Hedging has become somewhat of a dirty word lately.  People have correlated it with Hedge Funds and “betting against America”.  In reality hedging, like many things (i.e. alcohol), can be abused or used incorrectly and cause harm. But when hedging is used correctly it can be a useful tool or a prudent necessity.  A homeowner will usually hedge the chance of a fire destroying his home by purchasing fire insurance.  Hedges can also improve the safety and reduce risk in an investment portfolio.  Hedging is a portfolio diversification strategy to reduce risk by owning something that is correlated inversely to other assets in the investment portfolio.

Owning precious metals investments, including gold & silver mining stocks, are a hedge. The primary purpose of owning these investments is because they do well during times of rising inflation or economic and political turmoil.  These are the times other asset classes like stocks, bonds or real estate may not do well.  Therefore it is prudent to hedge a portfolio by owning some investments related to precious metals. During periods of economic stability most portfolio managers recommend a target of 3-7% of a portfolio in precious metals related investments, but that percentage could be much higher at certain times. It is important to constantly monitor economic and political risks to achieve the optimum asset allocation in precious metals.

A recent popular vehicle for investing; Exchange Traded Funds (ETF’s), provide an instrument that moves inversely, or the opposite direction of a stock market index.  Some of these inverse EFT’s even move 2 or 3 times as much as the underlying index.  The need for frequent rebalancing makes inverse ETFs dangerous for anyone who doesn’t understand how they work or does not pay close attention to the need for frequent rebalancing. In other words, inverse ETFs require an active asset allocation strategy.

For Investors who employ an active asset allocation strategy the inverse ETF can be a useful tool by allowing an investor to take the market risk partially or wholly out of one’s stock portfolio.  For example, let’s say you own $100,000 of 20 great companies with solid balance sheets and high dividends, but believed strongly the stock market is going to decrease in value. You may not want to sell your stocks so you buy $50,000 of an EFT that moves 2X the inverse of the market.  You now have removed all the market risk from your portfolio of stocks.  If the market moves lower, as you believed, you will make money on the ETF to make up for losses in your stocks.  Of course, if you are wrong and the market moves higher, you will lose money on the ETF that will offset the gains in your stocks. The purpose is to continue receiving the dividends and not incur the taxes and commissions selling and buying your 20 stocks.

Hedging is an important and useful diversification strategy to reduce investment risk and improve long term portfolio performance.  It is also a strategy that requires careful application, monitoring, and frequent rebalancing.  Properly used, hedging can reduce investment risk. 

The Arbor Investment Planner provides the Arbor Asset Allocation Model Portfolio (AAAMP) which uses hedges to reduce portfolio risk.  Investors use the AAAMP as a guide but stay in control of their assets, and make their own investment decisions.  The AAAMP uses precious metals investments and inverse index ETF’s to maintain asset allocations at levels believed to be optimum for the current investment environment.  Rebalancing is taken into consideration in Trade Alerts sent to subscribers. The AAAMP is updated with every trade or major market move in order to stay disciplined and focused on our asset allocation.

More Information is available at: www.ArborInvestmentPlanner.com.

Diversification is the single most critical element of investment management. How an investor allocates investment funds to different asset categories or groups is called asset allocation, and is the most important fundamental of diversification.  Asset allocation involves dividing an investment portfolio on a percentage basis among different categories of securities (international stocks, domestic stocks, bonds, precious metals, cash, etc). Determining the most effective mix of investment opportunities is the foundation for successful investing.

The main purpose of Asset Allocation is to diversify among asset groups that act differently and thereby reduce volatility of the portfolio as a whole. Asset Allocation is the single most important investment decision. Studies have shown that asset allocation accounts for a majority of the total return of a diversified portfolio. In other words, timing the market and which individual stocks or ETFs are in a portfolio is less important than asset allocation choices.

There are many types of asset allocation, but all follow under either a passive or active strategy.  Passive strategies would have set fixed allocations with periodic rebalancing.  Active strategies would have asset allocation percentages that vary over time.  Active strategies might take into account economic conditions, relative value of the different asset classes, or any other number of outside influences the portfolio manager might believe will affect future returns.

While under diversification may be the biggest mistake investors make, over diversification is also a major reason for poor portfolio returns in today’s environment.  Over diversification can result in a portfolio behaving like the market.  Many investors have experienced the bad results of over diversification during the current decade.  Most institutional vehicles (i.e. diversified mutual funds, pension funds, etc) are over diversified and simultaneously lack an asset allocation needed for success.

 Determining which assets maximize potential rewards and minimize risk make knowledge and research a critical part of proper asset allocation. Today’s investment environment is different from the 1980’s and 90’s when an investor could depend on equity index funds or any diversified portfolio to provide satisfactory returns.  During this decade, proper diversification through asset allocation has proven to be the best way to profitably invest without taking undue amounts of risk.  This has made it harder for the individual investor to invest profitably because they either invest in institutions (i.e. mutual funds, pensions plans) that over diversify, or lack the time, resources, or knowledge to make proper asset allocation decisions.

One solution is for Investors to manage their own portfolio with the help of a portfolio management service such as the Arbor Investment Planner. The Arbor Asset Allocation Model Portfolio (AAAMP) uses an active asset allocation strategy and carefully looks for areas of opportunity where prices may not reflect their real value or potential.  This takes time and knowledge to research economics, politics, and markets worldwide.  Investments are placed in their proper asset allocation category and constantly monitored to stay properly diversified at all times.

The Arbor Investment Planner is not a get rich quick strategy, but a disciplined, methodical, and conservative strategy with a track record of out performance and less risk than the market. 

Additional Reading on Diversification:

“Define Diversification” http://tinyurl.com/2vfl7yj

More information is available at: www.ArborInvestmentPlanner.com.