29 Dec I have $2 million in retirement accounts. Should I try a hedge fund?

Q. I have a friend who said he invested $250,000 in a hedge fund. I don’t know how much money he has, but I have about $2 million in retirement accounts. Is that something I should consider?
— Investor

A. It’s great that you’ve saved well for retirement.

Let’s take a step back and define a hedge fund and what it is as an investment strategy.

In essence, a hedge fund is an investment fund where investors pool their money together and entrust a manager to make investment decisions on behalf of all investors within the fund, said Michael Cocco, a certified financial planner with Beacon Wealth Partners in Nutley.

“While hedge funds are not as regulated as traditional mutual funds, they usually are considered particularly risky investments not suitable or appropriate for all investors or for investors who do have the sophistication or means to understand and accept to take on a substantial amount of risk with some of their investment dollars, with the hope of, and potential for, outsized returns,” he said.

Cocco said hedge funds can use leverage, meaning that they are allowed to use their investors’ capital as collateral to borrow additional funds from a lending institution, and invest those proceeds.

If the investments work out, that leverage may magnify the gains versus investing without leverage, he said. But if their investments don’t work out, the leverage can magnify the losses as well, and it is normal to experience wild swings when investing in a hedge fund, Cocco said.

“Also, most hedge funds, because of their aggressive nature, typically charge higher-than-average fees when compared to traditional mutual funds, exchange-traded funds (and other investments),” he said. “It is important to note that each hedge fund has its own investment policy and philosophy, so knowing the parameters of how a specific hedge fund invests is very important.”

Before you invest, he said you need to consider several things, starting with your risk tolerance.

“Hedge funds are known to be risky and volatile. How did you feel about the losses you may have experienced in the markets so far in 2022?” he said. “If that had you worried, being invested in a hedge fund could have been even more volatile.”

You should also consider liquidity. Some hedge funds only allow for redemptions at certain times, such as once a quarter, once a year, or a different arrangement, Cocco said.

Then there are the fees and costs.

“Are you fee conscious? Look under the hood to see how they charge their fees and how much. Some charge not just an advisory fee, but a fee based on any profits you make, in addition,” he said.

Also consider transparency. Cocco said hedge funds are not required to share all of their holdings or trades with you in the moment, so you may have no idea of what you are invested in. If you are someone who values transparency, a hedge fund may not be for you, he said.

It all comes back to your goals, he said.

You need to know what your investment goals are — income? growth? — and whether those goals match up with the investments that you may select for your future, Cocco said.

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This story was originally published on Dec. 29, 2022.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.