{"id":18756,"date":"2011-01-27T08:18:38","date_gmt":"2011-01-27T13:18:38","guid":{"rendered":"http:\/\/countingpips.com\/fx\/?p=18756"},"modified":"2011-01-27T08:18:38","modified_gmt":"2011-01-27T13:18:38","slug":"the-truth-about-leveraged-etfs","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2011\/01\/27\/the-truth-about-leveraged-etfs\/","title":{"rendered":"The Truth About ‘Leveraged ETFs’"},"content":{"rendered":"

By Jared Levy, Editor, Smart Investing Daily, taipanpublishinggroup.com<\/strong><\/span><\/a><\/p>\n

Back in early October, after a visit to the Texas State Fair, I wrote about inflation and the global food “problem”<\/a> and how you can take advantage. Every stock I mentioned in the report has seen substantial runs since then.<\/p>\n

Keeping all of our greed under control, Sara recently detailed why commodities and the agri-stocks<\/a> climbing with them needed a nap, and why maybe it was time to take profits.<\/p>\n

What does this have to do with leveraged ETFs, you might be asking? Well, I thought I would use food as an intro, because it offers a great analogy for my views on leveraged ETFs (OK, and maybe I wanted to remind you how Smart Investing Daily<\/em> keeps you ahead of the curve).<\/p>\n

Both gluttony and greed are two of the “seven deadly sins,” but with food especially, some of us tend to eat more than we need to and with that, the very thing<\/strong> that brings us life and energy can also cause<\/strong> illness disease and death (in severe cases). I bring up these morbid reminders, not to scare you out of satisfying your hunger for food, but to remind (or inform) you that some investment vehicles (leveraged ETFs) might be just as unhealthy and perhaps even dangerous for your portfolio, forcing you to “eat” fees and expose yourself to risks you may not even be aware of. Too much of something is not always a good thing.<\/p>\n

Leverage<\/h3>\n

According to Wikipedia, “leverage is a general term for any technique to multiply gains and losses.” You can attain leverage by borrowing money, purchasing fixed assets or using derivatives like options or futures. Basically, you can think of it as using a lesser amount of money to buy (or sell) a larger amount of something like a stock or other investments.<\/p>\n

Leverage can be a good thing of course; many of us use our credit as a source of leverage, so we can purchase high-ticket items now that we feel may rise in value (take your home, for instance).<\/p>\n

You also use leverage when you purchase a stock on margin from your broker.<\/p>\n

There is no such thing as a free lunch; for that leverage we have to pay fees, costs, interest, etc. (These are called carrying costs.) Hopefully the amount that we are paying in carrying costs is less than the appreciation or income we are receiving from the asset we have leveraged.<\/p>\n

If we take on too much leverage and the asset doesn’t appreciate or even worse, decreases in value, you will still have to digest tons of carrying costs. You will have to “consume” those costs with nothing to show for it, except for maybe heartburn, caused now by stress.<\/p>\n

Greed and Leveraged ETFs<\/h3>\n

Leveraged ETFs like Direxion<\/strong> Daily Financial Bull 3X Shares (FAS:NYSE<\/a>)<\/strong>, Direxion<\/strong> Daily Financial Bear 3X Shares (FAZ:NYSE<\/a>)<\/strong>, Direxion<\/strong> Daily Gold Miners Bear (DUST:NYSE<\/a>)<\/strong>, Direxion<\/strong> Daily Real Estate Bull 3X Shares (DRN:NYSE<\/a>) <\/strong>and many others have become extremely popular; they enable you to maybe make $2 or $3, even when a stock or index were to only move $1 (of course you would lose $2 or $3 for a $1 move in the opposite direction). There are even ETFs that move opposite to the way the underlying stock or index is moving. So if the stock is UP $1, the ETF would be DOWN $1 or $2 or $3, depending on what type of leverage they are using (talk about confusing).<\/p>\n

For that leverage, ETFs charge you a fee — more on that in a second.<\/p>\n

Leveraged ETFs are not evil; if you know exactly what you are doing, how they work and how to invest in them, you can profit. The reality though is that the “leveraged” part appeals to the greedy side of most retail investors, who have minimal knowledge of the way they work and end up losing money because they didn’t do their homework.<\/p>\n

(Investing doesn’t have to be complicated. Sign up for Smart Investing Daily and let me and my fellow editor Sara Nunnally simplify the stock market for you with our easy-to-understand investment articles<\/a>.)<\/em><\/p>\n

The Mechanics of Leveraged ETFs<\/h3>\n

Leveraged ETFs were specifically created for professionals and short-term traders and most have nuances you must understand before investing even $1 into them.<\/p>\n

Here is an example, using the Direxion Daily Financial Bull 3X Shares<\/a> (FAS:NYSE)<\/strong>, which is a very popular leveraged ETF. <\/em><\/p>\n

The FAS is purported to return 3X (300%) the movement of the financial sector index on a daily basis, which it can do so, but not all the time and not if held for a duration longer than a day (yes, a day).<\/p>\n

Here are some nuances of the FAS:<\/p>\n