A leveraged ETF amplifies the price fluctuations of underlying stocks and tracks an index with a leverage ratio, producing a higher return on investment. However, fees and taxes may reduce the net return. ETFs are a useful tool for investors to enter specific markets.
A leveraged ETF is a type of exchange-traded fund (ETF) that provides a specific type of return based on stock market activity. Exchange Traded Funds are a new way for investors to get involved in more diversified trading through a single financial product. When these items are “leveraged,” they will reflect fewer losses than gains.
What happens with an exchange-traded fund is that several different stocks are bundled into one easily traceable product and price. Traders can follow this price with online brokerage accounts and trade throughout the day. ETF allows a single investor to get involved in multiple different types of investments.
A leveraged ETF takes advantage of the financial process commonly referred to as “leverage”. Some experts describe leveraged ETFs as “amplifying” the price fluctuations of the underlying stocks. Many leveraged ETFs track an index, which means that their losses and gains are tied to the price of the index. When an index ETF is leveraged, derivatives and other financial instruments are used to “roll up” the investment and any price. Some professionals explain it as a “matching” fund where surface investor dollars are matched with additional debt or other value.
The upshot of the leveraged ETF is that it performs with a leverage ratio. Let’s assume the ratio is 3:1. This means that a $1 increase in the index or stock would produce a $3 increase in the leveraged ETF. The same goes for a loss of value.
It is important to note that not all of the leveraged ETF’s theoretical gains and losses will necessarily go into the investor’s net return. With all types of investments, the person investing money has to look at what he or she will realistically get back, a “return on investment”. What usually gets in the way of your ultimate return is in the form of broker fees, administrative costs, and “expense reports,” where the broker or trading firm will charge you for the opportunity to invest. Other subtractions from a gross return are relative to the investor’s annual tax return. Leveraged ETFs and other investment returns are often taxed as capital gains.
Some investors who follow the stock market will appreciate using leveraged ETFs to invest in or track an index. Online account options make ETFs some of the easiest tools to use to “enter” a specific index or market. From blue chips to penny stocks, these investment vehicles can add functionality to a portfolio.
Smart Asset.
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