Over the weekend I read an article from advisor David Nicholas, and in the article, he described the power of hedging. The idea behind this concept is that as your portfolio gains interest, you begin taking some of the gains off the table. You then invest those gains in things that are hedged from losses.
Here’s an example of how this works. Forbes states that the S&P 500 gained 26.9% in 2021. Clearly, a great year for the market. If you had a portfolio of one million dollars, that’s a gain of $269,000. You now have $1,269,000.
In our hypothetical example, if the market corrected, 40% this year, your $1,269,000 would turn into $761,400. In Nicolas’ article, he writes, “'Don’t worry, the market always comes back.' If you haven’t heard this comment yet -- from a well-meaning friend or co-worker, or maybe a concerned financial professional -- you almost surely will. We’re all hoping for the best but bracing for the worst as the market continues to react to political and economic uncertainty. Your friends and colleagues aren’t wrong. Historically, the stock market always has come back, and investing in stocks has been a good way to grow retirement savings over the long term.
Of course, historical data doesn’t offer much comfort when the loss is personal, especially for investors who are in or approaching retirement and don’t have a lot of time to recover from this latest bear market. Waiting for the market to come back may not sound like much of a solution if you are retired or you’re planning to retire in the next few years and are depending on those assets for income.”
Back to your $761,400 you were left with. If the market went up 26.9% next year like it did in 2021, you’d have $966,216. If we have 25 or 30 years until we need our money to create retirement paychecks this may not be problematic. If we’re in retirement or within ten years of retirement market corrections may become more meaningful.
A possible solution may be to use hedges or remove some of your gains and place them in financial vehicles that can predictably create retirement income. If our only tool we are using in our portfolio is equities, we can’t build a financial house that’s going to shield us from economic storms. Imagine only using a hammer to build a house. If you'd like to discuss this more or have a question, call our office at 864.641.7955.
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