Most of us have heard of hedge funds, but don’t really understand what they are. We think of them as a way rich people get richer, but sometimes lose big if they are not careful. While both of those can be true statements, there is a lot of other useful information to know about hedge funds, and why you might be in a prime position to become a hedge fund investor.
What is a Hedge Fund?
A hedge fund is similar to a mutual fund, but not restricted by the same rules by the Securities and Exchange Commission. While mutual funds are only allowed to invest in stocks, bonds, and a very short list of other investments.
Hedge funds can buy nearly anything they want. They can invest in stocks, bonds, commodities, real estate, or even purchase full companies.
One major difference between hedge funds and mutual funds is the ability to use debt, or leverage, to increase investment returns. With increased leverage comes increased risk, which is why some hedge funds have has big losses at times in the past.
But with big risk comes the opportunity for big rewards. Some hedge funds have had phenomenal investment returns in the past.
Who Can Invest in Hedge Funds?
Hedge fund investments were traditionally limited to the wealthiest investors who could invest at least $100,000. This goes far beyond the typical “accredited investor” criteria, which has a high hurdle to qualify in its own right. To qualify as an accredited investor by SEC rules, you must have an income of at least $200,000 per year or a net worth of at least $1 million.
New companies are working to bring hedge funds to a wider audience through lower minimum investment requirements and clearly defined investment options for lower net worth investors. Sliced Investing offers hedge fund investments starting at $20,000.
When evaluating investment options, it is important to understand your own risk tolerance and goals. If you are looking for a new way to diversify and grow your wealth through smart investment decisions, it is important to consider all investment options.
Investing in individual stocks gives you the opportunity for big gains, but you are also opening yourself up to a big risk, as one bad announcement from the company can drive a stock price down quickly. Diversification is important when investing to help mitigate losses.
The next logical step for most investors is to invest in mutual funds and ETFs, which provide you with a bucket of stocks. If one stock performs poorly, your losses will be smaller as the other fund holdings may not decline at the same time. However, when the market goes down as a whole, your mutual funds will go down with the rest of the market.
Investing in bond based mutual funds gives you a hedge against stock market losses, but takes out the big upside potential of market gains. Bonds pay a fixed income, so your investment income is very predictable. A mix of mutual funds and bond funds opens you up to the investment gains of the stock market with the stability of fixed income investments.
If you have the resources to make larger investments and maintain a diverse portfolio, hedge funds are a great alternative investment. You get the diversity of a mutual fund with the potential for leveraged gains formerly open to only the super wealthy.
Explore Alternative Investment Options
As you grow your portfolio, broad market investments such as an investment in a low-fee S&P 500 index fund make a great cornerstone to your portfolio. As your portfolio grows, consider adding in alternative investments in addition to the traditional stock and bond funds.
Real estate investment trusts, or REITs, are investments in pools of related real estate assets. REITs may focus on specific categories such as commercial real estate, apartment complexes, or retirement homes. Others focus on a more diverse pool of real estate assets.
I have investments in social lending, where I have been averaging returns over 9% even when the market was in a downturn.
Wherever you invest, be sure to make informed investment decisions. Understand your own risk tolerance, investment goals, what you are trying to gain, and what you can afford to lose. You might find that you can make investments you didn’t think were possible.
Disclosure: This blog post was written for Sliced Investing pursuant to a paid content arrangement I have with the company’s representatives as part of an effort to raise awareness about alternative investment options.
This post was originally published on February 27, 2015 and updated on June 19, 2021.