A leveraged ETF uses leverage to amplify the price fluctuations of underlying shares, with gains and losses tied to the price of the index. However, not all gains and losses go to the investor’s net return due to fees and taxes. ETFs are an easy way to diversify investments and track an index.
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 engage 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 lumped together into one easily traceable product and price. Traders can track this price with online brokerage accounts and trade around the clock. The ETF allows a single investor to engage in more diverse types of investments.
A leveraged ETF takes advantage of the financial process commonly called “leverage.” Some experts describe the leveraged ETF as “amplifying” the price fluctuations of the underlying shares. Many leveraged ETFs track an index, which means that your gains and losses are tied to the price of the index. When an index ETF is leveraged, derivatives and other financial instruments are used to “increase” the investment and the final price. Some professionals explain it as a “matching” fund in which acreage investor dollars are combined with additional debt capital or other security.
The result of the leveraged ETF is that it works at a leverage ratio. Let’s assume the ratio is 3:1. That means a $1 increase in the index or stock would produce a $3 increase in the leveraged ETF. The same goes for a loss in value.
It is important to note that not all of the leveraged ETF’s theoretical gains and losses will necessarily go to the investor’s net return. With all types of investments, the person investing money has to look at what he will actually get, a “return on investment.” What generally interferes with the bottom line is in the form of broker fees, administrative costs, and “expense ratios,” where the broker or trading company will charge for the opportunity to invest. Other subtractions from a gross return are related to the investor’s annual tax return. Leveraged ETFs and other investment income are typically taxed as capital gains.
Some investors who follow the stock market will enjoy using the leveraged ETF to invest in or track an index. Online account options make ETFs some of the easiest tools to use for “getting into” a specific index or market. From blue chips to penny stocks, these investment tools can add features to a portfolio.
Smart Asset.
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