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Dale Jackson

Personal Finance Columnist, Payback Time


The bulls are expected to keep running on major stock markets this summer thanks to strong corporate earnings and tame inflation. 

The benchmark S&P 500 has already advanced by more than 26 per cent over the past year and 86 per cent since the outbreak of the pandemic in 2020. In Canada, the TSX Composite is up a more modest 10 per cent over the past year and 37 per cent going back five years. 

That’s generally a good thing but for retirement investors focused on the long-term it brings an opportunity to lock in those gains with hedges in case the tide turns and markets go south.

The trick to hedging is to preserve what you have accumulated on paper without compromising opportunity. That’s where the advice of a qualified investment advisor can help. There are many ways to hedge but here are five simple strategies. 

1. Diversification

Spreading your investments across sectors and geographic regions can limit concentrated risk and expose your portfolio to a world of opportunity. 

While it might seem equity markets move in tandem, some sectors and regions often move in different directions at different times.

One recent example is technology and emerging markets. While the S&P 500 information technology sector has posted an annualized return of 25 per cent over the past five years, the MSCI Emerging Markets Index has been stubbornly flat.

2. Asset allocation

Higher interest rates have presented an opportunity in fixed-income investments not seen in three decades.

An entire generation of investors who have only known the ups and downs of equity markets can now find a safe haven for a portion of their retirement savings.

As major stock markets hit new highs, gains that might be getting ahead of their real value can be shifted to a fixed-income portfolio of bonds and guaranteed investment certificates that are currently generating a reliable annual return above five per cent.

The portion of the entire portfolio that should be allocated to fixed income depends on the individual investor's age and how soon they will need cash in retirement.  

3. Writing covered calls

The derivative or options market also presents the opportunity to generate safe income by writing covered calls on lacklustre stocks you already own.

The writer, or seller, of a call gives the buyer the legal right - but not the obligation - to buy shares in the underlying stock at a set price (strike price) any time on or before a set date. 

If the stock rises above the strike price the owner will likely be forced to sell at that higher price but if it remains below it the writer keeps the stock, any dividend it generates and a premium paid by the buyer.

Writing covered calls is also permitted in registered retirement savings plans (RRSP) and tax-free savings accounts (TFSA).

4. Short selling

If you think parts of the market are overheated, another option is a short selling strategy designed to balance a 'long' portfolio to generate returns when equity markets go down. 

Short selling involves borrowing securities, selling them on the open market, and buying them back at a future date (ideally at a lower price).

Short selling directly into the market is fraught with risk and generally for experienced traders but there are several long/short mutual funds that will do the balancing for you.

Investors can also take short positions through 'bear' exchange-traded funds (ETFs) for just about any index, commodity or sector.

5. Trailing stop-loss

Placing conditional orders on equities in your portfolio, such as a trailing stop-loss, can automatically lock in gains as the investment rises in value and limit losses if they plunge.

A basic stop-loss is a pre-set price below the current price that will automatically trigger a sell order if it falls to that level. For example, if a stock purchased at $10 has a stop-loss placed at $8, losses will be capped at $2 per share.

A trailing stop resets the stop as the stock rises. In other words, if a stock rises the trigger to sell moves up in proportion to the real-time price, like a moving stop-loss. In addition to locking in gains, a trailing stop locks in bigger gains as the stock rises.