Find The Right Inverse ETFs To Ride Out A Bear Market

Have you ever played musical chairs? Do you remember those instances when there are only a few players left and the music is playing longer than normal with the tension building as everyone knows the music will end at any second? It reminds me a little bit of the feeling of this current bull market. With reports, at the time of writing this article, that it is the longest bull market in history, supported by what might become the longest economic cycle without a recession in history, the music feels as though it has been playing longer than normal.

Add on top of that, stock market valuation indicators like the Schiller P/E ratio and the Buffett Indicator hitting record, or close to record, over-valuation metrics, and one might ask how much further will the bull run before the bear market rears its head? Since the last two bear markets closely coincided with their respective recessions, investors might be nervous about the yield curve starting to invert (an economic signal that has predicted previous recessions with an uncanny accuracy).

As with any investment approach, it is important to understand the pros and cons……the risks and rewards. Remember that smart investing is a process of managing risk factors while preserving as much of the reward as possible.

As the music plays on, some might be encouraged to brush up on their bear market tactics, just in case. These are strategies that could help an investor profit in a bear market or at least hedge their portfolio (offset losses on bullish positions). One of these approaches is the use of Inverse Exchange Traded Funds (Inverse ETFs). These are mutual fund like investments that could be a simpler and potentially safer strategy for investing during a bear market compared to shorting or the use of options. Also, unlike shorting the market directly, inverse ETFs are eligible to be used in an IRA. 

What Is an ETF?

As mentioned above, an ETF is, as its name indicates, a fund that trades on the open exchange. This is unlike mutual funds that do not trade on the open exchanges but instead must be purchased directly from their respective purveyors. Because ETFs trade on the open exchange, on a per share basis like a stock, there are added advantages over mutual funds. For example, stop orders can be used on an ETF and many are optionable (opening the potential for additional risk management strategies). They are also not actively managed but are a passive fund. In other words, they track a basket of investments to mimic the value of either an index, sector, commodity or currency. Because they are passively managed, many have very low management fees that could be as little as one-tenth that charged by a normal mutual fund.

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