How I Hedge

I am under the belief that hedging can be accomplished through multiple avenues. Some may short stocks. It’s not that I am against shorting (unless I’m long that particular company), it’s just that I’m not wired nor trained to analyze with that outlook.  I’m a glass half full guy who is always thirsty.  Clearly, there are many successful short sellers and bears.  Investing and trading is a zero sum game after all.

Other methods include, purchasing protective puts (which essentially act as insurance for your holdings), however, these can add up and become a drain on your capital as time passes.  Additionally, holding a small amount of an inverse S&P 500 ETF, anywhere from 3%-7% of your portfolio depending on your medium-term outlook of the market, is a logical choice.  And yet some endorse using a gold ETF.

While all of these are reasonable techniques, I prefer to go with what I have dubbed the Randy Moss method: straight cash homie.  Cash is wonderful way to hedge for many reasons. In bull markets, it allows you to purchase companies that have not participated in going to the upside. Also, you’re able to be more selective in the companies you want to add to your portfolio because your capital isn’t entirely invested.  In bear markets, there’s the obvious advantage in that you’re not loosing money. More importantly, you can buy market leaders and high growth companies on at discount, or lower your cost basis and add onto long term holdings only to sell a small portion of it when the stock goes back up.  Confirm that these were brought down because of the overall market, not because of company-specific factors.

Cash is important facet of my actively managed portfolios (not IRA’s or 401K’s), and one of the main asset categories.  Those groups include  Top Rated; Value (or more specifically,  unrecognized Growth or underappreciated Growth);  High Growth, Short-Term Trades (a very small portion of my portfolio and I defer to the guys on iBankCoin and in Exodus for these ideas); Moonshots; and Cash. In future posts, I will discuss each of these asset categories in detail including rules related portfolio allocation limit, cutting losses and taking gains, the types of companies I look for, etc.

This post is all about the Benjamins. I try to hold a range of 20%-30% in cash.  The percentage depends on a multitude of variables, including but not limited to, market conditions (trends in market breadth, credit spreads, specific market leaders); economic (financial condition indices, consumer spending, PMI and ISM readings, employment); corporate activity (particularly, what are they using their capital for- is it for CapEx, or more buybacks?); and volatility (extreme ranges of VIX readings as well as Fear and Greed Index, these act as contrarian indicators).

I’m sure a sizable amount of people reading this post will think I am dedicating too much of my portfolio to cash for their liking. I’ll be the first to admit that this is a fairly conservative strategy. However, this is strategy that Seth Klarman (go on Amazon and see how much “Margin of Safety” goes for) and Carl Icahn have implored, and who am I to argue with them? Reviewing my annualized returns, it turns out that when I have been disciplined like this, my returns are the highest and vice-versa.

Many of my future posts will discuss portfolio balance and asset allocation strategies, and a running them you’ll notice are rules that guide my buying and selling process. I need this discipline, otherwise my emotions will get the best of me. That can’t happen in investing or trading, ever. We’re all guilty of it (me included, multiple times), but the aim is to make our selves better, and hopefully wealthier.