UK Accounting Glossary
Portfolio insurance is a strategy used to reduce risk and protect stock portfolios against market declines. Portfolio insurance may entail short-selling stock index futures in a declining market, as opposed to selling the actual stock as it loses value. If the drop continues, an investor may repurchase the future at a lower price – using the profit to offset portfolio losses. Short-selling index futures as a form of portfolio insurance can offset any downturns, but could also hinder any gains. On the other hand, portfolio insurance may also entail purchasing futures in a rising market. Therefore, using portfolio insurance can be viewed as a hedging technique for a stock-only portfolio. Institutional investors often use portfolio insurance when they are dealing with a volatile or uncertain market. The ultimate goal of portfolio insurance is to prevent the value of a portfolio from dropping below a certain level. Of course, portfolio insurance is only effective if insured before the market declines. Investors should also be mindful of the IRS wash sale restrictions when implementing their portfolio insurance strategy.
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This glossary post was last updated: 6th February 2020.