Hedge funds have grown in popularity as investors start to take their money into their own hands.
They’re an aggressive method of investing in a time where the stock market never seems to slow down. Not only is it you investing the money, but often the hedge fund manager contributes a sizeable share.
Here is everything you need to know about hedge funds and whether they’re the right move for you.
What Are Hedge Funds?
Hedge funds are the next step up from mutual funds. They focus on pooling money together for investors and fund managers to experience substantial gains. This happens because they utilize more aggressive versions of stock market trading, compared to mutual funds.
You also are required to have a net worth of over one million dollars to get into a hedge fund. Or, you need to have made over $200,000 in annual income two years in a row. This makes it much more exclusive, as currently there are only around 47 million millionaires in the world.
There is no limit in terms of what a fund manager is going to invest in. This can range anywhere from bonds to currencies to real estate. It all comes down to how they can maximize your investment growth in a short or long period of time.
Hedge funds are also under very little regulations from the Securities and Exchange Commission (SEC). Because of the high net worth of the individuals contributing, the investors are often deemed affluent in the investment world enough that they understand the risks involved.
What Makes Them Different From Mutual Funds?
Mutual funds are the step down from hedge funds, as they work with a smaller pool of money. Typically, anyone can join a mutual fund with as little as $5. While mutual funds are also a combination of investors, you are limited to stocks, bonds, and other securities.
Rather than aggressive growth, mutual funds often rely on slower, less risky behaviour. This means investing in bonds and obtaining dividends from companies.
While you can decide to change your mutual fund to a higher risk and volatility option, they still have expense ratios. This means that it costs a certain percentage of your investments every year to operate the fund. Mutual funds only have this, compared to hedge funds, which also have a 20% cut of generated fees.
Different Types of Hedge Funds
The long/short equity hedge fund is by far the most popular of the hedge funds out there. They focus on opportunities for profit by going long on a company, where they think there is a substantial upside in the stock price. Or, by going short, where they think the stock will fall long term.
By doing this, hedge fund traders can expect to see results in a market where there are both positive and negative returns for others. This is part of the reason why hedge funds are attractive, as you can still make money while the market is down.
Another popular option in this investment partnership is the global macro strategy. This focuses on the macroeconomics of the world and companies that operate on a global basis. Global macro hedge funds will also dabble into currency trading, otherwise known as Forex.
Hedge funds are not limited to sticking to any one strategy either. You’ll often find a list of different hedge funds that say “multi-strategy.” Multi-strategy hedge funds utilize methods from every aspect, allowing them to not only diversify but make gains in multiple markets.
When the pool of money is large enough, they are able to do. This means you can reap the benefits of the stock market, while also making gains because the hedge fund manager invested in real estate in a booming metropolis.
Check out this list of hedge funds for those that are interested in getting into the market.
What Are the Pros?
The pros of hedge funds stem from the huge potential upside that these funds can create. They tend to make money regardless of the market, making it perfect for those that see the upside in everything.
You’re also not limited to just investing in stocks or bonds like mutual funds. You can extend into real estate, currency, and even precious metals if you so choose.
Beyond that, because hedge fund managers often provide a portion of their own money, they are less likely to be a scam. They want their own money to perform well, as they make money from that, rather than just constantly buying and selling for capital gains.
These managers are also some of the top investment managers around, as they are often handling billions of dollars, rather than just a couple million. They need to have a good track record before they can even get into the hedge fund game.
What Are the Cons?
The cons of hedge funds are the potential for extreme losses. Since you’re risking higher amounts of money, as well as investing in an aggressive manner, you can lose much more than with mutual funds.
Your losses can even be amplified to owing money, as hedge fund managers will leverage money (occur debt) to increase the portfolio when the cash isn’t on hand. This could mean that you not only lose all your money, but you end up in debt too.
You should also only get involved with hedge funds if you’re okay with not using this money for a long period of time. Hedge funds rely on rapid and aggressive growth that can happen over several years. This means it’ll be harder to pull your money out if you need it right away.
Hedge Funds: A Millionaires Mutual Fund
The potential to make your money make money for you is always going to be appealing.
While hedge funds are excellent at aggressive growth, always diversify your portfolio for risk management. That way you can reap rewards and minimize losses.
If you want to learn more about how the finance world works and increasing your financial literacy, be sure to check out the finance section of our blog. If you know someone that qualifies for a hedge fund, be sure to share this article with them too.