Hedging Your Life Exposures

by: Michael Loeb

As investors, our goal is to provide ourselves with income well into the future, and provide a stable base upon which to retire. But oftentimes it seems we view our investments as endeavors completely separate from the lives we lead and the world in which we live. For the most part, this is a good thing, because after all, a good company is a good company.

Let me posit an alternative way to perceive at least a portion of your portfolio. I have titled this article, "Hedging Your Life Exposures," so we might as well call this alternative by the same name.

The idea behind hedging our life exposures is that during the course of our day-to-day lives, we use products or others use products which affect our feeling of wealth and health.

To name a few, there is gasoline, which many of us use to commute to work. So, our feeling of wealth can be somewhat tied to the price of gasoline, because assuming we still make the same amount of money, and our commute stays the same, our income fluctuates with the price of gasoline.

Another could be cigarettes. Even if you have never smoked a cigarette, you still have probably breathed in second-hand smoke from someone you walked by.

Yet another could be diabetes medications. If you have a chronic illness such as diabetes, your wealth and health are directly tied to how much money you must pay for your drugs.

So, the idea is to hedge these real-world risks, at least in part, with our investments. I've finished talking about the conceptual framework, and now we can think about risks we face every day that can be hedged with investments in those companies.

Gasoline- Income goes down with price increases, so buy stable oil companies like XOM or CVX or even STO to offset some of that lost income.

Cigarettes- The more exposure one has to second-hand smoke, the higher the likelihood of lung disease. So, if the expected value of my medical expenses in the future rise due to smoke exposure, invest in cigarette companies like MO, PM, or LO to offset some of those future costs.

Diabetes- Assume you have a family member with diabetes, and maybe you, like most Americans, could stand to lose a few pounds. Perhaps you invest in leading diabetes-related companies such as DVA or NVO, again offsetting future expense with expected capital gains and dividend income.

In a similar vein, say you work in the headquarter city for a too-big-too-fail bank. If you own a home in the headquarter city, where house prices are affected by employment at this dominant employer, and have a job with this company, does it make sense to also invest your money in the stock of this company? There may be other valid reasons for buying stock in your company, but from a risk diversification perspective, it does not make a lot of sense to do so.

I'm sure there are plenty of other areas of our lives where we can hedge real-world risk with investment exposure in the other direction, but hopefully this provides some food for thought in how to more broadly view everything you do in your life as an investment in some form or fashion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.