Hamster fun and information The Importance of Hedging
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The Importance of Hedging
Hedging your stock portfolio is important for many reasons.
The obvious reason is to prevent huge losses should stocks crash or suffer a significant correction.
Years of gains can disappear in an instant.
What most traders and investors don’t understand are the actual long-term ramifications of crashes on your overall wealth.
When stocks crash, it affects your portfolio’s ability to efficiently compound.
This isn’t just about preventing short-term losses.
This is about creating more efficient exponential growth.
The long-term result of avoiding a portfolio drop when markets crash is astonishing.
If you can increase your average annual return from 10% annually (with corrections and crashes) to 20% annually…
…the end result is $3.2 Million over 21-years when starting with $100k invested in the broad market.
Common Hedges That Don’t Necessarily Hedge Anything
Do a quick internet search on hedging and you’ll find all sorts of ideas and methods used to hedge against a market crash.
Unfortunately, most of them are ineffective at best, and in some cases, actually INCREASE your risk during a major market correction or crash.
Here are a few that you’ll find, most are not actually hedges:
- Allocate a Portion of Your Capital to Cash
- Buy Gold or Silver
- Invest in a Bearish ETF
- Time the Market
- Cost Average When Market Moves Down
Do any of these sound familiar?
Let me briefly explain why most of these are not actually hedges against a major market correction or crash.
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Allocate a Portion of Your Capital to Cash
This Means Timing the Market Overall and Diminishing Returns.
When should you put a portion of your portfolio in cash?
Now?
Later?
What happens if you are wrong and you miss out on one of the biggest bull markets ever?
This is not a hedge, it is simply investing less, which means making less. And, what you have invested will still suffer in a market crash.
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Buy Gold or Silver
Buying gold or silver is super popular.
But it isn’t what the hypesters want you to believe so you’ll buy it from them.
It is not truly a hedge against significant market corrections or crashes, and in some cases, may INCREASE your overall risk
Red line is SPY, purple is a Gold ETF. Notice in 2007 and 2008 as stocks began to come down, so did the gold ETF. You would have lost in stocks & gold.
Gold did begin to recover sooner than stocks, but by the time stocks hit the bottom, the recovery in the gold ETF only made it back to where it was when stocks started to move down in the first place.
The net gain from the gold ETF at the bottom of the stock market crash was zero.
You suffered the entirety of the crash.
Moreover, if you are always long gold in order to always be hedged, the time period between 2012 and 2016 saw the gold ETF drop significantly, offsetting much of the gains in SPY during that same time.
Gold was just recently down 25% and it’s not even a full on crash yet.
Gold and silver cannot be relied on as true hedges, and can actually increase your risk.
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Time the Market
This is so silly it is almost not worth mentioning…but I’ve seen some articles out there promoting it as a hedge, so I’ll quickly address it.
What if you are wrong?
Not a hedge.
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Cost Average When Market Moves Down
This is more silly than the previous one.
If I have $100k invested in stocks, and that is all I have, please tell me how I’m going to cost average when stocks tank 40% and my $100k drops to $60k?
This is not a hedge.
Your portfolio drops, and you may or may not have more money to invest.
Moreover, what if your cost average and stocks keep dropping?
There is a Better Way
Proper hedging isn’t just about avoiding a market crash, although that is a huge benefit…
It is also about dramatically increasing the long-term gains…in other words, hedging actually increases potential returns by as much as 2x – 3x in the long run.
If you aren’t hedged, or you don’t know how to hedge, it’s not too late.
I have extensive webinars to help.
But that is the Truth About Trading.
Trade Smart,
Ryan Jones
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