• Skip to main content
  • Skip to secondary menu
  • Skip to primary sidebar
  • Skip to footer

Optimized Portfolio

Investing and Personal Finance

blank space placeholder
  • Beginners Start Here
  • Investing 101
    • Beginners Start Here – 9 Steps to Start Building Wealth
    • What Is the Stock Market? How It Works & How to Invest in It
    • How To Invest in an Index Fund – The Best Index Funds of 2020
    • Portfolio Asset Allocation by Age
    • How to Invest in the S&P 500 Index – 3 of the Best ETFs
    • Why and How To Buy Bonds Online: A Guide for Beginners
    • How To Invest Your Emergency Fund
    • 8 Reasons Why I’m Not a Dividend Income Investor
    • How to Invest Your HSA (Health Savings Account)
  • Lazy Portfolios
    • 60/40 Portfolio
    • All Weather Portfolio
    • Bogleheads 3 Fund Portfolio
    • Couch Potato Portfolio
    • Golden Butterfly Portfolio
    • HEDGEFUNDIE’s Excellent Adventure
    • Permanent Portfolio
    • Warren Buffett Portfolio
    • more…
  • Brokerage Reviews
    • The 5 Best Stock Brokers
    • The 4 Best Investing Apps
    • M1 Finance Review
    • M1 Finance vs. Fidelity
    • M1 Finance vs. Vanguard
    • Stash vs. Robinhood
    • Investing Brokers with the Lowest Margin Rates
    • M1 Borrow Review (How M1’s Margin Loan Works)
  • ETFs
    • VIG vs. VYM – Comparing Vanguard’s 2 Popular Dividend ETF’s
    • The 11 Best Dividend ETFs
    • The 7 Best Small Cap Value ETFs
    • The 5 Best REIT ETFs
    • The 5 Best Tech ETFs
    • The 6 Best ETFs for Taxable Accounts
    • The Best Vanguard Bond Funds – 11 Popular ETFs
    • The Best Vanguard Dividend Funds – 4 Popular ETFs
    • The Best Vanguard Growth Funds – 5 Popular ETFs
    • The 7 Best International ETFs
  • Leverage
    • What Is a Leveraged ETF and How Do They Work?
    • How To Beat the Market Using Leverage and Index Investing
    • The 9 Best Leveraged ETFs
    • Hedgefundie’s Excellent Adventure
    • Leveraged All Weather Portfolio
    • Leveraged Permanent Portfolio
    • Leveraged Golden Butterfly Portfolio
  • Dividends
    • The Best M1 Finance Dividend Pie
    • The 11 Best Dividend ETFs
    • The Best Vanguard Dividend Funds – 4 Popular ETFs
    • VIG vs. VYM – Comparing Vanguard’s 2 Popular Dividend ETF’s
    • 8 Reasons Why I’m Not a Dividend Income Investor
  • Bonds
    • How To Buy Bonds Online: The Ultimate Guide
    • Treasury Bonds vs. Corporate Bonds
    • The Best Vanguard Bond Funds – 11 Popular ETFs
    • The Best Bond Funds Out There – 13 ETFs
    • The 11 Best Treasury Bond ETFs
    • The 5 Best High Yield Bond Funds for Income
    • The 3 Best Corporate Bond ETFs
    • The 3 Best Municipal Bond ETFs
    • The 3 Best TIPS ETFs

What Is a Leveraged ETF and How Do They Work?

Last Updated: December 21, 2020 No Comments – 4 min. read

Financially reviewed by Patrick Flood, CFA.

Leveraged ETFs allow investors to increase exposure without additional capital outlays. Below we’ll explore what leveraged ETFs are, how they work, and why you might want to use them.

Prefer video? Watch it here.

Disclosure:  Some of the links on this page are referral links. At no additional cost to you, if you choose to make a purchase or sign up for a service after clicking through those links, I may receive a small commission. This allows me to continue producing high-quality, ad-free content on this site and pays for the occasional cup of coffee. I have first-hand experience with every product or service I recommend, and I recommend them because I genuinely believe they are useful, not because of the commission I get if you decide to purchase through my links. Read more here.

Contents

  • What Is a Leveraged ETF?
  • How Do Leveraged ETFs Work?
  • Conclusion – How To Use Leveraged ETFs

What Is a Leveraged ETF?

A leveraged ETF, as the name suggests, is an ETF (exchange-traded fund) that allows investors to utilize leverage in their portfolio. Leverage simply refers to increasing investment exposure without additional capital outlays. Thus, leveraged ETFs allow you to use leverage without taking on margin, and at degrees greater than what a margin loan would allow.

For example, a 2x leveraged ETF that tracks the S&P 500 seeks to provide 200% of the daily return of the underlying index. That is, if the index increases in value by 5%, the 2x leveraged ETF should increase by 10%. For a 2x leveraged ETF, “2x” and “200%” and “2:1” all refer to the same thing: the leverage ratio. It’s not all upside, though. Similarly, if the index falls by 5%, the leveraged ETF falls by 10%. As such, leveraged ETFs provide the potential for greater returns but also the potential for greater losses.

There are leveraged ETFs of many different leverage ratios available for many different indexes, e.g. 2x the S&P 500, 3x the NASDAQ-100, etc.

Now that you know what a leveraged ETF is, let’s explore how leveraged ETFs work.

How Do Leveraged ETFs Work?

Leveraged ETFs utilize debt and swaps to attempt to deliver their stated price movement. This borrowing increases transaction costs and management fees of leveraged ETFs. Their expense ratios are usually considerably higher than those of “normal,” unleveraged ETFs. Still, leveraged ETFs are still usually a cheaper form of applying leverage than margin, a collateralized loan from your investment broker. Leveraged ETFs also allow investors to maintain a constant leverage ratio and to avoid margin calls.

Leveraged ETFs are popular among day-traders aiming to capitalize on momentum or earnings announcements. There are also inverse leveraged ETFs (-2x and -3x), allowing traders to profit from bear markets, providing what’s called a short position. Because of their complex nature involving swaps, debt, and daily rebalancing, leveraged ETFs are likely only appropriate for experienced investors with a high risk tolerance.

Also note that the daily resetting of leveraged ETFs means the fund only provides the stated percentage return relative to the underlying index on a daily basis, not necessarily over the long term. Because of this, volatility of the index can eat away at gains; this is known as volatility decay or beta slippage.

Volatility decay is the boogeyman cited ad nauseam by financial bloggers and analysts as the reason that leveraged ETFs are inarguably unsuitable for holding as long-term investments. And while it’s definitely important to understand the potential pitfalls of leverage and the nature of the evil-sounding “volatility decay,” this intrinsic compounding also works in the opposite direction. If the underlying index moves up consistently with decent momentum, volatility decay actually works in your favor. This is why UPRO, the 3x leveraged S&P 500 ETF, has delivered close to 5x the returns of the index since its inception instead of the proposed 3x.

If you’re curious to see the math, I would encourage you to check out this page. It’s also actually been proposed that investors should not only diversify across assets but also across time, employing leverage early in one’s investing horizon to reduce risk near retirement. I myself utilize long-term leverage in my own portfolio with funds like NTSX (1.5x 60/40), UPRO (3x S&P 500), and TMF (3x long-term treasury bonds).

Now that you know how leveraged ETFs work, let’s look at how one might use them in an investment portfolio.

Conclusion – How To Use Leveraged ETFs

Liquidity is an important factor when choosing leveraged ETFs, as low-volume leveraged ETFs are often at risk of closure, and most investors don’t hold them long-term.

Again, leveraged ETFs can be used for swing trading, trend following, earnings announcements, or possibly long-term holding if you’re so inclined. They may even allow you to beat the market. To see some long-term leveraged ETF strategies in action, check out the Hedgefundie strategy and my designs of a leveraged All Weather Portfolio and leveraged Permanent Portfolio.

I reviewed some of the best leveraged ETFs here.

Thankfully, buying a leveraged ETF is as simple as placing a buy order like with any other security. Most leveraged ETFs are available at M1 Finance. M1 is an ideal choice of broker to use leveraged ETFs because they feature dynamic rebalancing of new deposits and one-click manual rebalancing. These features are extremely useful, as the volatile movement of leveraged ETFs means they can quickly stray from their target allocations. The broker also has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, and a sleek, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.

Be sure to read up on the potential pitfalls of using leverage before blindly buying in. Again, leveraged ETFs are better suited for experienced investors. Remember that using leverage – especially in the form of leveraged ETFs – increases portfolio risk and the potential for greater returns, but also the potential for greater losses. Do your own due diligence and read the fine print on these products.

Do you employ leveraged ETFs in your portfolio? Let me know in the comments.


Disclosures:  I am long NTSX, UPRO, and TMF.

Interested in more Lazy Portfolios? See the full list here.

Disclaimer:  While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.

m1 finance get started

Related Posts

  • 8 Reasons Why I’m Not a Dividend Income Investor
  • Ray Dalio All Weather Portfolio Review, ETF’s, & Leverage
  • How to Invest Your HSA (Health Savings Account)
  • Riding the HEDGEFUNDIE Adventure (UPRO/TMF) on M1 Finance
  • Golden Butterfly Portfolio Review and M1 Finance ETF Pie

About John Williamson

Analytical and entrepreneurial-minded data nerd, usability enthusiast, Boglehead, and Oxford comma advocate. I lead the Paid Search marketing efforts at Gild Group. I'm not a big fan of social media, but you can find me on LinkedIn and Reddit.

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

Most Popular

Ray Dalio All Weather Portfolio Review, ETF’s, & Leverage

Riding the HEDGEFUNDIE Adventure (UPRO/TMF) on M1 Finance

Golden Butterfly Portfolio Review and M1 Finance ETF Pie

Harry Browne Permanent Portfolio Review, ETFs, & Leverage

Treasury Bonds vs. Corporate Bonds – The Showdown

VIG vs. VYM – Comparing Vanguard’s 2 Popular Dividend ETFs

The 60/40 Portfolio Review and ETF Pie for M1 Finance

Bogleheads 3 Fund Portfolio Review and Vanguard ETFs To Use

The Best M1 Finance Dividend Pie for FIRE & Income Investors

Portfolio Asset Allocation by Age – Beginners to Retirees

The 5 Best Stock Brokers Online for Investing (2021 Review)

The 4 Best Investing Apps for Beginners (2021 Review)

The 7 Best Small Cap Value ETFs (3 From Vanguard)

m1 sidebar

Footer

  • Email
  • Facebook
  • Instagram
  • LinkedIn
  • Pinterest
  • RSS
  • Twitter
  • YouTube
  • Reddit

Amazon Affiliate Disclosure

OptimizedPortfolio.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

Email Newsletter

Sign up to receive email updates when a new post is published.

Don't worry, I hate spam too. No ads.

Copyright © 2021 OptimizedPortfolio.com


About - Privacy - Terms - Contact

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Ok, Got ItReject Read More
Privacy & Cookies Policy

Privacy Overview

This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
Necessary
Always Enabled

Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.

Non-necessary

Any cookies that may not be particularly necessary for the website to function and is used specifically to collect user personal data via analytics, ads, other embedded contents are termed as non-necessary cookies. It is mandatory to procure user consent prior to running these cookies on your website.