Inverse exchange-traded funds are exchange-traded funds which are traded on the public stock market. This type of ETF is aimed to perform the inverse of whatever index being tracked. These funds work through the use of leveraged investment tips such as futures contracts, short selling, and trading derivatives.
Inverse ETFs give a similar result to short selling the stock in the index, setting aside the impact of fees and other costs and providing over a short period of time results opposite of their benchmark. During bear markets these are very popular, since they are designed to rise in a falling market. For example, an inverse S&P ETF would try and move opposite of that of the S&P. If the S&P falls by 1% the invest ETF is designed to move up 1%.
Unlimited losses can occur to an investor’s stock portfolio through a short sale whether an ordinary share of stock or an ETF. Investors only lose the purchase price with an inverse ETF but retain all other advantages of a short sale. Unlike a short sale, inverse ETFs can be held in an IRA account.
Investors can benefit from several different long-term scenarios from inverse ETFs. When trapped in a bear market, investors can reduce losses by using an inverse ETF. Another strategy is if a long-term investor has a large gain and doesn’t want to pay high taxes they would invest in this fund.
Long-term investors can also avoid paying taxes if they realize a large paper gain by investing in these funds. When investors use inverse ETF strategies they must change their notional daily. Normally, this causes more trading. Some experts have said this has increased volatility, many other experts disagree and say it has no impact.
Inverse ETFs typically have higher costs than that of standard ETFs. Most of these funds are actively managed, which means higher broker commissions. If not closely monitored, costs can get out of control and eat away at gains.
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