If you’re looking for one new investment account, or if you are brand new to converting your money into more money, a hedge fund is undoubtedly an option that you have come to know.
But what is a hedge fund, you ask? Can anyone invest in one or is it just for the bigshots on Wall Street?
Below we will clarify all of your questions and examine the difference between hedge funds and other forms of investment.
What is a hedge fund?
A hedge fund is a type of pool fund that uses a number of strategies to generate active returns for investors. They tend to be much more expensive compared to other types of mutual funds. And they are usually only open to wealthy investors.
Therefore, when you hear the words “hedge funds” you have a very clear picture of a man in an expensive suit with a briefcase on his mind.
How do hedge funds work?
The way hedge funds are designed is to capitalize on identifiable market opportunities.
But what does that actually mean?
It can mean a lot. Hedge funds work with a number of different investment strategies. Hedge fund managers closely monitor market data so they can seize investment opportunities as they arise.
These managers pick the best places to invest your money and tend to tend towards riskier (but higher returns) options.
Who can invest in hedge funds?
Hedge funds are a special type of investment method that meets certain criteria before you can invest in one.
Hedge funds will examine a number of criteria including current wealth, assets, ability to absorb significant losses, tax status, and more.
Why so exclusive?
It’s not just a secret club. Hedge funds are associated with a much higher level of risk. As a result, the US Securities and Exchange Commission is putting some strict regulations in place on who can invest in them.
Criteria for investors
In order to invest in a hedge fund as a private investor, you must be accredited. This usually means that you must have a net worth of at least $ 1 million – the value of your main residence is not included. Or, you must have an annual income of more than $ 200,000, or $ 300,000 if you are married.
The other type of investor in hedge funds is known as an institutional investor. These are professional associations that invest on behalf of pension funds, government employees, and trade unions. They tend to invest large amounts of money at once and may be a little less scrutinized as they are considered less risky, professional investors.
Advantages and disadvantages of hedge funds
Advantages of hedge funds
Higher returns (possibly)
One of the main things that differentiate a hedge fund from other types of investments is its aggressive investment strategy. Hedge funds don’t play around; they strive for the highest possible returns.
Another advantage of a hedge fund is that it offers a little more flexibility than mutual funds. Because hedge fund investments are not publicly traded and their performance is not really regulated, a hedge fund manager can employ a number of strategies including derivatives, leverage, and short selling.
A hedge fund can invest in just about anything, be it real estate, land, stocks, currencies, or derivatives.
You are usually limited to stocks or bonds when compared to other forms of investment like mutual funds. So if you’re looking for a little more variety in your portfolio, a hedge fund might be for you.
Disadvantages of hedge funds
A major disadvantage for hedge funds is that they usually come with high fees. Most use a fee structure called 2 and 20 which we will explain.
Hedge funds have a more aggressive investment strategy. That means high risk and (hopefully) high returns. But the most important thing to know about any type of investment is that nothing is guaranteed.
These high returns can just as easily turn into high losses. The kind that makes your eyes water.
Money is often locked away
Many hedge funds require investors to essentially lock their money for years in order to get the maximum return.
This might not be a problem for those used to keeping their money in the market for the long term, but it does mean a little less flexibility to sell whenever you want. They are not for short term investors.
What are the hedge fund fees?
The standard type of hedge fund fee is known as the 2 and 20 fee. The 2 and 20 fee structure works by charging both an expense ratio and a performance fee (rather than just an expense ratio).
It gets its name from charging a 2% asset management fee and a 20% cut in all profits on top of that.
Hedge funds vs. mutual funds
Hedge funds are mutual funds, so are mutual funds, but what’s the difference?
The main difference is availability for the average investor.
Mutual funds are regulated investment products that are offered to the public and are available for daily trading. This makes them the most popular and more accessible option.
Hedge funds, on the other hand, are private investments that only accredited investors can use. They are much more exclusive.
Another unique thing is that hedge funds are known to use risky investment strategies in order to achieve the highest possible returns for investors. Mutual funds are a bit tamer in comparison.
Should I invest in hedge funds?
If you are in the mood for high risk, $ 1 million in the bank, and a financial security blanket to cushion you from a significant loss, then you should definitely do it.
However, since the selection criteria are so far out of reach for the vast majority of people, this is likely not a viable option.
Even if you are eligible, we wouldn’t recommend getting into hedge funds if you are one Novice investor. It’s best to start smaller with something like a Mutual funds or index funds (we would choose the latter).
Why choose an index fund?
Index funds are very tame compared to the glamorous world of hedge funds. But they’re also a great, stable way to get into investing.
Not everything has to be wagered on the top companies in the world blackjack style. Instead, index funds invest in a pool of different companies and stocks such as the S&P 500 or the Dow Jones Index.
Are index funds Ramit’s personal favorite, and what he recommends to most investors. You will be surprised to learn that his assets are not tied up in super-secret hedge funds, but mainly in index funds.
Index funds are far less volatile. Maybe you won’t get those mind-boggling returns, but you will probably won’t get these desperate losses either. (However, we cannot make any promises when investing.)
Another great thing about them is that they don’t have any reload fees when buying or selling a fund, so they are a cheaper way to invest too.
Hedge funds are a huge scare concept for many investors, and judging by the level of risk, that fear isn’t entirely out of place. They may be the first choice for high net worth or very experienced investors, but index funds are the way to go for the vast majority of people.
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