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5 portfolio hedges to help lock in market gains

The bulls are expected to keep running on major stock markets this summer thanks to strong corporate earnings and tame inflation. The benchmark S&P 500 has already advanced by more than 26 percent over the past year and 86 percent since the pandemic outbreak in 2020. In Canada, the TSX Composite is up a more modest 10 percent over the past year and 37 percent over the past five years.

While this is generally good news, retirement investors focusing on the long term might want to consider hedging strategies to lock in their gains in case the market trends downward. Here are five simple hedging strategies:

1. Diversification

Spreading investments across sectors and geographic regions can limit risk and expose your portfolio to various opportunities. Different sectors and regions often move in different directions. For instance, while the S&P 500 information technology sector has posted an annualized return of 25 percent over the past five years, the MSCI Emerging Markets Index has remained flat.

2. Asset Allocation

Higher interest rates have made fixed-income investments attractive. Investors can shift some gains from equities to a fixed-income portfolio of bonds and guaranteed investment certificates (GICs), which are currently offering reliable annual returns above five percent. The portion allocated to fixed income should depend on the investor's age and retirement timeline.

3. Writing Covered Calls

The options market offers a way to generate safe income by writing covered calls on stocks you own. By selling a call, you give the buyer the right to purchase your stock at a set price before a specific date. If the stock price stays below this price, you keep the stock and earn a premium. This strategy is allowed in registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs).

4. Short Selling

For those who believe parts of the market are overheated, short selling can generate returns when equity markets decline. This involves borrowing securities, selling them, and buying them back later at a lower price. While direct short selling is risky, investors can use long/short mutual funds or 'bear' exchange-traded funds (ETFs) to balance their portfolios.

5. Trailing Stop-Loss

Placing a trailing stop-loss order on your equities can automatically lock in gains as the stock price rises and limit losses if it falls. A trailing stop adjusts the trigger price as the stock's price increases, locking in bigger gains as the stock climbs. 

By using these strategies, investors can preserve their gains and protect their portfolios from potential market downturns.

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