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Archive for August, 2009

How To Hedge A Portfolio | Personal Wealth Management

There has been no shortage of media coverage regarding the widespread losses inflicted upon investors since the country formally entered what is now being called the “Great Recession”. After all, this is understandable considering that roughly $30 trillion was wiped out from world equities during that year. And how have investors taken it? Well apparently, not too well. Many investors, and particularly the beginner investors, abandon their investment strategy (instead of asking themselves “how can I generate wealth in a recession?”) and panic as soon as the market starts going down for a while. They panic and sells when everyone else is doing the same, and as a result, they get next to nothing from those sales. Then after that experience, most of them vow to never invest in the stock market again, convinced that they are that “investing just doesn’t work”.

Of course, this is not the approach taken by the wealthy investors. Do you think Warren Buffet panics and starts selling in droves when his portfolio goes down? Of course not! Neither does he say that he’s not going to invest anymore because he lost some money. Some might argue that he can afford to lose some money but that’s beside the point. Those guys hate losing money. So what they do is that first of all they only invest in opportunities where they have the best chance of making money. And even then, if they stand to lose some money, they do their best to minimize the damage, while keeping an eye out for other ways to make a profit. They don’t follow the herd. Actually the greatest fortunes in the world have been made by not following the herd.

If you want to make money like the big boys do, you have to use the same strategies the big boys do to protect their personal wealth and hedge their investment portfolios. Here are three relatively simple personal wealth management techniques you can use to minimize your losses during a market downturn. Of course there are more sophisticated techniques but the below three are the most accessible to beginner investors who want to know how they can limit losses on their investment portfolios.

Personal Wealth Management Techniques

1. Buy stocks that offer the lowest possible risk for you to lose money. This is something that all successful investors do: they buy undervalued stocks, meaning stocks that are cheap yet backed by a fundamentally sound business, but for a variety of reasons are priced below their real value. Since the bad news is already factored in, there’s less of a possibility that the stock will go further down. On top of that, when things are tough economically, make sure you own medical, healthcare, utility, and food stocks. Theses are the last things that people cut when they’re in a bind.
2. Sell covered calls. This is a very conservative wealth management strategy where you sell call options on stock you already own: you sell a call option contract based on the fact that you own an equivalent number of shares in the underlying stock. In other words, the buyer has the right to buy your stock (at the strike price), and you are paid a premium (price paid for the purchase right). In essence, you’re betting against another investor that the stock’s price is not going to go up, and he bets that it is. You get the some immediate income in exchange for sacrificing future gains on the stock should it rise above a certain level. If the stock fails to reach that level, you get to keep the entire income from the call option. The net effect is a hedge against market decline.
3. Buy put options. When trouble visits the markets, you can buy protective put options against your holdings. Put options serve as a type of “insurance” in a declining market. If you choose to buy or go long a put option, you are purchasing the right to sell the underlying instrument at whatever strike price you choose until the expiration date. If and when the underlying stock falls below the put strike price, you can exercise the put to short the shares at a higher price and then buy the underlying stock at a cheaper price to cover the short and exit the trade. The gains you see in the puts offset some of the losses from your stock or mutual fund holdings.

Historically, the stock market has trended up, despite cyclical bull and bear markets. Your goal as an investor is to stay in the market long enough to reap the benefits from that trend. By hedging your portfolio with sound personal wealth management, you give yourself the best chance to pull it through the bad times and reap the rewards when the market does turn around.

How To Hedge A Portfolio | Personal Wealth Management

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