Leveraged ETFs are a bad idea. Period. (2024)

Leveraged ETFs are a bad idea. Period. (1)

Leveraged ETFs get quite a bit of positive attention in the press, but often there are important aspects that are overlooked. In this article we’ll discuss the sobering reality you need to know if you are looking to invest in such vehicles.

What is a leveraged ETF?

You’ve probably seen these phrases flash across the screen. As a financial advisor in Philadelphia, we have.

  • Leveraged ETF gold
  • Leveraged ETF S&P 500
  • Leveraged ETF Nasdaq

They’re a popular investment option, but how exactly does a leveraged ETF work?

A leveraged ETF holds a basket of positions purchased with a certain amount of margin, or a line of credit that the fund sponsor maintains with the broker dealer they trade through. Here’s a hypothetical example of how leveraged ETFs work.

A three times leveraged ETF, or Leveraged ETF 3x, holds positions on three times leverage. Exposure to the gains and losses of the underlying index are magnified by three times.

  • If the underlying Index of XYZ were to have an uptick of 3%, the ETF’s index exposure would increase by 9%
  • If the underlying Index of fund XYZ were to decrease by 3%, the ETF’s index exposure would decrease by 9%.

If you held underlying index XYZ directly and then levered it up three times directly with your broker dealer, the losses could potentially cause your position to fall below zero. In other words, you could potentially be liable for more than you invested because you bought the position on leverage.

But can a leveraged ETF go negative?


If you own a leveraged ETF you can’t lose more than your initial investment amount. You would never be liable for more than you invested; in a sense, the amount you could lose is capped. However, that doesn’t take away the very significant risks that do prevail, such as high volatility and tracking error, or failure to mirror the returns of the index you are purported to track.

Can spiral down at light speed

In our view, leveraged ETFs can be great when there is a bull market.

However, when positions are held with leverage, losses compound quickly. Remember that by the power of compounding, any loss requires more than the original extent of decline to return to be recouped.

For example, if you were to lose 20% on a $100 investment, you will have $80. The investment would have to come back by more than 20% to get you back to the $100 you originally had – in fact, you’d have to earn 25%. That’s why catastrophic losses aren’t that easy to come back from.

This concept is particularly problematic for a leveraged ETF’s daily rebalancing, which is commonly overlooked.

The harmful impact of daily rebalancing in a down market is often overlooked

Here’s how this works. A leveraged ETF rebalances daily to maintain the proper ratio of margin to assets. The effect this has on the overall instrument’s performance is very sobering.

What is a daily rebalancing (also called a “reset”)? It’s important to understand this if you are considering investing in these vehicles.

Here’s an example.

The following table illustrates the potentially harmful impact of compounding with leverage in a down market. Let’s say you invested in a 2x leveraged ETF with a starting price of $100 per share, and the index performed as such over the next four days.

The column on the left is the index; the column on the right is the ETF’s index exposure per share owned.

Leveraged ETFs are a bad idea. Period. (2)

Due to the fact that you compounded losses, you lost more than the 5% you would have lost if you held an unleveraged ETF that tracked the index 1 to 1. In fact, you lost more than double the 5% the index lost - due in part mostly to the effect of daily resets.

Here’s what happens behind the scenes in a situation like this, and why it drives up cost. Suppose this 2x leveraged ETF has $100MM in assets on one day when you bought in.

  • It has $100MM in assets and $200MM in index exposure at the beginning of the day.
  • The market goes down 5% one day.
  • It has $10MM in losses at the end of that day (assume no expenses)
  • It has $90MM in assets at the end of that day

Now here’s the thing. Because this is a 2x leveraged ETF, the fund needs to have $180MM in index exposure for tomorrow to maintain its leverage ratio of 2 to 1. Otherwise, it doesn’t track the index it said it would track. The fund has to reduce its index exposure. How does it get from $200MM to $180MM? It has to trade derivatives such as index futures and equity swaps, the cost of which is quite significant (we’ll get to that in #3!).

So the fund sponsor does that, and the market opens the next day.

  • The fund has $90MM in assets and $180MM in index exposure at the beginning of the day.
  • The market goes up 10.53% one day.
  • It has $18.95MM in gains at the end of that day (assume no expenses)
  • It has $108.95MM in assets at the end of that day

To maintain its 2:1 leverage ratio, the fund needs index exposure of $217.90MM, or $37.9MM more than what it started with the previous day. Again, the fund has to trade derivatives to gain this level of index exposure.

Which leads us to the third drawback of leveraged ETFS – they’re potentially very expensive.

Leveraged ETFs are expensive

One of the benefits of investing in ETFs is their low cost. However, leveraged ETFs tend to run on the expensive side of the ETF spectrum.

You aren’t paying for the margin as you would if you were to leverage up your portfolio yourself, but the fund sponsor certainly isn’t letting you get anything for free. You won’t have to pay margin interest or deposit more collateral – but there’s a price for the convenience of letting the ETF take care of that. Leveraged ETFs hold derivatives, and resetting them on a daily basis is costly. They must pay transaction costs and interests costs because they trade derivatives.

Compared to non-leveraged ETFs, these vehicles tend to be very expensive. High cost of investment erodes investor wealth over time which is why we advocate for investors to pursue low-cost investments and follow a long-term strategy.

Why you can do fine without them

For all of the reasons stated in this blog, we feel that leveraged ETFs aren’t what they are cracked up to be. The S&P 500 may be down 10% over a period of time but an investor in a short S&P 500 index won't be up 10% over that same period of time.

People often view Leveraged ETFs as an appealing way to increase return potential. We see this as an attempt to take a shortcut to wealth creation. They may be appropriate for a day trader, but they aren’t necessary for long term investors. We think they are a bad idea and the only viable use that we see making sense is to use them to hedge on a short-term basis.

The best way to grow your wealth over time is to craft an appropriate asset allocation and follow it for the long term. Proper assessment of your risk tolerance in accordance with your long-term goals must be attained.

We are a financial advisor in the Philadelphia area, but we work with clients across the country. We provide fee-only, objective advice to our clients. If you would like to discuss a possible relationship, contact us.


Yates, Tristan. (2021, Nov 16th). Investopedia. Dissecting Leveraged ETF Returns.

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Leveraged ETFs are a bad idea. Period. (2024)


Are leveraged ETFs a bad idea? ›

A leveraged ETF uses derivative contracts to magnify the daily gains of an index or benchmark. These funds can offer high returns, but they also come with high risk and expenses. Funds that offer 3x leverage are particularly risky because they require higher leverage to achieve their returns.

Why are the leveraged ETFs not an ideal long-term investment? ›

Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.

How long is too long to hold a leveraged ETF? ›

The daily rebalancing of leveraged and inverse ETFs creates a situation that for periods longer than a day or two the return of a leveraged or inverse ETF will deviate from the margin account benchmark.

What is the biggest risk associated with leveraged ETFs? ›

The two major risks associated with leveraged ETFs are decay and high volatility. High volatility translates to high risk. Decay emanates from holding the ETFs for long periods.

What is bad about leverage? ›

However, leverage can also pose some risks and other financial disadvantages, including: Increased financial risk resulting from the cash flow that will be required to service the debt. This additional pressure on cash flow can lead to an increased risk of insolvency and bankruptcy during a downturn.

Are concerns about leveraged ETFs overblown? ›

By some estimates, returns generate up to 74% less rebalancing by leveraged and inverse ETFs once capital flows are taken into account. As a consequence, the potential for these types of products to exacerbate volatility should be much lower than many claim.

Why do leveraged ETFs lose value? ›

Even if the index rises, if the volatility within the year is too high, holding a leveraged ETF can still result in a loss. From the graph, we can see that assuming the index has an annualized return of 0, if the index's volatility is 10%, then the leveraged ETF loses 3%.

Can you lose more money than you invested in a leveraged ETF? ›

In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.

Why is leveraged ETF for short-term? ›

Leveraged ETFs are often used by short-term traders to maximise returns. For example, consider a trader who expects the price of gold to increase over the course of the trading day – exposure to leverage means they can generate higher returns if they are correct.

Can 2x leveraged ETF go to zero? ›

Because they rebalance daily, leveraged ETFs usually never lose all of their value. They can, however, fall toward zero over time. If a leveraged ETF approaches zero, its manager typically liquidates its assets and pays out all remaining holders in cash.

Do leveraged ETFs reset daily? ›

Most leveraged and inverse ETFs reset each day, which means they are designed to achieve their stated objective on a daily basis. With the effects of compounding, over longer timeframes the results can differ significantly from their objective.

What is the most volatile 3X ETF? ›

The Direxion Daily Junior Gold Miners Index Bull 3x Shares (JNUG) and the Direxion Daily Junior Gold Miners Index Bear 3x Shares (JDST) are the two most volatile exchange-traded funds of all. Each has a one-year volatility reading of about 170.

What is the most famous leveraged ETF? ›

For these traders, there are more than 170 leveraged funds in the space targeting different asset classes. ProShares UltraPro QQQ is the most popular and liquid ETF in the leveraged space, with AUM of $21.9 billion and an average daily volume of 67.3 million shares a day.

Why doesn't everyone buy leveraged ETFs? ›

These products were built for traders - not investors. They match the daily return of the underlying index and multiply that. As such, over time, the returns start to get very skewed. The longer you hold onto these leveraged ETF products, the bigger the disparity in returns you'll see (and it's not in your favor).

Can an ETF go to zero? ›

Yes, an inverse ETF can reach zero, particularly over long periods. Market volatility, compounding effects, and fund management concerns can exacerbate losses. To successfully manage possible risks, investors should be aware of the short-term nature of these securities and carefully monitor their holdings.

Can I lose all my money with leveraged ETFs? ›

Leveraged ETFs amplify daily returns and can help traders generate outsized returns and hedge against potential losses. A leveraged ETF's amplified daily returns can trigger steep losses in short periods of time, and a leveraged ETF can lose most or all of its value.

Can you go negative on leveraged ETFs? ›

Yes, leveraged ETFs can go negative in value. However, it's essential to understand the mechanisms behind leveraged ETFs and how they can lead to negative returns. Leveraged ETFs aim to deliver a multiple (2x or 3x) of the daily returns of an underlying index or benchmark.

Can you make money with leveraged ETFs? ›

Leveraged ETFs are exchange-traded funds that use derivatives and debt instruments to magnify the returns of a benchmark or index. Leveraged ETFs can generate returns very quickly, but they are also very risky.

How risky is leverage investing? ›

If investment returns can be amplified using leverage, so too can losses. Using leverage can result in much higher downside risk, sometimes resulting in losses greater than your initial capital investment.

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