversifying away from the U.S. Buy a house and some international stocks, and you could have security and a good investment return even if the American economy goes to pieces.

Of course, you shouldn't assume that every expensive purchase you make is an investment. Sorry, but those Jimmy Choo shoes don't count.

An investment is something that you might reasonably expect to sell for more than you paid, even after considering maintenance and inflation. This usually happens because of income generated by the investment or because of scarcity value. Your car is not an investment because it is going to require maintenance and repair. (A classic motorcycle might be a different story.) And Jimmy Choo shoes are a kick, but they aren't investments.

Lee Schultheis, a portfolio manager at AIP Mutual Funds in White Plains, N.Y., says investors should think about how different assets are correlated. Do the prices of the assets move in the same direction or in opposite directions? Do price moves reinforce or counteract each other?

Diversification ensures some of the price moves in your portfolio will counteract others and reduce overall risk. Chart: The more you own, the safer you are

Professionals use other tools as well, but not all of them are as easily adapted by individual investors.

For instance: Experienced professionals frequently use short selling of one sort or another to hedge their positions. One common strategy is the sale of securities the seller has borrowed: You borrow the security, sell it and hope the price will go down. If you can replace the security you borrowed at a price lower than the sale price, you'll make money on the transaction.

But pros caution that short selling is not a wise course for amateurs. And unless someone else is paying you to handle investments, you are an amateur.

"If you are educated about the market and are an active or semi-active trader, hedging can be a way to increase returns," says Harmon. But he cautions that less-experienced investors can get into a lot of trouble with short positions.

"Diversification is enough for most people," he says.

Investors interested in aggressive hedging strategies -- but hesitant to short positions themselves -- will sometimes enlist the aid of financial planners experienced with these strategies.

And several mutual funds, including the two that Schultheis manages, use the same short-selling, derivative and fast-trading strategies that hedge funds use to create investment returns not correlated with the stock market.

Thinking more like a hedge fund can help you in other ways.

For instance: Focus on maximizing your most valuable asset. For most people, that's human capital. If you invest time and money in increasing your value as an employee, it may very well translate into a better-paying job. And a healthier paycheck can protect you from a lot of market gyrations. What's your greatest asset?

Similarly, the right kind of insurance can protect your earnings power if you become sick or disabled. It can help your family pay your bills if you die and your human capital goes to zero.

It's all part of viewing your life as your diversified portfolio.

Published April 24, 2008