Financial hedging is an investment strategy which is aimed at minimising the level of risk that investors are exposed to. Hedging is a form of diversification, this means that the individual or company who is looking to hedge their investment will spread it out, or diversify it, over a number of different investment opportunities.
The aim of doing this is to limit the damage of any one investment failing, the idea being that by having multiple investments on the go, should one fail, the others will minimise or absorb the losses entirely. Both diversification, and in particular hedging, have long been popular strategies among investors who are either more cautious, or simply willing to wait longer for their return.
The most obvious downside to hedging is that investors will need more capital to see the same level of returns. This is because while they are investing in more options, they are investing less in each one and as such each needs to mature to a greater degree to generate the same returns.
Generally speaking, hedging investments mean that they take longer to mature, but that they are less likely to be lost before that happens. In this article we take a look at three of the key ways in which financial hedging can help to improve a businesses sustainability.
Reduce Your Overall Risk
This is the biggest selling point of financial hedging and it is worth taking the time to understand exactly how this aspect of it works and how it is achieved. Imagine that your business has £1000 of assets that it wants to protect. There are a number of ways that the business might go about this, they could simply deposit the money in a bank and leave it there. The problem with simply leaving it in the bank is that it is then not dong anything for the business, and what’s the use of making money if it isn’t going to do anything with it?
Investing the money is risky because the investment could turn bad, thus exposing the business to more risk. By hedging, and investing the money across a range of different options, a business can shield itself from the fallout of an investment going awry.
If you are considering hedging, you should make yourself aware of the different forms the practice can take, there are a number of different financial products, such as hedging strategies with financial derivatives, each of which is best suited to different scenarios.
Increase Your Opportunities
Diversifying your company’s holdings doesn’t just shield you from the potential headache of one of your investments turning bad, it also means that you will have more opportunities to turn a profit. Only by hedging your assets in a variety of different holdings can you position yourself to benefit from any synergy between markets.
Without hedging, you can only benefit from upswings in the single market that you choose to invest in. With hedging you might see a smaller return, because you will have invested less money in each holding, but the fact that you are more likely to see a return at all is enough reason for many businesses to opt for financial hedging.
Protect Your Business
Hedging is an excellent way of minimising the risk of being hit by a bad investment, however it is a long way from being a perfect solution. Whenever you are investing your money, even if you are storing it in a bank, you are taking some level of risk. With hedging that risk is reduced and, should you find that you suffer losses on your investments, hedging makes it far less likely that such losses will cripple your business.
Hedging is a tried and tested method for protecting a business from potential losses and of improving overall sustainability. If you think that your business could benefit from hedging, then be sure to familiarise yourself with how it all works before embarking.
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