Issue #11: The Biggest Mistake Investors Make with Leveraged ETFs
Leveraged ETFs may look like profit machines, but their hidden risks could drain your portfolio faster than you think.
Reading time: 2 minutes
Hey!
I’ve noticed a significant drop in engagement on the daily uploads (traction has dropped 3x on days other than Thursday.
To ensure quality and consistency, I’ll return to the original weekly schedule, with uploads every Thursday, and will keep the new short format, as some of you told me you liked it more.
Thank you for your understanding and continued support!
What Are Leveraged ETFs?
An ETF (Exchange-Traded Fund) tracks the performance of an index, sector, or asset and trades like a stock on exchanges.
A leveraged ETF, however, amplifies the returns of its underlying index—typically by 2x or 3x.
For example:
A 2x leveraged ETF seeks to deliver twice the daily performance of its underlying asset. If the index rises by 1%, the ETF targets a 2% gain.
On the other hand, if the index falls by 1%, the ETF aims for a 2% loss.
But leveraged ETFs come with an important nuance that many overlook: volatility drag.
How Volatility Drag Works
Volatility drag occurs because leveraged ETFs compound returns daily. In a trending market (up or down), compounding can amplify gains or losses. But in a choppy market with frequent reversals, it eats away at returns, even if the underlying index moves sideways or ends flat.
Here’s an example to make it clearer:
Imagine an index starts at $100 and alternates between gaining and losing 10% daily over four days:
Day 1: $100 × 1.10 = $110
Day 2: $110 × 0.90 = $99
Day 3: $99 × 1.10 = $108.90
Day 4: $108.90 × 0.90 = $98.01
After four days, the index falls from $100 to $98.01, a total loss of -1.99%.
The 2x leveraged ETF doubles the daily moves of the index:
Day 1: $100 × 1.20 = $120
Day 2: $120 × 0.80 = $96
Day 3: $96 × 1.20 = $115.20
Day 4: $115.20 × 0.80 = $92.16
After four days, the ETF falls from $100 to $92.16, a total loss of -7.84%, far greater than the index’s loss of -1.99%.
Why It Matters
The rule of thumb with leveraged ETFs is to hold them for short-term periods—days, rarely weeks, or at most a few months. The longer you hold and the higher the volatility, the greater the drag on returns.
Timing is everything when buying leveraged ETFs. They are high-risk, high-reward tools designed for short-term strategies in trending (important!!!) markets.
I’ll make sure to write in the future about how to time your entry, whether it’s for a stock, crypto, ETF, or anything else.
Thank you for taking the time to read! I hope this knowledge will protect and even amplify your investments. See you next Thursday!