The Hidden Danger of Leveraged ETFs

Leveraged exchange-traded funds (ETFs) pose several dangers for retail investors tempted by potential high returns in a short period of time. High expense ratios and decay are big issues for leveraged (ETFs). These two factors alone eat into profits and exacerbate losses. This is not how you want to invest. (For more, see: Introduction to Leveraged ETFs.)

However, there is a bigger problem with leveraged ETFs. They can entice those prone to gambling. Since greed can be a driving force of human nature (for some), there is going to be demand for leveraged ETFs. Some retail investors look at this way: Why wait a year or more for a 10% return when I can have it in a day?

That might appear to be a salient point, but retail investors who invest in leveraged ETFs are ignoring the cardinal rule of investing: preserve capital. Trading a leveraged ETF is no different than going to a roulette table. It is impossible to time the market. Sometimes you win and sometimes you lose. The problem is that the house never runs out of money on a cold streak, but you will. Retail investors, as opposed to a traders, should avoid leveraged ETFs. (For more, see: Top 5 Reasons to Keep Leveraged ETFs to the Pros.)

Fundamentals

If we rewind 20 years, investors sought out companies based on fundamentals. Either they were investing in cash-flow strong dividend-paying companies that could offer steady returns or they were investing in small-cap stocks with tremendous long-term growth potential. That’s investing.

Will investors move away from leveraged ETFs and investment returns being driven by Federal Reserve policy, such as prolonged low interest rates, and back to investments being based on fundamentals? Savvy investors have completely ignored both factors and have done well. (For more, see: Why Leveraged ETFs Are Not a Long-Term Bet.)