Sitting atop this year’s performance gainers are leveraged ETFs. These are funds that use a combination of debt and derivatives to magnify their performance. Are leveraged ETFs right for you?
Before tackling this question, let’s examine key trends within this arena.
Among this year’s best ETFs are funds concentrated in semiconductors (SOXL), homebuilders (NAIL), and Chinese internet stocks (CWEB).
While leveraged ETFs are sometimes targeted by critics with biased or one-way viewpoints, the truth is that leveraged ETFs offer financial flexibility and alternatives for demanding investors and traders. Let’s analyze four benefits of leveraged ETFs.
No Margin Borrowing Required
Using a brokerage margin account is a common method of obtaining leverage. While it’s easy to focus on all the good things that can happen when you borrow moneyfrom your broker to buy securities, a lot can go wrong.
Let’s first begin with retirement accounts like traditional and Roth IRAs.
If you try to post IRA assets as collateral for margin trading within a retirement account, the IRS views it as a taxable distribution, which would subject the IRA owner to potential taxes and penalties regardless of whether the money stays invested or not. For that reason, many brokerage firms disallow margin borrowing in IRAs along with other qualified retirement plans. And even if you find a brokerage who does allow you to trade with margin inside your retirement account, you will put your money at significant tax risk if you run afoul of the strict trading rules. The tiniest slip-up could cause your retirement account to be taxed and penalized!
In contrast, leveraged ETFs give investors a powerful alternative to margin trading.
First, leverage ETFs allow you to customize the amount of leverage you desire. For example, if you like small cap stocks (IWM) but if you’re not too keen on using lots of leverage, you’ve got choices. Instead of using a 200% (SAA) or 300% (TNA) daily leveraged small cap ETF, you can go with a toned down version like the Direxion Daily Small Cap Bull 1.25X Shares (LLSC), which uses just 125% daily leverage.
