Hedging a Dividend Portfolio
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I was recently asked by a reader (thanks Edwin) about my take on using a hedging strategy in a dividend investing portfolio. Although I have never done any true hedging (other than covered calls) in my dividend growth portfolio, it has been a huge topic of discussion from many financial pundits as a way to help limit the downside with a sliding portfolio. I did some research on it and wanted to provide a quick overview here, and provide my take on it.
The intention of hedging is to offset the downside risk in a portfolio through the purchase of an asset that will reward you if your portfolio goes the other way than you intended. This definition from Investopedia really sums it up best:
The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn’t prevent a negative event from happening, but if it does happen and you’re properly hedged, the impact of the event is reduced.
Edwin’s suggestion was that an investor could hold 75% of their portfolio in dividend growth stocks and then purchase an exchange-traded fund that shorts the market using 3x leverage. The intention is that when the market tanks, you reap the gains three-fold. There are other types of hedging, such as using puts or covered calls to limit your downside. As I was doing some research on the topic, I could not find any definitive evidence that hedging was a good or bad strategy. I had to make my own call, and came up with the following two reasons that hedging using leveraged short ETFs are not for me:
1. I am a long-term Investor
My viewpoint is that over long periods of time (10+ or even more years) the market goes up more than it goes down. As such, I see portfolio hedging as a short-term strategy that simply helps to manage an investors emotional reactions when the market is going down. I have said it before, unless you truly understand your risk profile then you are prone to make rash portfolio decisions. If you are really comfortable with your asset allocation, then you should let it do its work over the long term.
2. Hedging can be Expensive
Buying portfolio insurance can be expensive. For example, the ProSharesUltraShort Russell 2000 (TWM) has an expense ratio of 0.95%. If the market is going up and this fund is working against you, then that additional MER will continue to erode the value of your portfolio. As a long-term investor (see above), my pontification is that the market will rise over long periods of time so why pay these additional fees.
This being said, I have been know to hedge using covered calls from time to time if the numbers look good. I therefore cannot say that I will never hedge, I just doubt I will hedge using a shorting strategy. The costs and the short-term focus simply go against my portfolio strategy.
The Dividend Guy 2008 Year In Review
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Typically on Saturdays I post my Weekly Roundup, which links to a number of the posts that I have found particularly valuable over the past week. However, seeing that we are in a brand new year, I thought it would be appropriate for me to link to a number of the articles I have published over the past year. It has been a busy year both at the blog and in the market. Thanks to everyone for continuing to come back time and time again. I really do appreciate it.
January 2008
February 2008
March 2008
April 2008
May 2008
June 2008
July 2008
August 2008
September 2008
October 2008
November 2008
December 2008
Some Additional Articles
I do want to link to one additional series of posts that Tim Ferris posted over at his blog, Four Hour Work Week. It is Tim’s thoughts on investing in uncommon times. Although I do not agree with everything he writes, I did find it very interesting. Here is Part 1 and Part 2.
Tracking My Portfolio Income
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The best thing about being a dividend growth investor is watching your dividend income grow over time. As I have written about time and time again, the power of a dividend growth portfolio is the compounded growth that an investor receives . As new dividends come into the account from the companies paying dividends, those dividends should be plowed back into more shares of the best companies. Over time your number of shares grow. Also, with the right companies the actual company dividend also grow. The net result is higher and higher dividend income into your portfolio. Nice scenario!
As a visual type of guy, I like to keep track of this data. I have a chart set up that shows my dividend income over time. It does nothing more than show me the impact dividend growth has had on my portfolio progress, however it is a powerful reminder of the power of this growth. The chart is easy to set up using any spreadsheet program. Put the date in one column, your yearly dividend income in another, select the cells, and click the graphing icon in the program. After selecting a few other options, you have a chart showing you the dividend growth. Here is what my chart looks like today:
Click to EnlargeSimple but powerful. It is certainly a motivating factor during the life of a portfolio.
Weekly Dividend Investing Roundup - December 27, 2008
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Welcome to the December 27, 2008 edition of The Dividend Guy’s weekly roundup of posts and articles about investing, dividend and non-dividend related. Once again a good week in terms of posts and information for all of us avid blog readers.
If you know of other blogs that are covering the topic of investing and dividends, please feel free to let us all know using the comment section below.
Build-a-Bear as an investment?
2009 Dividend Aristocrats
Dividend Aristocrats in danger
The herd mentatlity
Dividend increases are still happening
Stock valuation
The energy patch
Dividends are sexy
Saving some serious dough
The Articles
Portfolio planning for 2009
I love LifeHacker for non-investing reading. FAIL blog too for a quick laugh
The intelligent investor guide
Being rich
How insurance companies lost their way
Scott Adams (Dilbert) on finance
Emerging markets and downturns
A view on Suze Orman
This market can make you rich
Saving for college
5 tips for investing in any market
Thanks for reading!
Merry Christmas and Happy Holidays
I am going to take a couple of days to spend some time with my family and friends this holiday season. There will be no posts on December 24th. I will resume posting on December 31st well rested (I think) and rarin’ to go! Merry Christmas and happy holidays to all readers of tDG. See you in a couple of days…
RSS Update - Please Update Your Readers
My new feed address is: http://feedproxy.google.com/TheDividendGuy
As I work through everything on the new site, please let me know if you find any issues by using the comments below.
Thanks everyone for your patience!
Test Post - Ignore
Weekly Dividend Investing Roundup - December 20, 2008
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Welcome to the December 20, 2008 edition of The Dividend Guy’s weekly roundup of posts and articles about investing, dividend and non-dividend related. Once again a good week in terms of posts and information for all of us avid blog readers.
If you know of other blogs that are covering the topic of investing and dividends, please feel free to let us all know using the comment section below.
Arbitrage for you and me
Caution with high Return on Equity values
Nine dividend increases
Long term bonds for portfolio income
Interactive financial statements
Another bank fails
Where to invest in 2009
Dividend reinvestment plan example
On making charitable donations
The Articles
Things he learned this year
Make yourself happier (not investing related but good nonetheless)
The Yale Endowment Fund lost 25%
How to save your safety deposit box
A blogger’s investment update
Defining financial goals
Diversify with commodities
Is your home an investment?
It’s called Math - how to diversify your portfolio
Many smart investors are dumb
Australian dividends are set to crash
Sector investing does not work
5 ways to improve your investing skills
McDonald’s still lovin’ it
A bit promotional, but dividend related
Thanks for reading!
