By relying on inverse funds, investors can avoid all the hassles of shorting. Whether they are no-load mutual funds or ETFs, the inverse choices can be bought instantly online with a few keystrokes. No margin account is required. If a trade goes badly, there are no margin calls. The paperwork for inverse investments is the same as it is for any fund. Most inverse funds come with expense ratios of around 1%. In contrast, margin accounts used for shorting can charge up to 9% interest.
Because of their flexibility, inverse funds enable bearish investors to employ a variety of strategies. Say an investor is worried about technology stocks but optimistic about Apple (AAPL - Get Report). He could buy shares of Apple and also invest in ProShares Ultra Short Technology (REW), which delivers twice the inverse of the Dow Jones U.S. Technology Index. The trade would be a big winner if Apple rose while most technology stocks dropped.
An inverse fund can provide a long-term hedge. If an investor has owned pharmaceutical stocks for years but fears the shares will drop for several months if Barack Obama is elected, instead of selling the stocks -- and possibly booking capital gains -- the investor can hedge by buying Rydex Inverse 2X S&P Select Sector Health (RHO).
An important advantage of inverse funds is they can be held in retirement accounts, such as IRAs. Retirement accounts cannot be used for ordinary short sales. By adding an inverse fund to a retirement portfolio, investors may ensure their assets are protected from severe downturns.