Swordfish Trading: Leveraged ETFs and Dollar-Cost Averaging In the Long-Term

Investors often turn to leverage as a way to improve their returns. Leverage can be utilized in a variety of ways. An options trader is leveraged to the move of an asset if they buy a call option. If shares soar, the value of the call option should increase much larger on a percentage basis.

Likewise, several ETFs have been created that employ leverage. Investors can simply buy those ETFs for a variety of investment strategies. This avoids the complication of continually trading.

However, leveraged ETFs are far from perfect. Because these funds need to use leverage, they are often dealing with options and futures contracts. Those can lose value over time. This can create a drag on returns.

That’s particularly challenging for investors who dollar-cost average into such funds. Adding consistent amounts to a fund on a regular basis is not a sound approach for leveraged ETFs.

Investors should generally avoid buying and holding a leveraged ETF. Instead, the smarter move is to use these ETFs as timing tools. And to expect to take quick gains before those turn into losses.

Currently, with markets and many assets near all-time highs, leverage appears to be working. When markets shift to a sideways or down trend, leverage will likely create a drag on returns.

Investors should look to use leverage only for short-term trading, and where possible for quick downside opportunities across various asset classes.

To review the full impact of using leverage, including leveraged ETFs, click here.