Reverse Mutual Funds: Understanding How They Work & Potential Benefits

The mutual fund has been one of the most popular investments in the industry for years. While it is designed to benefit from growth, a reverse mutual fund benefits from a decline in value. Here are the basics of how a reverse mutual fund works and how you could benefit from it.

How It Works

A reverse mutual fund can be based on an index or it can be actively managed. If it is based upon an index, the bond goes up in value when the index decreases. Many of these funds will increase in value at twice the rate of the decrease in the index. This allows you to hedge your investments with only half of the money.

If a fund is actively managed the fund managers buy and sell a number of different securities to allow you to profit from decreases in the market. They might purchase derivatives, short sell stocks or use other methods to benefit investors.

The important thing to remember with this type of investment is that you benefit when the market declines in value. Therefore, this can be a very risky strategy. Over time, the market always goes up. This means it requires perfect timing in order to work properly.