Hedging in the Retirement Risk Zone



My latest MoneySense blog reveals some of my personal strategies for dealing with the bear market: How I’m preparing for Retirement in a bear market.

There may be a few ideas for anyone who, like myself, is in the “Retirement Risk Zone.” That’s the five years prior to and five years following your projected retirement date. If it’s 65, the traditional age, then the Risk Zone is between age 60 and 70. Based on the Hub’s demographic user patterns, a lot of people are in that category (although we actually have lots of millennial and Gen X traffic too on both sides of the border).

Towards the end of the blog, I talk about portfolio hedging. I have to credit my fee-for-service financial advisor for most of these concepts. He didn’t want to be named for the MoneySense blog but he is listed in the Hub’s “Guidance” section elsewhere in this site.

It took me awhile to accept that hedging — that is, using options or selling short certain ETFs representing the major indices — is as much a risk reduction strategy as it is a “risky” strategy.

Hedging means trading off some upside for downside protection

The best way I can describe it is that you’re willing to give up some upside in return for protecting the downside. In this respect, it’s not unlike asset allocation or a classic balanced fund. Naturally, a portfolio half in bonds and cash should be less volatile than one 100% in stocks. You’d expect the aggressive portfolio to have the highest returns in a continuing bull market in equities and if you were in a balanced fund would accept the lower returns that let you sleep soundly at night.

To my mind, hedging is similar. In the MoneySense blog I describe a hypothetical situation (close to my own) in which asset allocation across both registered and non-registered portfolios is roughly 50/50. Ideally, registered plans are mostly in fixed income (and my case some US dividend-paying stocks), and non-registered plans are mostly in stocks, especially Canadian stocks.

But when you’re in “The Zone,” you hardly welcome watching half your portfolio sink. Yes, we’re already down 20% and are firmly in correction or bear mode in most global markets. It could be that now is the proverbial buying opportunity, and that’s probably true for younger investors who have plenty of time on their side.

The Long Run eventually runs out


The Eagles’ late Glenn Frey (YouTube.com)

Not so we aging baby boomers. The deaths the past week of David Bowie at 69 and of the Eagles’ Glenn Frey at 67 should be sufficient reminder (“memento mori“) that we are all mortal. The concept of stocks for the long run is certainly a good foundation for young people and the middle-aged to build growth portfolios but as Keynes also reminded us, “In the long run we’re dead.”

Here at the Hub our slogan is to achieve financial independence “while you’re still young enough to enjoy it.” It’s hard to really enjoy Findependence when you’re worried about the stock market crashing 50% or more, as it did in 2008.

But as my adviser told me at the time — as he sailed through the financial crisis intact via his hedging strategies — you don’t need to stand helplessly like a deer blinded by headlights as markets go south.  If you care as much now about capital preservation than growth, then it follows that you’re willing to trade off some future upside for a lower downside. Asset allocation may get you there and one of the regular contributors to the Hub is a firm believer in retirees relying on cash flow from high-quality individual stocks.

Partial hedge is still net long equities

Currently “we” are only a sixth to a third hedged so we’re still happy if markets recover. As the MoneySense blog warns, if you do start to hedge, it will be inevitable that you may get whipsawed. So if you choose to initiate a hedge by shorting ETFs covering the TSX or the S&P500 or EAFE ETFs, realize that if markets start to rise, you will be losing money on the the sell side of the hedge. (But if you’re net long you’re still “happy”).

Conversely, if they sink further, you will be glad you purchased the “insurance,” as those positions rise even as the indexes sink further.

No guarantees either way but when in investing was there ever a guarantee? And as the other blog notes, you don’t want to try this without the guidance of a good financial planner or investment adviser who is thoroughly proficient at risk management, options and hedging.

Bearish books and what you can do if you agree with their dire prognosis

This weekend’s Financial Post contains two articles from me that may be of interest to readers of this site. One looks at two new books that are very bearish on the global economy and the stock market the next few years: Harry Dent Jr.’s The Great Crash Ahead and a new revised edition of Aftershock, originally published in 2009. You can read it here although the print edition has nice cover shots not only of the two new books but several more like it that have appeared over the years.

The other article, here, talks about how baby boomers in particular are starting to run out of investment time horizon. My point is that if you’re not prepared to go through another 2008, you either have to take some risk off the table now before things get worse, or use the kind of portfolio hedging strategies I’ve mentioned in this site. (See for example the talk I gave at the MoneyShow).

It is of course possible that the bottom is now in and that most of the portfolio damage the markets can inflict has already been inflicted on investors. Gloomy as the environment appears, the market has a way of doing what you least expect: who expected gold to plunge $100 this week?

How to have you equity cake and protect the downside

With interest rates so low, most of us still need equity exposure. When dividends pay more than bonds and carry with them the prospect of future dividend increases, that’s not an asset class you want to be out of, bear books or no. By hedging your long-equity exposure with inverse ETNs you can have your cake and eat it too — in theory anyway.

As for the two new bear books, read what Dan Hallett has to say in the “attic” above the version in the paper: he talks about “confirmation bias” and how bullish investors tend to avoid bear content and vice versa. We all tend to seek confirmation of our existing worldview but there’s value in considering the other side.

In the case of these two books, as I point out in the review, they don’t even agree with each other in their bearish prognosis. One thinks interest rates will rise, the other fall; one thinks the US dollar will rise (Dent); the other that the greenback will fall. Dent thinks gold will fall while Aftershock thinks it will rise. However, they both agree the China bubble will burst at some point and when it does, it will be bearish for stocks globally.

A comment on this site: while I do try and keep it updated with new content, such as what you’re reading now, you can always keep up with new FP articles and new Wealthy Boomer blog posts by reviewing the scrolling titles to the right. And of course, I’m on Twitter and Facebook (click on icons top right of this site) and also Linked-In.

A recommendation: Flipboard app for Apple iPads

If you have an iPad, I strongly recommend getting the free “Flipboard” app.  It presents all these feeds in a sort of electronic magazine format. In particular, if you’re on Twitter, I suggest you “follow” my FindependenceDay list there. That list follows 500 good sources on financial independence and when you view it on Flipboard, it will be like  a timely continually updated electronic magazine on Findependence Day.

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