We just aren't wired for down markets. We can wrap our brains around bull markets, but when the market turns the other way and the bear takes over, it's hard to think about making money from bad performance.
However, it's still possible to profit from a weakening economy. Other than closing your eyes, holding your investments and waiting for the market to come back, you have two choices: you can ride it out by getting into low volatility ETFs or go for it and try your hand at an inverse ETF. Let's look at both.
If you watch financial media channels like CNBC, you've likely heard terms like "risk off" and "flight to safety." When the market goes south, some investors transfer out of high volatility growth products and park their money in low volatility ETFs that are less sensitive to overall market events.
- Consumer Staples Select Sector SPDR Fund (XLP)
Dividend stocks often equal low volatility. Because the company no longer sees massive stock appreciation, they pay a dividend to attract investors.
XLP is a relatively stable investment and holds names that consumers don't abandon when the economy weakens. These are often large companies that pay a dividend. XLPs top-five holdings include companies like Coca-Cola, Procter & Gamble and Walmart. At times of market decline, the XLP has held its value much better than the S&P 500.
- iBoxx $ High Yield Corporate Bond Fund (HYG)
Possibly the best way to protect your portfolio in times of market turmoil is with bonds. You could go with an investment grade bond ETF or park your money in a high yielding junk bond fund like HYG. Although the S&P 500 has outperformed the fund in bull market times, HYG holds its ground quite impressively during the bad times and even better, it pays you more than 7% while you wait for happier days to return.
Make Some Money
If you're more interested in trying your hand at market timing, beware that you might end up losing more money than if you would have waited for the storm to pass but if you're so inclined, here are some ideas.
If you did all of your research and became an expert in the ETFs in your portfolio, remember that you can short sell ETFs. Short selling allows you to profit when the product goes down. If you're a big fan of the famous SPDR Gold Shares ETF (GLD) but think it's on the way down, short sell it. If it goes down 2%, you profit 2%.
- ProShares Short S&P500 (SH)
If you want to use an ETF that is designed to make money when the market goes down, first look at the ProShares Short S&P500 ETF. This inverse ETF allows the fund to rise in value as the S&P 500 falls. Note that inverse ETFs have higher expense ratios than traditional long funds. SH has an expense ratio of 0.90% where the SPDR S&P 500 (SPY), a long oriented S&P 500 ETF has only a 0.09% ratio.
- ProShares UltraShort FTSE China 25 (FXP)
Maybe it's not the U.S. market. Maybe you're concerned about China. You could use the ProShares UltraShort FTSE China 25 (FXP). This fund is a leveraged ETF that allows you to score twice as big when the underlying index goes down. If the FTSE China 25 index drops 2%, you'll make 4% before accounting for fees and expenses.
- Direxion Daily Small Cap Bear 3x Shares (TZA)
Two times not enough for you? Maybe you think that small cap stocks are going to take a real beating over the next couple of days. In the case of the Direxion Daily Small Cap Bear 3x Shares (TZA), if the Russell 1000 index loses 1% of its value, you'll see a 3% gain before fees and expenses are subtracted.
Be warned that levered ETFs like FXP and TZA shouldn't be used with retirement funds or other money that is earmarked for something else. The potential for big gains makes these funds attractive, but the losses can be just as big. All inverse ETFs are day trading vehicles, so don't hold these funds for longer than a couple of days.
The Bottom Line
You don't have to sit by and watch the markets tank. You can move your money to safer ground by using low volatility ETFs, or you can use inverse funds to make money when the market loses money.