What if you could get an insurance policy for your portfolio? Well, you can -- smart investors have been doing it for years. It's called hedging, and believe it or not, it's not too expensive or too complicated for you to put to work for your investments. Here's the rundown.
A Brief History of Hedging
Believe it or not, hedging has nothing to do with foliage. It actually gets it name from the Roulette table. In Roulette, players can place a bet on multiple numbers by putting their chips on a border-line called a hedge. When you play a hedge-line in Roulette, your chances of seeing a payout are increased (albeit at a lower rate) because you're betting on more numbers.
Just like in the casino, investment hedging is a way to increase your portfolio's upside and reduce overall risk. A hedge is an investment you make to protect another investment. It's a lot like insurance.One of the most common ways to hedge an investment is by pairing a stock with the opposite position in a related stock. In other words, if you think Company A is going to increase in value, but you want to limit your downside, you could short an index fund that tracks Company A's industry. That way, if the industry takes a hit, your short gains will make up for any losses you take on Company A's stock. Even if you weren't familiar with hedging before, chances are your portfolio is somewhat hedged right now.