Over the past year or two the popularity of leveraged ETF’s has increased tremendously. These ETF’s seek to double or triple the returns on various stock indexes. Leveraged ETFs function by using financial derivatives, such as options, swaps, and index futures to magnify the returns on a particular basket of stocks. (Sometimes leveraged ETF’s will even seek to return double or triple the inverse of an index)
I was planning on writing a whole post about the pitfalls of these funds. However, it would have been too hard for me to explain their dangers without getting into complicated compounding math. This video explains why these ETF’s don’t give investors the returns they may be expecting…
The bottom line is leveraged ETF’s aren’t a good choice for long-term investors. These funds are meant to be used by professional traders with short term holding periods. I’d highly recommend that amateur investors stay away from them.
Steve, can you give some examples of the differences between these leveraged ETFs and ‘normal’ ETFs? What are some specific examples of them?
Very true. Leveraged ETF’s are trading vehicles that should not be held long term. They have the potential to magnify losses.
Eric, The XLE is an example of a normal ETF whereas the SKF is a leveraged ETF. Leveraged ETF’s rely on debt. For example every dollar that you purchase can purchase $2 worth of assets.
http://moneycentral.msn.com/investor/partsub/funds/etfperformancetracker.aspx
The link above has a list of ETF’s. Mark pretty much sums up the difference between a normal ETF as opposed to a leveraged ETF. Basically anything that says you’ll get 2 times or 3 times anything is leveraged.