Hedge Your Investment
Hedge your investment is a phrase that’s thrown out frequently in the investing world. To hedge is to limit or qualify something by conditions or exceptions.
“But what does that mean?”
A hedge investment, in a sense, is an insurance policy on a previous investment. Much like a life insurance policy, the investor looks for ways to offset the risks in case another asset goes to zero, or “dies”. The “perfect hedge” is one that is ties directly with the original investment.
Example 1: As the U.S. dollar continues to rise the price of gold tends to fall. Afterall, with a strong dollar people like to buy, and you can’t buy a house with gold (atleast it’d be pretty tough :D). However, as people begin to fear for the strength of the dollar they start putting money in other assets, like gold, or exchange their dollar for another currently, like Euros. Thus, the dollar begins to drop.
Example 2: Let’s say that you wanted to invest tabacco product (ewww). The foundation of the tobacco industry is that people smoke, they become addicted, and then they smoke more frequently. Thus, buying more tobacco. To hedge your investment you would also invest in anti-smoking patches, gum, or vape companies. Naturally, as the consumer leaves one market they enter the other.
There are pros and cons to hedge investing.
Being properly hedged prevents an investor from “going to zero”
Ensures proper diversification
Peace of mind
Hedging can inversely reduce the rate of return
You can often look for ways to hedge against circumstances that don’t happen
Another example of hedging is what a gambler might do. A “hedge bet” is a way of locking in a profit at a specific time.
Example: Lets say I place a bet for the Seattle Mariners to win the World Series for $10 at 25 to 1 at the beginning of the season. Now the series is about to begin and the Mariners are going against the Cubs who are now at 1.65 to 1. At this point I can “let it ride” and hope the Mariners win and I make $250 or I can do a little math to identify to proper hedge bet to lock in my profits. I start by taking my potential earnings ($250) and multiply it by my hedge bets odds (1.65). In this situation that gives me $151.51. If I now take $151.51 and place a bet for the Cubs to win at 1.65 to 1 odds, I will now win $250 if the Cubs win as well ($151.51 x 1.65=$250). At this point in time I would have placed $161.51 in bets ($10 on the Mariners and $151.51 on the Cubs), however by the end of Game 7 would be guaranteed to win $250.
Again, by doing this I significantly cut my potential returns but I guarantee that I won’t “go to zero” and can watch the game in peace.
Hedging is a very useful technique for an investor to learn, especially if you think an asset you own might be at risk. Consult your financial advisor to see what the best options are for you.
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