What are leveraged ETFs and how do they amplify your gains and losses?
The rise in exchange-traded funds (ELIF: What are ETFs?) created a steroid-induced version of itself — leveraged ETFs — which nearly doubled in assets since the start of 2020.
Leveraged ETFs are similar to ETFs except they amplify the gains and losses by 2-3x.
Example: The NASDAQ 100 index is a list of some of the largest non-financial companies — with a heavyweight towards global tech companies.
- An investment in the ETF, Invesco QQQ Trust (NASDAQ:QQQ) — replicating the return of the NASDAQ 100 — returned 210% in the past 5 years.
Lever TF up: Then there’s the ProShares UltraPro QQQ (NASDAQ:TQQQ) — which also replicates the NASDAQ 100’s return — except on steroids (3x the return). TQQQ is up 1,174% in the past 5 years.
But leverage works in both ways. During the market crash last year, the TQQQ fell by — you guessed it — nearly 3x as much. TQQQ fell nearly 70% while QQQ fell 27%.
Playing with leveraged ETFs is a risky game and they also charge investors higher fees than regular ETFs.
- Leveraged ETFs are still too new to truly understand how they’ll behave in different market scenarios.
- In theory, they could perform worse in periods of market volatility where the market trades sideways.
Direxion is one of the largest issuers of leveraged ETFs — offering ETFs that give investors exposure to different industries (i.e. biotech, financials, industrials, etc).