Tax Rascal

The Heating Bill Hedge

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The Heating Bill Hedge

It’s hard to miss the headlines about hedge fund collapses. It seems like every day there’s a story of another hedge fund that blew up thanks to esoteric bets on mortgages, metals, or currencies. One easy lesson to draw from this is that the hedge fund concept has been thoroughly debunked. But a better lesson is to ask how you can behave more like a smart hedge fund owner.

I don’t mean to suggest that any small investor should play with the financial high-wire act that some funds use. Nor should typical investors play around with complex securities like stock options — if a team of MIT-educated PhDs could lose billions of dollars on ‘risk-free’ options trading, it might be a good plan to stay away.

Instead, I think most people don’t appreciate the power of hedging. The original hedge funds understood this: if they bought stock of Ford, they’d bet against General Motors at the same time, on the theory that nobody could predict how the auto market would turn out, but a smart investor could tell that Fords were outselling Chevrolets.

These hedge funds were run by a more entertaining cast than the current crowd, including Benjamin Graham, the polyamorous polymath who traded undiscovered and unloved stocks; the journalist Alfred Winslow Jones, whose career was built on a single article he wrote about stock trading for Fortune (past articles were on subjects like prep schools); and more recently Nunzio Tartaglia, a former Jesuit-in-training who turned to astrophysics and then stock trading.

What these people had in common wasn’t their strategy — it was their method. Whatever they did, they focused on: instead of accepting the huge amounts of risk inherent in many activities, they did everything to mitigate the risks they didn’t care about, so they could pay closer attention to the ones they did care about.

Think about the risks you have to take: if you work for a company, and own stock in your employer, then if the company does badly you could lose your income and some of your savings — but people often buy shares of their employers’ stocks anyway. That’s an easy risk to hedge, especially if you work for a private company and can’t buy their stock in the first place.

But what about other risks? Take gas and heating oil prices: if these rose, you’d be poorer; if they dropped, you’d be richer. By owning a car or heating your home, you’re basically speculating on the price of energy — but is that really something you’d like to speculate on? The minute you drove off the lot, you bet thousands of dollars on the future price of gas.

I have a simple suggestion: instead of worrying about energy prices, consider putting some of your savings into a royalty trusts. These companies are organized to lease assets like oil and gas. When the price of those assets goes up, the companies make more money. Even better, nearly all of this money is paid out to owners and taxed directly as income — so you end up paying less than you would from a normal dividend!

Unlike many other energy cost-saving measures, it’s tax-advantaged, and if you change your mind you can sell it and recover some money, or even turn a profit (try that with storm windows)!

Like any investment, there’s a chance that a royalty trust will lose value. But overall, the fluctuations in their price, and the income you get from them, will be similar to the fluctuations in some of your bills. If your trust checks and your gas expenses even out, you’ll be able to worry less, and spend more time where it counts.

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