What percentage of my portfolio should comprise of Inverse ETFs?
How much of my portfolio should consist of Inverse ETFs in order to hedge against a general downturn in the market?
Zero. The inverse ETFs are bad financial products that are geared to lose money over time. I have dedicated a significant part of my career to studying inverse ETFs. I suppose they are OK short-term trading vehicles, but over longer periods of time they simply destroy value for investors.
The best hedge against a general downturn in the market is to keep some liquid cash on the sidelines. One of the best vehicles for doing so is an FDIC insured online savings account. The best rate out there at the time of this writing (that I'm aware of) is 1.25%, FDIC insured up to $250,000 per depositor.
Look to deploy most of the cash reserves from your savings account into the market after a 20% downturn in the broader market indexes. We haven't experienced a 20% or more selloff in the S&P 500 since the summer/fall of 2011, but that certainly doesn't mean it will never happen again.
Imagine that over the course of your investing life, you had only one trading strategy: Sit in cash in a savings account until the S&P 500 has a 20% peak-to-trough selloff, then buy an index fund and hold on. The returns of that strategy over the course of the past 50 years would be spectacular. The hardest part about implementing that strategy is having the patience to wait for the big selloff. Too often, investors pile in exactly at the wrong time, near the top of the cycle, often due to fear of missing out on the next leg of the rally.
So, to reiterate, the best hedge against a big downturn is to take a portion of your assets and sit in cash and wait for the big market bust, and to try to get in when others are panicking. Don't touch the inverse ETFs.
You shouldn’t own any. These are short term vehicles designed for speculation and day trading. Many investors misunderstand the way that they work and how they rebalance. Markets historically appreciate over the long term. Keeping them in a portfolio for the long term works against you.
Your long term investment portfolio should not have any Inverse ETFs in it. There are specific reasons inverse ETFs exist and should be used for timely hedging, but they should NOT be held for the long term. The components of the ETF are usually futures contracts which expire every month. Repurchasing these contracts by the ETF issuer is costly and that cost is passed thru to the shareholders. Over the long term, the stock market rises so being short (inverse) is not the right position to be in.
The Brexit event would be a good example of a time when using an inverse ETF may be appropriate. To hedge your long exposure while awaiting the Brexit results, you could have owned some inverse ETFs and then sold it after hearing the result and seeing that the markets were heading higher. This is an active strategy, but could be beneficial if used appropriately. Also it is for advanced, experienced investors who understand stop losses and risk control.
0%. A good long term investment strategy does not involve market timing. Inverse ETFs invite just that kind of injurious behavior. Pick an asset allocation that is consistent with your risk tolerance and capacity to bear risk ... and stick with it.
Secondly, Inverse ETFs are an inefficient way to offset risk. It's easier and cheaper to shift stocks to bonds or cash if you want to reduce portfolio volatility. Indeed, there may be life events that would necessitate risk reduction that are independent from one's own market outlook. Things like marriage, job loss, retirement, or children might all be reasons to reduce one's risk appetite. Using inverse ETFs offsets long positions elsewhere in your portfolio. You have no net exposure to any market risk factors yet you are paying the trading costs and management fees for both the long and short investment vehicles. Does't seem like a solid investment strategy.
Finally, do NOT take a net negative exposure to the stock market. That is a recipe for disaster. Today's financial markets are highly efficient with virtually all public information factored into security prices. Predicting market downturns without benefit of hindsight is nearly impossible. The conventional wisdom in October 2016 was that a Trump electoral victory would spook the markets. Those who shorted the S&P 500 would be down 15% in the last 6 months plus the costs of the negative exposure ETF. Painful.