The True Cost of Inverse ETFs
Understanding expense ratios, tracking error, and hidden costs
Expense Ratios
Inverse and leveraged ETFs typically have higher expense ratios than standard ETFs:
- Standard index ETFs: 0.03% - 0.20%
- Inverse ETFs: 0.88% - 1.15%
- Leveraged inverse ETFs: 0.90% - 1.10%
These fees are deducted daily from the fund's assets, reducing your returns over time.
Why Are Costs Higher?
Inverse ETFs cost more to operate because they:
- Use derivatives (swaps, futures) that have their own costs
- Require daily rebalancing, incurring transaction costs
- Need active management to maintain target exposure
- Have higher regulatory and compliance requirements
Tracking Error
Tracking error is the difference between the ETF's actual return and its target return. Causes include:
- Expense ratio drag
- Imperfect derivative pricing
- Rebalancing timing differences
- Cash drag from uninvested assets
Even on a single day, an inverse ETF may not perfectly match its target multiple.
Comparing Costs
When considering inverse ETFs, compare total costs:
Inverse ETF: ~1% expense ratio + leverage decay + tracking error
Direct shorting: Borrow cost (varies) + margin interest + potential squeeze risk
Put options: Premium cost + time decay + bid-ask spread
Each approach has different cost structures. The "cheapest" option depends on your time horizon and market conditions.
Key Takeaways
- Inverse ETFs have significantly higher expense ratios than standard ETFs
- Costs compound with leverage decay over time
- Tracking error means returns may not match expectations
- For short holding periods, expense ratios matter less than decay
- Always factor in total cost when comparing shorting methods