Much like you can plant a hedge around your property to protect it, you can select investment elements that do the very same thing for your portfolio. Hedging isn’t a strategy for making money, it’s a strategy for protecting the money that has already been made from any potential losses. How do successful investors benefit from hedging?
Mix It Up
The best investment strategy is always to diversify a portfolio with a mixture of stocks and bonds that aren’t tied to any one sector or index. This reduces an investor’s exposure to risk during price swings.
Staying liquid is one strategy for hedging against potential losses in the markets. Cash is cash and it won’t decrease in value. But run of the mill savings accounts, money market accounts and certificates of deposit don’t make much interest income in the current economy.
U.S. Treasury Bonds are considered some of the very safest investments available. They are backed by the government so there is no chance the bonds will become worthless. Treasuries are fixed-income vehicles that make their interest payments regularly, even if the rate of return isn’t very high.
Stocks that Pay Dividends
Buying stocks that pay dividends is one way to hedge against market volatility. Dividend stocks are often considered very conservative investments. But some analysts believe that the dividend is the very anchor that keeps the stock price from soaring during the good times and then crashing in the bad times.
Companies that pay dividends are usually high-quality with a good track record and may be good bets as hedges and as longer-term “holds.”
The Sparkle of Gold
Gold has been used as a currency since the beginning of civilization. Investors continue to buy it as a hedge against inflation and unrest around the world. In some instances investors actually hold onto bullions or bricks. Others invest in exchange traded funds, that move with the value of the commodity.
Some financial advisers also recommend that portfolios include gold and other commodities as part of a diversified mix.
Using derivatives as a hedge against the swings of the market is not a strategy for beginners.
A derivative is something that’s value is based on another asset. One example is a stock option. A stock option gives the holder the right to buy or sell an asset at a predetermined price on a predetermined date in the future. It’s an option to buy or sell, not a requirement.
An option is a derivative because its value is derived from something else, the price of the stock.
Having the option with a right to buy is known as a “call.”
Having the option with a right to sell is known as a “put.”
Hedging a portfolio isn’t a series of techniques to gain wealth. It is instead, a series of available options to try and preserve wealth during the ups and downs of the financial markets. Tolerance for risk is a personal thing for investors and helps guide decisions on when to hedge and when to let it ride.