Should I Incorporate Derivatives Into My Portfolio? | Ask a Fool

TL;DR

Learn about derivatives, their benefits, risks, and the recommended percentage of assets to allocate to them.

Transcript

hey fools Brian Henman here analyst with Molly fo Pro and Molly fo options I'm here today to answer a question that came to us via Facebook for ask a full series Andrew sulock asks should one consider incorporating derivatives into their portfolio what percentage of net assets with respect to what age and specifically talk about Futures Contract an... Read More

Key Insights

• 📼 Derivatives are contractual assets derived from underlying assets like stock or commodity indexes, serving as a form of diversification.
• 😘 They are less correlated with traditional investments, resulting in a smoother portfolio and potentially lower volatility.
• ❓ However, derivatives are complex, expensive, and not intuitive for individual investors.
• 🥺 Managed futures funds are often required to access derivatives, leading to high fees and potentially locking up funds for multiple years.
• ⚾ The recommended allocation to derivatives varies based on retirement proximity, with percentages decreasing as retirement approaches.
• 🏛️ Allocating a portion of one's portfolio to derivatives might not be necessary to achieve retirement goals, considering other traditional asset classes.

Questions & Answers

Q: What are derivatives, and how do they derive their value?

Derivatives are contractual assets whose value is derived from an underlying asset, like stock or commodity indexes. They are not tangible assets but rather contracts that represent an agreement to bet on the upside or downside of the underlying asset.

Q: What are the benefits of incorporating derivatives in a portfolio?

Derivatives provide portfolio diversification by being less correlated with traditional investments. This reduces volatility and smooths returns. Additionally, they allow investors to speculate on the future movements of the underlying asset without directly owning it.

Q: What are the risks associated with derivatives?

Derivatives are complicated and not intuitive for individual investors. They often require the assistance of managed futures funds, which come with high fees and expenses. Moreover, investing in derivatives may result in locked-up funds for several years.

Q: What percentage of assets should be allocated to derivatives?

According to retirement expert Robert Brokamp, if you are more than 10 years away from retirement, you could allocate up to 10% of your portfolio to alternatives, including derivatives. If you are closer to retirement or already in retirement, the recommended allocation decreases to 8% or 5% respectively.

Summary & Key Takeaways

• Derivatives are assets that derive their value from an underlying asset, such as stock or commodity indexes.

• They offer the benefit of being less correlated with traditional investments like stocks and bonds, resulting in a smoother portfolio.

• However, derivatives are complex, not intuitive for individual investors, expensive, and often require locking up funds for multiple years.