If you’ve spent time with investors, you’ve probably heard the term hedge fund being thrown around frequently. In case you’re not familiar with this term, it’s basically used to describe a pooled investment structure create to make a return. In layman’s terms, it can be thought of as a tight partnership between multiple investors.
While many people live their lives from paycheck to paycheck, financially independent people know that one of the best ways to accumulate wealth is through investments. For some reason, there is a common belief that only rich people invest their money. In reality, anyone who wants to have a long-term plan to substantially increase their savings can start investing today.
The Basics of Hedge Funds
One of the main characteristics of hedge funds is that they don’t measure their performance against a benchmark or index. Regardless of how the stock market is doing, a hedge fund can still make a profit from their investments. The reason behind this is that members of a hedge fund invest in various assets.
The main goal of a hedge fund manager, the person in charge of making investment decisions, is to find and apply different investment strategies to get a return. If you take a look at a hedge-fund like Appaloosa Management, which is incredibly successful, they invest in bonds, exchange warrants, notes, futures, options, and junk bonds.
The only thing that a hedge fund manager is concerned with when creating an investment strategy is whether it stands to make a profit in the future. This type of mentality allows hedge funds to make a hefty return on investment regardless of which assets they put their money into.
How do Hedge Funds Work?
It’s difficult to give a concrete definition of how hedge funds work because they all implement different investment strategies. That’s why it’s important to understand the goals of a particular hedge fund before joining it. It’s on you to determine whether the benefits outweigh the risk in a certain strategy before investing your money.
Although the strategies of different hedge funds vary heavily, there are a few common characteristics of this investment structure. For instance, hedge fund managers always use complex financial tools known as derivatives to determine which investment options are good.
Nearly all hedge funds use short selling strategies to get a huge return on investment in a small period of time. In case this is something you’re not familiar with, short selling refers to a process that involves selling assets that you don’t own yet in the hopes that their price will drop significantly and you’ll be able to buy them back at a cheaper price once that happens.
Another common strategy popular in hedge funds is gearing, which is a practice that involves making a large investment with a small deposit. For a gearing approach to be successful, there needs to be a huge amount of money borrowed. It’s worth noting that you can never be completely sure when things are going to go right when investing funds, so gearing might not provide good results. If that occurs, the financial consequences can be disastrous.
The Advantages of Hedge Funds
You can look at a hedge fund as an investment vehicle that can help you diversify your investment portfolios and produce substantial returns over time. Due to the current popularity of hedge funds, it goes without saying that they’re a popular option among investors.
There are multiple reasons why hedge funds are the preferred investment vehicle for many investors. For instance, they offer a lot more flexibility than mutual funds. A mutual fund represents an open-end professionally managed investment fund that operates similarly to hedge funds.
Nevertheless, the main difference between the two is that the former is heavily regulated by the Securities and Exchange Commissions. On the other hand, the SEC doesn’t pay much attention to hedge funds because they’re not traded publicly.
If you’ve ever been curious about investing your money in any type of asset, then you’ve probably heard how important it is to diversify your portfolio. In other words, you should invest your funds in all types of different assets. Because hedge funds are open to putting money into any asset that has a high chance of yielding a big return, it’ll minimize your risk as an investor.
Finally, one of the biggest advantages of investing your money through a hedge fund is that you’ll have access to expert advice. Hedge fund managers have a wealth of knowledge and experience when it comes to investing, so you can learn quite a lot from seeing them develop strategies.