Hedging Stocks

Many millions of ordinary people have, over the past 25 years, been steadily bombarded with the voices of conventional wisdom telling them over and over how stocks outperform every other form of investment. They have collectively entrusted their individual retirement accounts to the markets.

Alternately, they have entrusted their public retirement benefits, namely social security and medicare, to the government. The government has mismanaged these programs and now finds itself with trillions of dollars of unfunded liabilities, going forward. (i.e. the system is headed for bankruptcy)

Hmm. Stock market and government. Who should we trust less?

I would contend that people can, really and truly, only depend upon THEMSELVES. To trust politicians and Wall Street sharks to take care of your money has got to be the height of mass gullibility. Ordinary people learning to take care of their own financial lives is why we started Pennyjar. It's not as complicated as the "experts" would have you believe; and it can be fun, with the right approach.

But I digress.

It is quite true that one can become very wealthy through owning stocks, but for the majority of us, it simply has not come true. So many ordinary people lost money in the dot.com bust. So many ordinary people have watched their mutual fund based retirement portfolios wallow in mediocrity since the bull market ended in 2000.

So who is really making money with stock?

In very basic terms, there is a class system in play in this country.

The working class has basically nothing. They are living paycheck to paycheck and are prisoners of debt. They are depending on social security and medicare to take care of them after they finish working. There are some uncertain times ahead for this group of 50 million or so unfortunate Americans. Fact of the matter is that they may not be able to retire and will probably have to keep working to make ends meet, until they cannot.

The middle class has invested trillions of dollars in mutual funds, most of them invested in a basket of US stocks. When stocks go up, they win. When stocks go down, they lose. Very simple game. Of course, the brokers, investment advisors, mutual funds, corporate executives and tax man all win, no matter what. All the risk of loss is in the hands of the individual holding the stocks (i.e.: YOU).

The rich are a very different story. The rich, that is to say, people with a liquid net worth of more than a $ million, are able to be designated as “Accredited Investors” and can invest their money in “private equity funds”, often better known as hedge funds. They, like the middle class, buy stocks with the anticipation that they will go up in value. Unlike the middle class, however, rich investors also may have a percentage of their investments configured so that if stock prices drop, they also make money. This is known as hedging and is where name “hedge funds” originated.

So what can you do if, like most ordinary people, you don’t have over a million dollars available for investing? To begin with, it is possible to do some hedging of your own.

There are some relatively new products available. Some in particular caught my eye recently. They are newer mutual funds utilizing a 130/30 strategy. It is a strategy that hedges against stocks going down and is available for ordinary people. The managers of these funds "short" 30% of theirs stocks. I will post more on 130/30 strategy later.

There are also some relatively new ETFs (exchange traded funds) that are engineered to move inversely with the market. That is to say, if the market drops, the ETF goes up. If the market goes up, the ETF goes down.

Using hedging as a strategy is most certainly not good for everyone. But it is an option, and it is utilized by a lot of very rich people, so there must be something in it.