We get asked the question all the time. "How much hedging should I have in my portfolio?" With the market at all time highs of a trend that is over 8 years long, its a perfectly valid question to wonder if, and by how much should you hedge your portfolio. If you are a long term investor then the question becomes more and more meaningful. Who wants to suffer a decline that gives back all that the markets gave you for the last 8 years. So, while were not saying that the markets are due to collapse, having at least some kind of hedge is warranted.

Product: The first thing you want to ask is: "How do you want to hedge?". The easiest way to hedge is to reduce position size, or reduce the size of your portfolio all together. For most investors, they want to continue to hold their long term positions, contributing more along the way, but they want to protect from any adverse declines in the markets. To do this you can look at a variety of options. 

One way is to use a hedge based product like the (VXX  ). We have discussed the pro's and cons of the VIX in the past, and even explained how the product works. This is the fastest way to hedge some of your portfolio. One can buy shares of this product directly or use an option strategy to synthetically produce the appropriate hedge.

Another way would be to short a particular market (requires a margin account to do so). If your positions are largely based in, say the Nasdaq 100, then shorting the Nasdaq 100 (QQQ  ) is one way to offset a long portfolio. This is not the most ideal situation though as margin is required, and it comes at a large cost.

Finally, you could sell covered calls on the positions you have in your portfolio. This will limit future upside, and will not protect you fully to the downside, but does add a small level of protection should there be a slight decline. Also, it helps you generate a little income while you hold.

How much to hedge? This is the magic sauce, if you will. Most investors want some kind of a hedge. There is no need for a full hedge, since you wouldn't gain from a full hedge (if you wanted to hedge your whole portfolio you could just exit every position), so the question is how much should you hedge? The popular mindset is to hedge about 30-40% of the overall portfolio. This will require a little math on your part to figure out what that means, but most focus on that 30% area. This allows you to save some of your gains if the markets fall, but still participate at a fair rate if the markets continue higher.

Given that the markets have been up for 8 years, most would think that a 70/30 split is fair at these high levels.