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What is a Leveraged ETF?

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  • Written By: A. Leverkuhn
  • Edited By: Andrew Jones
  • Last Modified Date: 28 August 2016
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A leveraged ETF is a kind of exchange traded fund (ETF) that provides a specific kind of return based on stock market activity. Exchange traded funds are a new way for investors to get involved in more diversified trading through a single financial product. When these items are “leveraged” they will reflect fewer losses than gains.

What happens with an exchange traded fund is that various different equities are bundled into one easily trackable product and price. Traders can follow this price with online brokerage accounts and trade throughout the day. The ETF allows a single investor to get involved in more various kinds of investments.

A leveraged ETF takes advantage of the financial process commonly called “leveraging.” Some experts describe the leveraged ETF as “amplifying” the price fluctuations of the underlying equities. Lots of leveraged ETFs track an index, which means their losses and gains are tied to the price of the index. When an index ETF is leveraged, derivatives and other financial instruments are used to “bulk up” the investment and the eventual price. Some professionals explain it as a “matching” fund where surface investor dollars are matched with additional debt equity or other value.

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The result of the leveraged ETF is that it performs at a leverage ratio. Suppose the ratio is 3:1. That means that a $1 increase in the index or equities would produce a $3 increase in the leveraged ETF. The same goes for a loss in value.

It’s important to note that not all of the theoretical loss and gain of the leveraged ETF will necessarily go into the investor’s net yield. With all kinds of investments, the person who invests money has to look at what he or she will realistically get back, a “return on investment.” What usually interferes with the final return is in the form of broker’s fees, administrative costs and “expense ratios,” where the broker or trading firm will charge for the opportunity to invest. Other subtractions from a gross yield are related to the investor’s annual tax return. Leveraged ETF and other investment yields are most often taxed as capital gains.

Some investors who follow the stock market will enjoy using the leveraged ETF to invest in or track an index. Online account options make ETFs some of the easiest tools to use to “get into” a specific index or market. From blue chips to penny stocks, these investment tools can add function to a portfolio.

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