The market has certainly been all over the place the last few months. Not surprisingly, investors started to liquidate positions. Is this prudent? Time will tell, but when an investor does sell it can bring up some issues:
- If and when do you get back in?
- Does being in cash compromise your long-term goals?
- Is this a panic move?
A potential solution that helps eliminate or at the very least reduces the above issues – beta hedging*.
Beta is how an investment or an entire portfolio moves relative to an index. For this discussion we will use the S&P 500:
- A beta of 1 indicates the investment(s) should move in line with the S&P 500.
- Greater than 1 indicates the investment(s) should move more than the S&P 500.
- Less than 1 indicates the investment(s) should move less than the S&P 500.
For example, a stock portfolio has a beta of 1.20. The S&P 500 goes down 10%. That investor’s portfolio should be down around 12% given past movements of the investments relative to the S&P 500. Using the same scenario, if a stock portfolio had a beta of .80 the portfolio should be down roughly 8%.
So by lowering your portfolio’s beta you can help shield it from moves down in the market. In my next post I will outline how to do this without running into the issues mentioned above.
* No investment strategy can guarantee a profit or protect from a loss in a declining market. Beta assumes specific time periods being covered. 1 year, 3 year, 10 year. Behavior of stocks will vary versus the Beta during unexpected shocks to the market
