Leveraged ETF

One of the newest ETF products on the market is a leveraged ETF that is probably just as controversial as it is popular. While ETFs are, for the most part, considered to be a rather safe way to diversify your investment portfolio, a leveraged ETF does have a certain amount of risk involved. On the other hand, we all know that greater risk equals the potential for greater gain. Before making a decision on whether or not a leveraged ETF is a sound addition to your personal investment portfolio it would be good to understand how they work along with the potential for greater profits as well as greater risks.

Broad Understanding of a Leveraged ETF

A leveraged ETF is considered to be an innovative variation of a traditional ETF because it does not simply try to emulate the performance of a specific segment of the market. This is one type of ETF that is actually designed to try to outperform the index of the underlying investment product/s they are tracking. For example, a conventional ETF simply wants to emulate the return of the underlying commodity or index it is tracking. A leveraged ETF, on the other hand, wants to provide returns two or three times that of the index/commodity it is tracking.

Inverse Leveraged ETF

One of the other innovations in a leveraged ETF is that you can also get something known as an ‘inverse leveraged ETF’ that can provide a positive return if the index doesn’t increase but declines instead. The difference between an inverse leveraged ETF and a conventional inverse ETF is that they are aimed at providing multiple returns (on products in the ETF portfolio).

Features of a Leveraged ETF
Not only does a leveraged ETF contain securities within the index it is emulating but it also includes derivatives of those securities as well as the index itself. Some of the types of derivatives involved would be forward contracts, options, futures and swaps. However, those derivatives are not all inclusive as there are others as well. However, in all cases, the leveraged ETF is designed in such a way that the return on the underlying index is a multiple such as 2x or 3x the amount. (At the moment those are the most popular returns.)

Why Leveraged ETFs are Controversial

While a leveraged ETF is controversial, there really isn’t any one good answer as to why this is so. First of all, although the double or triple rate of return sounds easy, it is a bit more complicated that you might think. Also, because this investment product is relatively new, it is forecast to evolve and change over time which just adds to the controversy and of course, the public’s distrust in anything that is a state of flux. This is all the more true of investment products. However, one of the most significant controversial factors is that just as a leveraged EFT can return multiple gains it can just as easily return multiple losses based on what happens with the underlying index.

One thing to keep in mind when considering a leveraged ETF is the fact that there may be greater risk, but on the flip side there is greater potential for increased profits. An ETF is not always easy to understand, but a leveraged ETF is doubly or triply so. As a result, many financial advisors suggest that you get your feet wet with a traditional ETF before venturing into the world of leveraged ETFs.

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