A Good Plan Gives You Peace of Mind

Many DIY investors lamenting recent losses in their investment portfolios are seeking out financial advice. Hedging portfolio risk is the key to lowering risk and losses. If you could always take the opposite directional exposure of the broader market, your investment portfolio would be perfectly hedged. 

In search of the perfect portfolio hedge, more investors are being sold short by high risk ETFs. In particular, financial advisors recommend caution when investing in these ETFs.

VIX Volatility ETFs

For many investors, the volatility in the S&P 500 in 2020 has been like watching a roller coaster ride. As the stock market benchmark, the index has a beta of around 1, representing the volatility of the broader market. Investing in VIX ETFs is like getting on the roller coaster. They go long or short S&P 500 market volatility forecasts reflected in VIX (CBOE volatility index) futures prices.

A VIX ETF holds long and/or short positions on VIX futures indexes. The VIX is rightfully called the fear index; it captures investor sentiment. But unfortunately, VIX ETFs only mirror 25–50 percent of VIX moves, and less for mid-term forecasts.

Gold Bear ETFs 

Gold bears short gold prices. Betting against gold is betting against the world's favorite safe haven asset. The price movement of gold is uncorrelated with that of the broader market (e..g, stocks, bonds, real estate). Gold is also an inflation hedge. For these reasons, when stock markets are jittery, investors pile into gold.

More investors are going long gold in a market downturn with ETFs, creating more pain for short sellers. Owning physical gold comes with hassles, namely paying for storage and insurance. ETFs are convenient, low cost, and secure. They buy gold bars to back the assets in the fund and store them in a bank vault. To minimize portfolio volatility, financial advisors recommend allocating 5–10 percent of your portfolio to gold.

Leveraged ETFs

Leveraged ETFs trade on margin to magnify the potential investment gains.  If you had invested in a Gold ETF with 2X leverage, with the 16 percent rise in gold prices this year, your return would be double, 32 percent.

Unfortunately, losses are also magnified. By mid-year 2020, many leveraged ETFs were the worst performers. They included oil and gas, regional banking, and gold bears and biotech bears that went short these high performing markets. 

The lesson in all these ETFs is the same: what goes up must come down. Your financial advisor can help you create a diversified portfolio with a low beta (risk-adjusted returns). When markets do fall, your losses will be minimized.