Defensive ETFs For Tough Markets

By Investopedia Staff | May 30, 2012 AAA

Today's uncertain economic landscape is creating havoc for many investors and their portfolios. While there is little substitute for the success of a value investing philosophy in any market environment, it is certainly acceptable, and prudent, for investors to desire a little more safety over the value of their respective portfolios. For most, trying to short stocks to benefit from a market decline is a recipe for disaster.

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Flight to Safety
The majority of investors may find possible alternatives in the form of certain exchange-traded funds, or ETFs. Rather than having to bet against one stock, ETFs allow investors to make broader bets. As the population of ETFs has exploded over the years, investors can now bet on whole industries, countries, currencies and even macro events. One of the biggest concerns facing the U.S. and global economy, is the fear of continued monetary disorder. With record amounts of dollars and other currencies being injected into the system, the automatic flight-to-safety instrument is gold. For centuries, people have always sought value in gold. The SPDR Gold Shares (ARCA:GLD) ETF is the most appropriate exposure for most investors seeking to own gold. Many investors attempt to invest directly in gold mining, unaware of risks involved in mining gold. Those risks of course are somewhat offset by the profit potential that comes with a higher and higher gold price. The Market Vectors Gold Miners ETF (ARCA:GDX), however, lets investors bet on gold mining by holding a diversified group.

Possible Alternatives
The ProShares Short S&P 500 (ARCA:SH) is just as it sounds, an ETF that essentially performs inversely to the performance of the S&P 500. So if the market falls further, this ETF will go up in price and thus, provide a hedge to a long stock portfolio. The ProShares Short QQQ (ARCA:PSQ) is the similar ETF for the Nasdaq. A portfolio containing lots of technology exposure may benefit by owning PSQ as a hedge. ETFs have become popular investment tools for many investors looking to make a broader bet on a certain area of the economy. With the economy currently lacking any sense of direction with regards to a recovery, the possibly of a severe setback looms. Investors may wish to consider ETFs as a way to prepare for any upcoming havoc. (For related reading, also see, Inverse ETFs Can Lift A Falling Portfolio.)

The Bottom Line
The ease with which ETFs have allowed individual investors to trade like pros is what has led to their appeal. Their growing popularity is due to the increasing number of investors who choose to use them instead of individual stocks. Investors should exercise caution: like any individual stock, you can get burned if you don't know what you are doing.

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