Since leveraged exchange traded funds (ETFs), were introduced to the financial world, they have rapidly increased in popularity because of their many benefits.

However, trading in leveraged ETFs also comes with its own disadvantages. Therefore, if you want to trade these financial instruments profitably, you need to familiarize yourself with their pros and cons.

Advantages

• Offer an easy way to benefit from leverage

Leveraged ETFs are different from a majority of other ETFs because they use the concept of borrowing to multiply the amount you can use for trading in the market. As such, they provide a simple and inexpensive technique of utilizing leverage without using options or margin.

• An excellent way to earn short-term profits

Leveraged ETFs are speculative short-term investment products that endeavor to double or triple the daily return of a particular index. If you are a short-term trader, they could be your best investment tool.

• Diversification

Just like other ETFs, leveraged funds provide you with exposure to various equities and market segments. With these funds, you will be able to trade oil, precious metals, commodities, forex, and many any other financial assets.

• Lower management expense ratio

Leveraged ETFs have lower managed expense ratio as compared to most mutual funds. You will incur up to 3% of the fund’s assets when investing in managed mutual funds. However, with leveraged ETFs, the expense ratio is about 1.15%.

• Great tool for lowering portfolio volatility

If you are an experienced investor, you may employ leveraged ETFs to lower your portfolio volatility and probability of experiencing losses. This technique is very great, especially if you use short selling .

Disadvantages

• Your losses are amplified

Just like any other leveraged investment, your profits are amplified – but so are your losses if the market fails to behave according to your expectations. If the leveraged fund intends to double or triple your investments, and the index take a different direction, your losses will be doubled or tripled.

For instance, if the aim of the leveraged ETF is multiply the return of the index three times, and the index unfortunately plummets by 5%, the share value of the ETF will decrease by 15%.

• You may incur more losses in the long term

If you want to hold your investments for longer than a day, you will incur losses. You will not take home 2 or 3 times, or minus 2 or 3 times the return of the underlying instrument. This will take place because the leveraged ETFs rebalance or ‘releverage’ each day to ensure the amounts borrowed tally with the actual stock owned, which makes you to lose money.

• Low liquidity

Most leveraged ETFs are not actively traded in the markets. They usually trade a few thousand shares each day. As a result, their liquidity is generally low.

Conclusion

Investing in leveraged ETFs provide enormous potential for getting huge returns. However, you need to adopt the correct strategy and carry out due diligence if you want to maximize your returns.