Inverse exchange-traded funds (ETFs) have exploded in popularity in 2025 and are becoming more prevalent. Not every inverse ETF is worth buying, though, and most investors should probably stay away from them. But in certain situations, they could be a useful tool in building a portfolio.
Inverse ETFs are specialized investment vehicles designed to deliver returns that move in the opposite direction of a specific index or asset, typically on a daily basis. For example, if the tracked index falls by 1%, an inverse ETF aims to rise by 1%. These funds use derivatives such as futures and swaps to achieve their objectives, offering investors a way to hedge against market downturns or capitalize on bearish market views without directly shorting stocks.
Inverse ETFs are not suited for long-term, buy-and-hold strategies due to daily rebalancing, which can lead to performance drift over time. Instead, they serve as tactical tools within a diversified portfolio, complementing long positions in stocks, bonds, or other assets. By allocating a small portion of their portfolio to inverse ETFs, investors can reduce risk during volatile periods, helping to offset potential losses while still maintaining exposure to growth-oriented investments.
However, their complexity and higher expense ratios demand careful monitoring and a clear understanding of their risks. Below are three of the top inverse ETFs investors should consider for building their portfolios.
ProShares Short Russell 2000 (RWM)
The ProShares Short Russell 2000 (NYSEARCA:RWM) provides inverse (-1x) exposure to the Russell 2000 Index, which tracks approximately 2,000 small-cap U.S. companies. Small-cap stocks are often more volatile than large-caps, making RWM an effective hedge for investors with significant small-cap exposure or for those anticipating a downturn in this sector.
For instance, small-caps are particularly sensitive to economic slowdowns due to their reliance on domestic markets and limited access to credit. RWM can be used to protect a portfolio heavily weighted in small-cap ETFs like the iShares Russell 2000 (NYSEARCA:IWM). With an expense ratio of 0.95% and assets under management (AUM) of around $129.9 million, RWM offers sufficient liquidity for short-term trades.
Investors might allocate 5% to 10% of their portfolio to RWM during periods of high valuations or economic uncertainty, such as fears of recession or tightening monetary policy, to offset potential losses in small-cap holdings. However, its tracking error of 0.42%, due to the illiquidity of some underlying stocks, requires active management to avoid performance discrepancies over extended periods.
ProShares Short S&P 500 (SH)
The ProShares Short S&P 500 (NYSEARCA:SH) targets inverse (-1x) daily performance of the S&P 500, the popular broad-based benchmark index of 500 large- and mid-cap U.S. companies.
SH is ideal for hedging broad market exposure, as most stocks move in tandem with the S&P 500. Additionally, approximately 40% of the index’s constituents’ profits come from international markets, offering partial protection against global slowdowns.
With $1.1 billion in AUM and a 0.90% expense ratio, SH is one of the most liquid inverse ETFs, boasting a 90-day average volume of 7.8 million shares. Investors can use SH to hedge a diversified equity portfolio, particularly during anticipated corrections driven by factors like rising interest rates or geopolitical tensions.
For example, a 10% to 20% allocation to SH can reduce portfolio volatility. SH’s simplicity makes it a cornerstone for bearish strategies, but daily resets necessitate frequent monitoring to align with short-term objectives.
ProShares Short QQQ (PSQ)
The ProShares Short QQQ (NYSEARCA:PSQ) delivers inverse (-1x) exposure to the Nasdaq-100 Index, which includes 100 of the largest non-financial companies, but is heavily weighted toward technology giants like Apple (NASDAQ:AAPL | AAPL Price Prediction) and Amazon (NASDAQ:AMZN). With a 49% allocation to information technology, PSQ is a strategic choice for investors seeking to hedge concentrated tech exposure or bet against overvalued tech stocks.
Its low tracking error of 0.05% and $482.2 million in AUM ensure reliable performance and liquidity. PSQ is particularly useful when the Nasdaq-100 shows signs of a bubble, such as when the Magnificent Seven stocks have a disproportionate influence on the index.
Investors might pair PSQ with long positions in tech-heavy ETFs like Invesco QQQ (NYSEARCA:QQQ), using a 5% to 15% allocation to offset potential declines during market corrections. PSQ’s 0.95% expense ratio is standard, but its daily reset mechanism requires active management to avoid return erosion in volatile markets.
Key Takeaway
RWM, SH, and PSQ offer targeted ways to hedge specific market segments — small-caps, broad large-caps, and technology, respectively. By incorporating these inverse ETFs judiciously, investors can enhance portfolio resilience, but they must remain vigilant due to the funds’ short-term focus and inherent complexities.
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