What Are Leveraged Exchange-Traded Funds?
If you have been following the stock market for any length of time, you have likely encountered something called a leveraged exchange-traded fund (ETF). An exchange-traded fund collects stocks into shares and is traded under an identifying symbol. They are bought and sold throughout the day at prices that may be higher or lower than the net asset value.
How Do Leveraged Exchange-Traded Funds Work?
A leveraged exchange-traded fund with 3x leverage can use stocks listed on the S&P 500 to create three times the returns or three times the losses. The broker may use debt and equity or cash to purchase stocks on behalf of the exchange-traded fund. Debt allows the broker to buy an expensive stock and pay off the debt with the return and the new value of the stock if it has grown, keeping the remainder.
Should You Invest in Leveraged Exchange-Traded Funds?
Although the temptation to speculate in leveraged exchange-traded funds may be strong, it should be clear that they are not intended to be part of a diversified long-term portfolio. If you have an advisor and they have placed one of these funds in your account, you should consider looking for another advisor.
If you include one in a personal management account or buy it for a brokerage account, you are taking on significant risk with your money. You can and likely will lose a large amount of money if you continue to hold a leveraged exchange-traded fund. This is because they are designed to be traded over short time periods, such as one day. There are leveraged exchange-traded funds designed for longer periods, such as a month; however, this does not reduce the risk you are taking on.
Furthermore, the expected return may not be as large as you imagine. Additionally, leveraged exchange-traded funds typically have investment management fees higher than 1%. If you are successful in trading leveraged exchange-traded funds, all your profits will be subject to much higher income tax rates as they are short-term gains.
If you are looking to build wealth, it is simple enough. You can buy high-quality shares from large companies. Be sure to find stocks that allow you to benefit from tax-deferred liabilities by limiting trading and taking advantage of compounding.
Source: https://www.thebalancemoney.com/leveraged-etfs-for-beginners-357490
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