What Does Leveraged ETF Mean?
An exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index. Leveraged ETFs are available for most indexes, such as the NASDAQ-100 and the Dow Jones Industrial Average. These funds aim to keep a constant amount of leverage during the investment time frame, such as a 2:1 or 3:1 ratio.
A leveraged ETF does not amplify the annual returns of an index; instead it follows the daily changes. For example, let's examine a leveraged fund with a 2:1 ratio. This means that each dollar of investor capital used is matched with an additional dollar of invested debt. If one day the underlying index returns 1%, the fund will theoretically return 2%. The 2% return is theoretical, as management fees and transaction costs diminish the full effects of leverage.
The 2:1 ratio works in the opposite direction as well. If the index drops 1%, your loss would then be 2%.