Over the past couple of weeks, I have featured two readers’ experiences in setting up a hedge as per my free e-book “The SimpleHedge Strategy.” Both understood the concept and applied it well.
Despite the markets having shown dramatic drops (-25%), followed by sharp rebounds (+27%) year-to-date, the hedge concept has held up extremely well. However, when markets move in such extreme ranges, it is important for you to rebalance once your hedge gets lopsided.
I touched on that in my e-book, but I want to further elaborate on this very important concept. Yes, you can simply set up a hedge and hold it, but you’d be missing out on a lot of profits as well as bringing more of the downside risk into play.
Let me show you the difference of what happens to your hedge returns if you’re simply buying and holding vs. re-balancing as I recommend. Let’s look at the period from 12/31/2008 to 4/24/2009, since we’ve had extreme volatility and violent swings in the market place:
1. Domestic Hedge using SH vs. 2 mutual funds (buy and hold): +1.75%
2. Domestic Hedge using SH vs. 2 mutual funds (re-balanced twice): +6.79%
3. Domestic Hedge using SH vs. 2 ETFs (buy and hold): +1.87%
4. Domestic Hedge using SH vs. 2 ETFs (re-balanced twice): +7.72%
These are dramatic differences that you need to be aware of, and the impact on the bottom line over less than 4 months is very impressive by any standard.
So when should you re-balance?
As you know, we always start out with a 50/50 ratio between long and short. I will re-balance to that ratio, once the hedge gets lopsided by 61%/39% in either direction. So far this year, it has meant that two adjustments were necessary.
This is a small price to pay considering the positive effect these changes can have on your portfolio. I am obliged to tell you that this past performance is no guarantee of future results; however, using a methodical approach in your investing endeavors will enhance the odds of you being successful.