Hedging Your Portfolio with Reverse ETFs

When your outlook on the stock market turns bearish, selling your entire portfolio (or part of it) isn't the only option to reduce risk. A practical alternative is investing in a reverse or inverse ETF, which profits when the market declines. These ETFs are traded like regular ETFs through any broker and offer a straightforward way to hedge against market downturns.

Using Reverse ETFs Conservatively 

The primary use of a reverse ETF is to hedge your portfolio, not to speculate on market declines. Here's an example:

- Portfolio: $100,000 in stocks and $50,000 in cash.

- Hedge: Allocate $20,000 to a 3x leveraged reverse ETF.

This hedge provides approximate coverage for market drops, as the ETF is designed to move inversely to the market on a daily basis. While the calculation isn't perfect—because reverse ETFs are optimized for daily performance—the hedge can offset some losses if the market falls.

Which Reverse ETF Should You Buy? 

Choose the ETF that matches the market or sector you expect to decline the most. For example, if you anticipate the Nasdaq dropping more than the general market, you might consider a reverse ETF tied to that index. Leveraged options (e.g., 2x or 3x) amplify gains and losses, making them more volatile but potentially more effective for hedging small cash allocations.

Key Considerations

- Reverse ETFs are meant for short-term strategies, as their performance may deviate from expectations over longer periods.

- Not for Speculation: These are tools for protection, not gambling on a bear market.

- Alternative Protection: Selling part of your portfolio remains a valid option for managing risk.

For those interested, here’s a link to tickers of commonly used inverse ETFs.