The Last Word: Risky Business With ETFs

With inverse and leveraged ETFs, you should really know what you’re doing.

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Reviewed by: Heather Bell
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Edited by: Heather Bell

[This article appears in our February 2021 issue of ETF Report.]

 

Inverse and leveraged ETFs have been the perceived bogeyman lurking in the ETF universe for a long time. But they really don’t deserve that reputation. Time after time, they do what they’re designed to do. It’s the investor that’s behind the undoing.

There are plenty of warning signs for the uninitiated. The trading platforms that do allow you to trade them generally have plenty of alerts that pop up letting you know what you’re getting into when you try to make a trade in this type of product—sort of like a roller-coaster warning, which is what it can be.

Investors Who Enjoy Investing
I’m not the target audience for these products. I’m perfectly content with my plodding retirement portfolio that holds boring index funds that simply track the market. I have neither the attention span nor the desire to do the work geared ETFs require to increase the likelihood of a positive outcome. If I look at my 401(k) more than once a quarter, I feel like I’ve gone above and beyond when it comes to “adulting.”

I may simply be a buy-and-hold investor because I’m lazy. And you absolutely cannot be a lazy investor if you’re going to add these products to your portfolio. That’s like putting on a blindfold and going for a drive in the mountains. It’s just not going to end well.

These are products for traders—and to an extent, confident, disciplined and engaged investors—with specific goals and plans. These products are almost like a job unto themselves, requiring daily attention to the markets and the forces that move them. On top of that is the daily reset math one must understand before investing in them.

Accepting Risk
Certainly, they’re higher risk than a good chunk of the ETF universe—but that risk is limited to how much money you invest.

With a leveraged or inverse ETF, you’re not going to lose more than your initial investment like you could by, say, shorting a stock or employing margin.

Two things seem to be key when driving the leveraged/inverse route:

1) know (and respect) your risk tolerance; and 2) know when to bail out.

If you accept the reality that you could lose a significant portion of your investment, the next step is to know exactly when you want to get out of the market. When the ETF hits either your pain point or your end goal, exit your position. And for heaven’s sake, pay attention! Certainly, “if you snooze, you will lose” with these products.

Once you’re out of the fund, if you believe in the product’s goals and like the opportunities it offers, you can just wait for another reentry point. The leveraged and inverse tides change rapidly.

In the end—beyond understanding simply how leveraged and inverse ETFs work—it’s all about being disciplined enough to stick to the parameters you set for yourself in advance, and stay on top of the information that’ll come your way about the markets you’ve sought exposure to. Above all, know what you can bear to lose long before you buy the product, and stick to that limit.

Heather Bell is a former managing editor of etf.com. She has also held editorial positions at Dow Jones Indexes and Lehman Brothers. Bell is a graduate of Dartmouth college and resides in the Denver area with her two dogs.