What is a bear market fund?
A bear market fund is a mutual fund whose goal is to go up when the market goes down. At worst, these funds aim to outperform the market during declines, perhaps falling as well but by a lower percentage.
Why you should avoid bear market funds
Markets generally rise
In their pure form, bear market funds seek results that are opposite the market. Of course, when you invest, you seek growth. Despite crashes and panics, the market rises over time. Putting your money in a bear market fund is a bet against history, one that has failed every investment cycle. Figure 20-1 compares the change in value of stock and bond index funds and the average of all bear market funds tracked by Morningstar. During a decade that included one of the worst bear markets ever, bear market funds lost over 85% of their value.
You would pay two fees for nothing
Assuming you would not put all of your money in a bear market fund, what about ‘hedging’ a little, holding a bear market fund while you also hold stocks or regular stock funds? Don’t. Each fund will charge fees. For every dollar invested in both, the net expected return is about zero, minus those fees. It is a ridiculous combination. It would be more effective to hold cash.
Market timing is a bad tactic
Since bear market funds are doomed to fail in the long run, what about short horizons when markets go down? If you know when the market will rise and fall, by all means take advantage. Unfortunately, no one knows. Market timing sounds like a great tactic, but even professionals cannot do it profitably. What are your chances?
Derivatives are bad instruments
To move opposite the market, bear market funds must hold short positions (Chapter 40) and/or derivatives. Aside from the benefits of diversification, a fund is no better than the sum of its parts. If the parts are faulty, the fund is faulty. Volatility, withering value and participation in negative sum games are the building blocks of bear funds. You would not buy these instruments directly. You should not buy them through a fund.
What you should do instead
First, do not try to time the market. If you are considering a bear market fund, you are probably worried about a major market decline. If your fear is at all fleeting or based on scant evidence, resist the temptation and move on.
If instead your concern is palpable and deep, it is possible your risk profile has shifted. You may want to reassess your tolerance. Moving toward a more conservative posture may make sense. If so, reduce your stock holdings and either put more to work in bonds or let the proceeds from stock sales sit in cash until your tolerance shifts back in the other direction. Click here for help assessing your current risk profile.
* Data sources:
The Vanguard Group, Inc., Morningstar, Inc.