An ETF is similar to mutual funds and consists of multiple combined investment securities. Instead of a single investment, investors are investing in a “box” or assortment of multiple securities, either a specific type or a variety.
These funds track a specific index, commodity, industry sector (such as tech or energy), or other assets, and are also bought and sold like stocks in an exchange. They also offer investors diversity when purchasing stocks, as well as lower commissions and expense ratios than buying each stock separately.
An ETF’s price fluctuates during the day as it’s bought and sold. It can be managed actively or based on an index. ETFs can be structured to track specific investment strategies, a particular commodity, or a wide variety of securities. Investing in EFTs can offer advantages such as offsetting or hedging risk in a portfolio.
Leveraged ETFs
In a standard ETF, if its tracking index (such as the S&P 500) moves by 1%, the ETF itself will also move by 1%. But a leveraged ETF using the S&P uses debt and other financial products to increase that move to 2% or 3%.
While a higher increase can mean higher returns, a move in the other direction can lead to bigger losses. Additionally, the fees for transactions and management of leveraged ETFs can diminish returns even more.
Inverse ETF
Also known as “short funds,” inverse ETFs earn returns on markets that are trending downward.
Additional ETF Risks
While no investments are risk-free, inverse and leveraged ETFs carry more risk than a traditional ETF. Because ETFs are “reset” every day, meaning that their performance longer-term isn’t the same as daily. This is amplified in a volatile marketplace, and investors can be exposed to considerable losses.
Single-stock ETFs are based on a single stock rather than a variety, meaning that everything is predicated on the success or failure of the one stock.
Leveraged and inverse ETFs that invest in Bitcoin futures also include a higher element of risk because of the speculative nature of Bitcoin and cryptocurrency in general. The nature of these ETFs increases the impact of unstable price changes inherent in Bitcoin futures at the base.
Before Investing In ETFs
As with any potential investment, due diligence should be first. You should thoroughly understand the ETF, what it includes, and how it works. Consult with an investment professional who understands ETFs and understands how including an ETF in your portfolio would fit in with your investment objectives.
You also ask questions such as:
- What costs are involved?
- Are there tax implications?
- How would the ETF fit into my risk tolerance and investment objectives?
- What if you hold onto this ETF longer than one day?
- Is it possible that the ETF would not meet its stated daily objective? How would this impact my portfolio?
It’s important to have a complete understanding of how the investment works prior to participating.
Did You Invest In Leveraged and Inverse ETFs?
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