Legendary investor Warren Buffett once remarked, “If you’re smart, you don’t need leverage.” While easy for him to say with a net worth exceeding $100 billion, many of us navigate the choppy waters of investing without billions at our disposal. So, what’s the harm in a little leverage, one might ask?
As we embark on this journey, it’s time to delve into the realm of leveraged single-name exchange-traded funds (ETFs) to unravel their mysteries and discern their suitability for the ordinary investor. Let’s set sail.
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The Ins and Outs of Leveraged ETFs
Leveraged exchange-traded funds (ETFs) are financial products utilizing derivative instruments, such as stock options, to amplify price movements of an underlying security. In essence, a leveraged ETF seeks to magnify the daily returns of a specific stock or index, like the S&P 500.
Unlike traditional funds, GraniteShares ETFs focus on enhancing the daily returns of individual stocks, including prominent names like Apple, Nvidia, and Tesla. While some funds aim for double the positive return (long funds), others strive for double the negative return (short funds).
For instance, GraniteShares 2x Long NVDA Daily ETF intends to double the daily percentage return of Nvidia stock. If Nvidia’s shares climb 2% on a given day, the fund aspires to yield a 4% return on that same day.
The reverse holds for short funds; for example, the GraniteShares 2x Short NVDA Daily ETF seeks to double the inverse daily return of Nvidia’s shares. In practice, a 2% drop in Nvidia’s stock would ideally result in a 4% positive return for the ETF.
Why Long-Term Investors Should Steer Clear
At first glance, leveraged ETFs might appear enticing for the long-term investor. After all, being twice as bullish on a stock like Nvidia seems like a logical strategy. However, as with many things in life, the reality is more nuanced.
Leveraged ETFs are ill-suited for long-term investment horizons. GraniteShares’ 2x Short NVDA Daily ETF succinctly articulates its investment objective:
“The Fund seeks daily investment results, before fees and expenses, of -2 times (-200%) the daily percentage change of the common stock of NVIDIA Corp. There is no guarantee that the Fund will meet its stated objective.”
The fund explicitly states two crucial points: it does not assure performance aligns with its objective, and it is not designed to deliver leveraged returns beyond a single day.
- The fund offers no guarantees regarding performance alignment with its objective.
- Long-term leveraged returns should not be anticipated beyond a day.
These caveats carry significant weight for long-term investors. By acknowledging the fund’s limitations and the short-term nature of leveraged returns, GraniteShares delineates the target audience for these products: short-term traders seeking amplified daily movements.