Please ensure Javascript is enabled for purposes of website accessibility

Thousands of Robinhood Investors Want to Profit From a Stock Market Crash

By Dan Caplinger – Jul 27, 2020 at 6:33AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

But will the specialized investment vehicles they're picking get the job done?

It's never been a better time for young people to start investing, and many have turned to the Robinhood mobile app to buy their first stocks. The stocks Robinhood investors are buying have inspired a lot of debate about their suitability for people who are new to the market, but it's still good to see newcomers embracing the idea of getting their money to work through investing.

Yet thousands of Robinhood investors are actually taking the opposite view on stocks. Rather than expecting good times ahead, these bearish app-users have focused their attention on ETFs that are tied to stock market volatility. These volatility ETFs typically do rise in value when stocks fall, but their long-term behavior leaves a lot to be desired.

Person looking at wall with downward-facing chart and lots of down arrows, in front of a table with glasses, pens, and paper.

Image source: Getty Images.

The idea behind volatility ETFs

Fund companies designed volatility ETFs to track what's known as the S&P Volatility Index (^VIX -4.81%), or the VIX for short. Many market participants refer to the VIX as the "Fear Index," because it tends to go up when the market falls sharply but then go down when the market recovers.

Volatility ETFs come with different characteristics, and three in particular have made their way into a large number of Robinhood investors' portfolios. The most popular is ProShares Ultra VIX Short-Term (UVXY -6.62%), with more than 16,000 investors counting it among their holdings. iPath Series B S&P 500 VIX (VXX -6.65%) weighs in with almost 5,400 investors, and another 3,400 Robinhood users own shares of ProShares VIX Short-Term Futures (VIXY -5.56%).

Two of these ETFs have the same investment objectives, but one differs. The regular ProShares ETF and the iPath offering tries to achieve a daily return that exactly matches the daily change in short-term futures contracts tracking the VIX. The ProShares Ultra ETF is designed to offer a leveraged return equal to 1.5 times the daily change in VIX futures.

Volatility ETFs can work extremely well when markets plunge over short periods of time. Consider this best-case scenario for the funds, which happened during the coronavirus bear market:

  • The regular ProShares volatility ETF jumped 405% from Feb. 19 to March 18.
  • The iPath fund did just a little better, climbing 409%.
  • The leveraged ProShares Ultra ETF exploded higher even further, with gains of 932%.

It's those kind of quick paydays that many new investors who gravitate to volatility ETFs want to see.

Why volatility ETFs aren't ideal long-term investments

The problem, of course, is that you can't be sure exactly when that big market crash is going to happen. In the meantime, volatility ETFs don't make very suitable long-term investments, because they're designed with daily returns in mind.

As an example, look back two years with these three funds. With a market scare in late 2018 in addition to the COVID-19-inspired bear market, you'd think it would've been a pretty good period for volatility ETFs. However, the regular ProShares and iPath ETFs are down about 3% over those two years. The ProShares Ultra ETF is down more than 40%.

In other words, even with those big gains during turbulent times, volatility ETFs lost even more ground when times were good for the stock market. That left long-term investors in those ETFs with overall losses.

The better choice

Some Robinhood investors are likely trying to time a big market drop perfectly, but others might simply think that owning a volatility ETF can help you avoid the pain of stock market crashes. Yet that's not the best philosophy to have about your investing.

Unfortunately, volatility is the price investors pay for the attractive long-term gains in stocks. Investors should seek to control and manage volatility rather than getting rid of it, because eliminating risk typically also eliminates good returns.

The better choice is to identify stocks of high-quality companies and buy shares with the intent of holding them for the long run. That way, you'll participate in the success of companies whose businesses you understand and believe in. When volatility hits and stock prices fall, having cash on hand to take advantage can become some of your most profitable investments.

Volatility ETFs  are interesting investment vehicles for short-term traders. Those Robinhood investors who have a longer-term mindset, though, should steer clear and focus more of their attention on great businesses.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

ProShares Trust II - ProShares Ultra VIX Short-Term Futures ETF Stock Quote
ProShares Trust II - ProShares Ultra VIX Short-Term Futures ETF
$12.00 (-6.62%) $0.85
iPath Series B S&P 500 VIX Short-Term Futures ETN Stock Quote
iPath Series B S&P 500 VIX Short-Term Futures ETN
$19.80 (-6.65%) $-1.41
ProShares Trust II - ProShares VIX Short-Term Futures ETF Stock Quote
ProShares Trust II - ProShares VIX Short-Term Futures ETF
$16.15 (-5.56%) $0.95
CBOE S&P 500 Volatility Index Stock Quote
CBOE S&P 500 Volatility Index
$30.10 (-4.81%) $-1.52

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/03/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.