The Financial Industry Regulatory Authority (FINRA) and the United States Securities and Exchange Commission (SEC) released a joint alert to give investors some information on inverse and leveraged exchange-traded funds (ETFs).
What Exactly Are ETFs?
ETFs differ from traditional mutual funds by trading throughout the day at prices that the market establishes on a securities exchange, and in most cases, they are registered investment companies with shares representing an interest in securities portfolios tracking an underlying index or benchmark. These investments have become more complex over the years as they’ve evolved with the market, and investors need to assume each ETF is different and carefully evaluate every investment when they consider investing.
What Are Inverse and Leveraged ETFs?
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Inverse ETFs track benchmarks or indexes, and are designed to deliver the opposite of how those measurements perform, while leveraged ETFs are designed to deliver multiples of the performance of the metrics they track. Inverse ETFs, sometimes referred to as short funds, are commonly marketed as ways for investors to profit from markets on a downward trajectory.
Both of these types of ETFs are designed to meet their stated objectives daily, but their performance over an extended period of time can dramatically differ from the performance of the benchmark or index they are based on around the same period of time, and this difference can become even more pronounced when the market is especially volatile.
What You Should Consider Before Making an Investment
The best way to protect yourself from an unsuitable investment is to research the pros and cons of these types of ETFs. Some important questions to ask include:
- How will my investment achieve its objectives, and what risks come along with it? Understanding how your investment works and what techniques it uses is a key part to keeping your money safe.
- ETFs are designed to work for a short period of time – what happens if I keep it for longer than a day? While some hedging and trading strategies may justify holing ETFs for an extended period of time, doing so comes with risks. Because inverse and leveraged ETFs reset every day, their performance may differ from the performance of the benchmark or index they are based on.
- Could an ETF not meet its objectives? Every investment comes with some level of risk, which means that you need to be fully aware of the potential negative impact it could have on your portfolio’s performance.
- How much do they cost? Inverse and leveraged ETFs can be more expensive than a traditional ETF. Your investment adviser can help you calculate any expenses or fees that may be included with your investment.
- Are there any tax consequences? These types of investments can be less tax-efficient than a traditional ETF, so it’s important to check in with your investment adviser about any potential consequences you may face by investing in an inverse or leveraged ETF.
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