Can These ETFs Save Your Portfolio?

Jeez Louise -- how much worse can it get?

On Friday morning, I arrived at Fool HQ, sneaked a peek at the futures market, and promptly groaned so loudly that my cube-mate asked if I was all right. I was fine, but the market was in for a doozy of a losing session.

Stocks like Research In Motion (Nasdaq: RIMM  ) , Wachovia (NYSE: WB  ) , and Sun Microsystems (Nasdaq: JAVA  ) all posted sharp declines, while even folks who favor the relative safety of diversified vehicles such as the SPDRs exchange-traded fund (AMEX: SPY  ) were treated (maltreated, really) to a decline of roughly 1.1%.

If things keep going this way, we'll all have to consider working longer than we might have planned. After all, a nest egg of $250,000 invested in the S&P 500 12 months ago would have been worth roughly $202,000 when the curtain finally came down on this, our most recent black Friday.

What's a Foolish, in-it-for-the-long-haul investor to do?

Glad you asked
The good news is that there are some exchange-traded funds that crafty investors can use to stop the bleeding: inverse ETFs.

Designed to move in the opposite direction of such market indices as the S&P 500 (Short S&P500 ProShares (SH), for example) or the small-cap-focused Russell 2000 (Short Russell2000 ProShares (RWM) is one), these puppies allow investors to short the market via a long purchase, effectively hedging a portion of their equity exposure.

The bad news is that, unless you use them judiciously, these reverse race cars can run right over your portfolio. That's particularly true of "leveraged" inverse ETFs, vehicles that use debt to make bigger bets against the market.

Which of course raises the question ...
How to use 'em judiciously? To my way of thinking, the smartest use is as a way of reducing your net equity exposure without realizing capital gains.

If, for instance, your portfolio comprises an 80% stock market stake and 20% cash, you could put that cash to work in an inverse ETF and reduce your equity exposure to 60% -- without selling anything and, therefore, without paying Uncle Sam a dime on any realized gains. Convenient, no?

Convenient, yes, but remember: The long-term trajectory of the market is up, and shorting is not a long-term investment solution. What goes down will likely go up again, so the best use of inverse ETFs is as a tax-efficient asset-reallocation tool, one you put to work only after thinking long and hard about your timeline and tolerance for risk.

Speaking of which ...
That's precisely what we've done with the Fool's new Ready-Made Millionaire service, a set-and-forget portfolio designed to "shock-proof" your nest egg with a compact basket of eight holdings that includes a high-octane (read: leveraged) ETF specializing in the mid-cap likes of Southwestern Energy (NYSE: SWN  ) , Joy Global (Nasdaq: JOYG  ) , and Flowserve (NYSE: FLS  ) . Each of these companies has delivered a double-digit gain over the past year while the S&P has been in free fall.

We're confident that our lineup will trounce the market over the next three to five years and beyond -- so confident that the Fool has invested a million dollars of its own money in it. If you'd like to invest alongside us, just click here to take Ready-Made Millionaire for a risk-free spin.

At the time of publication, Shannon Zimmerman didn't own any of the securities mentioned above. You can check out the Fool's strict disclosure policy by clicking right here.


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