Considering leveraged or inverse ETFs? Ask these questions
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As part of a recent warning to retail investors, the Financial Industry Regulatory Authority (FINRA) and SEC included a list of questions to consider before investing in leveraged or inverse ETFs:
How does the ETF achieve its stated objectives? And what are the risks?
Ask about—and be sure you understand—the techniques the ETF uses to
achieve its goals. For example, engaging in short sales and using
swaps, futures contracts, and other derivatives can expose the ETF—and
by extension ETF investors—to a host of risks.
What happens if I hold longer than one trading day?
While there may be trading and hedging strategies that justify holding
these investments longer than a day, buy-and-hold investors with an
intermediate or long-term time horizon should carefully consider
whether these ETFs are appropriate for their portfolio. As discussed
above, because leveraged and inverse ETFs reset each day, their
performance can quickly diverge from the performance of the underlying
index or benchmark. In other words, it is possible that you could
suffer significant losses even if the long-term performance of the
index showed a gain.
Is there a risk that an ETF will not meet its stated daily objective?
There is always a risk that not every leveraged or inverse ETF will
meet its stated objective on any given trading day. Be sure you
understand the impact an investment in the ETF could have on the
performance of your portfolio, taking into consideration your goals and
your tolerance for risk.
What are the costs? Leveraged or inverse ETFs may be more costly than traditional ETFs. Use FINRA’s Fund Analyzer to estimate the impact of fees and expenses on your investment. The SEC’s Mutual Fund Cost Calculator can also help you estimate and compare costs of owning mutual funds.
What are the tax consequences?
Leveraged or inverse ETFs may be less tax-efficient than traditional
ETFs, in part because daily resets can cause the ETF to realize
significant short-term capital gains that may not be offset by a loss.
Be sure to check with your tax advisor about the consequences of
investing in a leveraged or inverse ETF.
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