Leveraged ETF’s in the News – Wall Street Journal

I continue to be concerned about the use of leveraged ETF’s by retail clients. These complicated products offer the exact opposite return of an index multiplied by a factor of either 2 or 3, but this performance is only for one day. Basically, if the S&P drops 5%, an inverse ETF goes up 5%, a 2X Leveraged ETF goes up 10%, and a 3X Leveraged ETF goes up 15%. However, when these products are held beyond one day, their performance can be wildly different than what most investors would expect.

The leverage creates a characteristic that is called volatility drag. It is very similar to compounding and causes the longer term performance to be much higher or lower than the underlying index. These products have a place, but only the most knowledgeable active managers should use them. I’m not convinced that they reduce risk and believe, that for most investors, they dramatically increase portfolio risk!

Evidently, one major brokerage firm agrees. Here’s the article from the Wall Street Journal.

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