An Insurance Policy for Investors

Alfred Winslow Jones is credited with inventing the hedge fund in 1949.

- James K. Glassman

It was an investment pool that sold some stocks short to minimize the risk of owning other stocks. In a short sale, you make money when a stock's price falls, so if the market takes a sharp drop, the profits from short sales would provide a cushion for Jones's clients.

Today, some hedge funds deploy Jones's strategy, but most invest in a more opportunistic way, taking positions in mergers, buying and selling currency, or using leverage to purchase pieces of companies their managers like. "Do Hedge Funds Hedge?" was the title of a well-known 2001 paper in the Journal of Portfolio Management. The answer: not so much. Instead, they try to make money any way they can.

Still, there's no reason you can't build a hedge against the vicissitudes of the market-a buffer against a severe decline in stocks. This may sound odd, coming from me. I'm an evangelist for long-term investing and a believer that you should just ride out the rough seas. I have also been optimistic during the past six months that the bottom won't drop out of the economy.

Stocks have certainly had their ups and downs, but the Dow Jones industrial average, my favored index for its relative stability, was at roughly the same level at the end of January 2023 as it was a year earlier. Yes, the S&P 500 index, which is broader, has fallen about 8%. (Returns and other data in this article are as of January 31.) But considering that the war in Ukraine and COVID are still raging and the Fed has raised rates by 4.50 percentage points since March 2022, well ... down 8% isn't that bad.

And that's what worries me. As they used to say in the Old West: It's just too quiet out there.