Stock market feeling a bit too risky for you? Here’s a list of ways you can fight back.
Some market watchers look at stock market valuations. Some look at the economy. Others focus on geopolitical events. And all are trying to account for the risks that the impact of Covid-19 is far from over.
Whatever risks to your wealth you are trying to guard against, the solution is not to worry or be complacent. It’s to hedge your portfolio in some form.
When I talk about portfolio hedging, many people assume I am speaking only of the most blunt risk-management methods around. For instance, investing in inverse ETFs or buying put options. Those investments are designed to specifically zag when the market zigs.
However, to investors like me, hedging is more like a way of life than an urgent transaction. It is more like exercising regularly throughout your life, versus getting in shape only after your doctor demands you do it immediately.
So, if buying put options on major market indexes, as well as buying inverse ETFs are the “obvious” hedging methods, what are the others? The full list is too long to cover here. So with Covid-19 in mind here are 17 more forms of portfolio hedging to add to the 2 I already cited.
Naturally, none of these are specific recommendations. They are a list of items to potentially learn more about, if you are inclined to consider hedged investing during or after the pandemic era.
- Bonds (tactically) – buy and hold bond investing is treacherous at these low interest rate levels. But as rates hop up and down, bond ETFs can produce pockets of temporary opportunity.
- Gold – through an ETF or a vault, the “yellow metal” has a reputation for being a stock market hedge. Gold tends to profit from fear. However, this relationship is not a slam-dunk, so look carefully before you assume you have the golden touch.
- Gold stocks – didn’t he just cover gold? Well, yes, but that was the metal. The stocks of businesses that mine for gold are often correlated, yet more volatile than gold itself. That difference makes them a related, but separate, alternative.
- Tactical equity management – one close to my heart, as I do a lot of it during times of market trouble. All this means is that you shorten your time horizon for part of your portfolio, and seek to profit from renting slices of the market, not buying them to hold for years.
- Bitcoin – I am still one of those middle-aged dudes who is a bit skeptical of the whole crypto thing. However, these tend to rise in price when the U.S. Dollar weakens. That makes it within the realm of hedges to consider, in my book.
- Leveraged Inverse funds – to be clear, I specifically do NOT consider these myself. I think they are too close to being a casino game. However, this is a list of hedges “one” might consider, even if I don’t. So there you go.
- Money market funds – sure, “cash” is a hedge. Even when it yields zero. As they say, return OF your capital comes before return ON your capital.
- Non-U.S. stocks and bonds – simply for the favorable currency aspect of owning foreign securities when the U.S. Dollar is suffering, these make the list. And, it’s been a very long time since Europe, Japan and the rest of Asia outperformed the U.S. Large Cap stock market.
- Merger Arbitrage – this is one of many “long-short” strategies that are accessible in fund form. This one has to do with trying to capture the “spread” between the stock prices of companies being acquired and the firms acquiring them.
- Call-option buying – call options allow you to pursue upside in a market area, while defining your downside (you can only lose what you invest, which is typically a fraction of the value of the assets you control through the option. There are some ETFs that do this too.
- Covered call writing – to me, this may be the most overrated item on the list. The marketplace is littered with strategies that sell call options to collect cash in exchange for capping your upside. Space limits my ability to explain why I think these are overrated. However, if at least a couple of people ask me to explain it further, I will devote a future article to it. Deal?
- “Tail Risk” hedging strategies – on the other hand, this type of option strategy is one I find value in during shaky times, depending on the specific structure. The bottom line is that you invest a fairly modest amount of capital in exchange for potentially large gains if the market tanks like it did 6 months ago.
- “Pairs” ETF positions – I wrote about this earlier this year. This just refers to taking a regular equity ETF, buying a similar (or slightly higher or lower) amount of an inverse equity ETF, and treating them as one “paired” position. This creates an arbitrage between the two. Translated to English, that means your profit or loss is primarily tied to the difference between how the two ETFs perform, instead of both of them moving up or down together.
- Commodities – if inflation fears are to blame for the stock and/or bond markets cracking, this investment category stands a chance. Rising prices usually include food, energy and raw materials like lumber and steel. There are several funds that own these in basket form, individually, or through stocks in these industries.
- Foreign currency – either through a fund, a foreign exchange account, currency-CDs or that bill or coin you found in your wallet upon arriving home from an international vacation, foreign currency hedges Dollar weakness.
- Custom portfolio hedging – you may have specific risks in your portfolio that require more than an “off the shelf” hedging technique. One common situation is when you have a very big position, or at least a big gain, in a stock. It could be from working at a public company for a long time, or from just buying years/decades ago and making tremendous gains in a taxable account. This calls for identifying what might offset the risk of that position, while still retaining much of your upside.
- Not being greedy – no, the final item on this list is not a stock, ETF or complex futures strategy. It is the reality many investors face during the whipsaw year that is 2020. Yes, you can “rebalance” your portfolio as so many do. But that may only mean you are selling winners (and paying taxes if the gains are taxable) and holding your problem-children in the portfolio.
Instead, I am talking about simply investing within your tolerance for major loss. Like the baseball player whose value to the team is to hit singles and steal bases, if he hits one home run, you worry it will go to his head and take his focus off of his strengths. Whatever your strengths are, don’t let greed sap your investment power. Staying humble might be the best for any investor.