A Hedge That Actually Works

Adding one of these funds could boost your returns and reduce your portfolio’s risk.

Hedge funds have given the word hedge a bad rap. As originally intended, the word refers to an investment made to offset risk. But today the term evokes thoughts of astronomical fees, excessive leverage and a devil-may-care attitude toward risk-taking.

But there is much good to be said of hedges in the original sense. Holding investments that zig when others zag can decrease your portfolio’s volatility significantly. A simple thought experiment illustrates the point: Suppose you had a portfolio of two assets -- Stock A and Bond B. Imagine that Stock A and Bond B are perfectly negatively correlated with each other and are equally volatile (in other words, one’s zigs are the mirror image of the other’s zags).

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Elizabeth Leary
Contributing Editor, Kiplinger's Personal Finance
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.