Why investors should apply caution while investing in leveraged and inverse ETFs? (Part 9 of 9)

Why investors should stay away from leveraged ETFs in times of volatility

Investors should stay away from leveraged ETFS in times of volatility

Every investment product caters well to a sector of the investor population and isn’t suitable for the rest. Likewise, leveraged ETFs are meant primarily for informed investors who can track the fund’s performance daily and read the market well.

As we discussed earlier in this series, leveraged ETFs do well in bull runs and post lower-than-expected multiple losses in a bearish market. However, it’s during times of heightened volatility that they can wreak havoc and result in heavy losses for investors. While stock market volatility has reduced recently, as you can see in the following chart, it may go up if any unforeseen catastrophic event occurs.

As leveraged ETFs focus on daily returns and not holding period returns, they’re not the best bet for long-term investors. Instead, they serve well for investors with short-term, typically one-day trading strategies.

As we at Market Realist advocate passive long-term investing without taking up leverage, as we explain in our realist principles. we don’t recommend leveraged ETFs for our readers.

Investors still looking to take on exposure to leveraged ETFs (SSO ) should apply caution and understand the product completely by reading the prospectus and looking for things like investment objectives, strategies, costs, and resetting frequency. As we say, don’t invest in securities you don’t understand .

If you decide to invest in leveraged ETFs, keep track of the underlying index daily. In the case of signs of increasing volatility in the underlying index, quickly get out of leveraged ETFs.

If you’re an informed investor and see a clear sign of a bearish market, inverse ETFs such as the Proshares Short S&P500 (SH ) can help you generate positive returns—even in a falling market. If you’re looking to take on leveraged exposure on a particular stock like Apple (AAPL ), you can buy futures and options. Trading in futures and options requires more expertise, and the downside is that investors can lose more than the invested amount (the premium paid) if the trade goes bad.

If you’re a retail investor looking for a diversified investment, investing in the SPDR S&P 500 ETF (SPY ) and Vanguard S&P 500 ETF (VOO ) can benefit you over the long term.