Inverse ETF: A Contrarian Exchange Traded Fund
I've thought about the idea of an inverse exchange traded fund (ETF) on occasion. The idea is that this ETF would move inversely to some index so that when an index goes down, the ETF would go up. For those that like to bet against the market, such ETFs might seem like the perfect contrarian investment tool.
Something about this idea bothered me, but until today I didn't know what it was. Sure an inverse ETF could probably be constructed to actually perform as promised, but if you're a buy and hold investor, does it make sense? Or to put it another way, if you had the ability to determine with certainty that an index would go down, you would effectively know when to get in and out of a market. And there's no one out there that can do that.
You'll have a better chance of a success if you follow the idea behind a diversified portfolio which is to assemble holdings that are uncorrelated, but trend upward in the long-run. The uncorrelated feature is key as it is what reduces volatility which in turn can prevent panic-selling. And the long-term upward trend is also key since you want your portfolio, in its entirety, to grow over time.
Adding an inverse ETF to your portfolio would be counter-productive. By its nature, such an ETF would simply move in the opposite direction of an index. So if you held equal amounts of an index ETF and an inverse ETF for that index, you would make no money whatsoever. Seems kind of pointless, doesn't it? Morningstar even goes so far as to call these sucker bets.
And with that I get to toss the inverse ETF idea. And I'm glad I didn't find a way to waste money on such a product.