What does it mean to hedge

What does it mean to hedge?

Sometimes I forget that not everybody knows what I’m talking about when I use the term “hedge.” One of the most popular topics in financial news are hedge funds.  But why are they called that?

 

What does it mean to hedge

 

“Hedging” has been a term floating around since the 1600s, and it originally refers to plants which act as a border to “lock-in” a property.  Hedging is exactly that.  You’re locking in the maximum amount of risk you can take in an investment.

 

For example, one of the most common ways in which investors use options is that they invest in a stock, and then “Hedge” against their risk by also buying a put option. A put option is an insurance policy such that the insurer has to buy the stock at a set price.

 

For example, if you bought IBM for $150.00, and bought a put option that promised to honor a sale price of $140.00, you are locking your downside to $10.00.  You are hedging against risk.

 

Hedge funds are called their name because they are able to invest in many types of assets that traditional mutual funds cannot.  They can trade options, lend on real estate, short the market and more.  There are many ways to arrange a portfolio where if one investment goes down, the other is likely to increase.

 

Hedging against risk can also hedge against gains….

If you put half or your portfolio in the market, and half or your portfolio in an inverse fund that moves opposite of the market, then you are pretty well hedged.  If one goes down, the other goes up.  But if you lose a dollar to gain a dollar, what’s the point?

 

Blindly hedging in order to minimize risk also tends to minimize reward.  It’s done in many forms including buying contradicting assets, diversification, dollar cost averaging, etc.  Overall, even these methods will manage risk and you can make some profits.  (Not enough where we’d consider it).

 

Intelligent hedging….

We believe in owning multiple types of assets.  Stocks, real estate, gold, etc.   But rather than blindly buying fixed amount of each at any given time, we recommend learning to be more strategic aka “STOCKPILING”

 

Stockpiling is a way of hedging your risk and yet increasing the chances that all of your investments will substantially increase in value over time.  For example, if I was to blindly hedge against risk in my portfolio, I would make set allocations in stocks, gold, bonds and real estate.  If one or two went down, perhaps another one or two would go up.

 

HOWEVER, if I was to stockpile I would set some sort of criteria in order to BUY ON SALE.  Let’s say that stocks were at an all-time high, but gold just dropped below a 200 hundred day moving average.  It you stockpiled gold as it was tanking, and avoided stocks, you would likely see a rebound in gold.  And when stocks dropped below a 200 day moving average, you could begin to stockpile equities, and lay off gold.  Over the long run, buying into weakness rather than blindly buying in has historically produced better returns.  And in the long haul you are still acquiring different assets that hedge against risk.

 

Are you looking to beat the odds? To limit risk WITHOUT limiting reward?  Follow along as we show you exactly how we do it.

 

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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