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Tom Lydon is Editor of ETFtrends.com, President of Global Trends Investments, and a leading expert on ETF investing. His latest book, The ETF Trend Following Playbook, is available via the link above.
Leveraged and inverse exchange traded funds (ETFs) have been a lightning rod for controversy. Reasonable concerns underpin criticism of them, but these funds are largely misunderstood. Let’s set the record straight and identify those investors for whom leveraged and inverse funds are appropriate.

The aim of leveraged and inverse ETFs has been to double or triple the moves of the market on a daily basis. For example, in a short double-leveraged fund, if the index goes up, then the fund goes down twice that. In a long doubled leveraged fund, if the index goes up, the fund then doubles that.
While these funds may have a reputation as risky and volatile – and it’s true that they should not be used lightly or without understanding – they also serve some valuable purposes for investors, including:
- They’re a hedge if an investor believes the market is due for a short-term correction but doesn’t want to sell a position. By buying a leveraged or inverse ETF, the investor can effectively hedge what the market is doing.
- They can be used to capitalize on the movements of the market. If an investor believes that the market is going to go on a tear, a leveraged ETF can maximize their potential gain.
The Financial Regulatory Authority (FINRA) issued a warning about leveraged and inverse ETFs in July, reminding brokers to be mindful of the suitability of the products they offer to customers. While FINRA backed down from the July statement directed at professional investors, in August the body, along with the SEC, issued a statement aimed at retail investors:
“These products are complex and can be confusing. Investors should consider seeking the advice of an investment professional who understands these products, can explain whether or how they’ll fit with the individual investor’s objective and who is willing to monitor the specialized ETF’s performance for his or her customers.”
Leveraged and inverse ETFs aren’t for everyone. They don’t work like typical ETFs, for at least two reasons:
- Compounding. Leveraged and inverse ETFs reset daily to replicate the intended performance (relative to their index) accurately each day. For example, on Aug. 12, the S&P 500 gained 1.2%. On that same day, the Rydex Inverse 2x S&P 500 (RSW) lost 2.3%. On Aug. 13, RSW resets and starts back at even again. In stable markets, the performance of these funds relative to their index will work over extended periods of time. But the funds will drift from their benchmark. The longer the holding period, the greater the drift. The effects of compounding generally were understood until 2008, when the markets were slammed with record volatility, causing excessive drift in some leveraged funds.
- Volatility. When you combine a few days of 500-point swings with a fund that’s supposed to double or triple those movements, it could be a stomach-churning ride. The side effect of this volatility is that leveraged and inverse ETFs can veer from their benchmarks by wide margins. According to a study by ProShares, though, compounding works both ways, and the negative impact is simply heightened in wild markets. But in both up and down markets, compounding can work in an investor’s favor.