A leveraged ETF is a specific type of exchange-traded fund (ETF) that’s designed to amplify investment returns. With traditional ETFs, which are mutual funds that trade on an exchange like a stock, the aim is typically to match the performance of a benchmark index. Leveraged ETFs, on the other hand, seek to multiply the returns of a specific stock market index or asset class. In other words, it’s an active, rather than passive, investing approach.

• How do leveraged ETFs work
• Which indexes do leveraged ETFs track?
• Pros and cons of leveraged ETFs
• How to use leveraged ETFs in your investing strategy
• Most popular leveraged ETFs

How do leveraged ETFs work

Traditional ETFs own shares of stock or other securities that represent all of the securities in the underlying indexes they track. So an ETF that tracks the S&P 500 Index, for example, would include shares of all of the companies in that index.

A leveraged ETF takes a different approach, relying on debt instruments and derivatives to boost investment returns based on the performance of an underlying index. A leveraged ETF can use any of the following investment strategies to achieve its goals:

• Options
• Futures
• Swaps
• Cash

2x and 3x leveraged ETFs

Leveraged ETFs typically use an amplification factor of two or three to magnify the gains of an underlying index. This means the ETF is buying two or three times the exposure to the index.

So a triple-leveraged ETF, or 3x leveraged ETF, would have a ratio of $1 of investors’ money for every $3 of debt. In theory, investing in a 3x ETF would then return a 3% gain for every 1% gain realized by the underlying index that the fund is attempting to outperform.

A 2x ETF, on the other hand, would use a leverage factor of two instead to double returns for investors. Remember, this is based on the returns of an underlying index within a specific trading window — typically one day — not the average annualized return of the index.

Inverse leveraged ETFs

Some leveraged ETFs can be inverse ETFs, meaning they attempt to amplify returns based on the opposite of how an index performs. So if you own a 3x ETF that’s inverse and the index it tracks sees returns drop by 3%, the ETF would return 9%. But if the index posts a positive return of 3%, then a 3x inverse leveraged ETF would drop by 9%. With an inverse leveraged ETF, the intent is to profit from declines in the index being tracked.

These funds can sometimes be referred to as bearish leveraged ETFs. The Direxion Daily S&P 500 Bear 3X Shares ETF, for example, offers 3x daily short leverage to the S&P 500 Index. This type of ETF might appeal to investors who have a bearish view of U.S. large-cap stocks in the short-term.

Which indexes do leveraged ETFs track?

Leveraged ETFs can be benchmarked against a number of stock market indexes. Some of the largest indexes that are often utilized for leveraged ETF trading include:

• The S&P 500
• The Dow Jones Industrial Average (DJIA)
• The Nasdaq 100
• The Russell 2000 Financial Services Index
• The NYSE Arca Gold Miners Index
• Dow Jones U.S. Oil & Gas Index

By tracking such a broad range of indexes, leveraged ETFs offer investors an opportunity to diversify investment gains beyond just stocks.

Some leveraged funds can also be sector- or asset class-specific. A leveraged gold ETF, for example, can deliver amplified daily or monthly returns on gold prices for investors who are looking to add precious metals exposure to their portfolios. A leveraged oil ETF seeks to do the same, only investors are swapping out oil prices for gold prices.

One important thing to note about leveraged ETFs and inverse leveraged ETFs is that they typically reset their exposure to the index they’re tracking daily. This means the objective of the ETF and its return multiplier can change each day. Some leveraged ETFs reset monthly but that’s less common.

Pros and cons of leveraged ETFs

Investing in leveraged ETFs can offer advantages and disadvantages. It’s important to weigh both sides to determine whether these investments are right for you.

Aside from those considerations, it’s important to note that investing in leveraged ETFs requires you to be hands-on when it comes to choosing which ETFs to invest in and making trades. This is not an investment approach that’s designed for the passive investor who’s hoping to remain hands-off with their portfolio.

If you don’t have the time or the patience to thoroughly research leveraged ETF investments and stay active with trading, then you could be setting yourself up for losses rather than gains.

How to use leveraged ETFs in your investing strategy

If you feel confident that leveraged ETFs are right for you, understand first that they make the most sense as part of a short-term investing strategy. If you need long-term diversification and index exposure, then you’re likely going to be better off with a traditional index mutual fund or ETF.

Before buying your first leveraged ETF, take time to research funds. Specifically, you should:

• Determine which indexes or sectors you’re interested in gaining exposure to in your portfolio.
• Review the fund’s prospectus to understand its objectives and how it attempts to achieve them.
• Consider the fund’s historical performance trends, though do keep in mind that past performance is not an indicator of future returns.
• Compare the performance of the underlying benchmark or index the ETF tracks.
• Determine what percentage of your portfolio holdings you’re comfortable committing to leveraged ETFs.
• Consider the costs involved, in terms of management fees and commissions.

When in doubt, it may be best to start small with investing in leveraged ETFs. You can then expand your position as you become more familiar with how these ETFs operate.

You may want to talk to your financial advisor about where leveraged ETFs fit into your overall investment plan. Your advisor can offer perspective on what leveraged ETFs can (or can’t) help you do when it comes to satisfying your investment objectives.

Most popular leveraged ETFs

If you need some direction on which leveraged ETFs to invest in, consider this leveraged ETF list and 3x ETF list, both of which include some of the most popular choices for investors.

Top leveraged ETFs for 2020

• ProShares UltraPro Short QQQ (SQQQ)
• ProShares UltraPro Short S&P 500 (SPXU)
• ProShares UltraPro Short Dow30 (SDOW)
• ProShares UltraPro Short Russell2000 (SRTY)
• Direxion S&P 500 Bull 2x (SPUU)
• ProShares UltraPro Short MidCap400 (SMDD)
• ProShares UltraPro Short Financials (FINZ)
• ProShares UltraPro Short Nasdaq Biotechnology (ZBIO)
• iPath LX Russell 2000 TR Index ETN (RTLA)

Top 3x leveraged ETFs for 2020

• Direxion Daily S&P 500 Bear 3X Shares (SPXS)
• Direxion Daily Gold Miners Bull 3X Shares (NUGT)
• Direxion Daily Small Cap Bear 3X Shares (TZA)
• Direxion Daily Financial Bear 3X Shares (FAZ)
• VelocityShares 3x Inverse Natural Gas (DGAZ)
• Direxion Daily Real Estate Bear 3x Shares (DRV)
• Direxion Daily 20-Year Treasury Bear 3X (TMV)
• VelocityShares 3x Inverse Crude Oil ETN (DWT)
• United States 3x Oil Fund (USOU)

A blind trust allows you to grant control of your financial assets to another party, called a trustee, who manages them for you. There are a variety of trusts that serve different purposes; blind trusts are for people who need to avoid potential conflicts of interest that could arise between their work and their investments.

What’s the difference between a blind trust and a normal trust?

The main difference between a blind trust and other trusts is that neither the grantor nor the beneficiary know where funds in the trust are invested, or have any real say in how they are being invested.

Every trust establishes a fiduciary relationship between someone who owns financial assets and someone who manages those assets. In most cases, when setting up a trust there are three parties involved:

• The grantor: The person who owns the assets and creates the trust.
• The trustee: A party chosen by the grantor to manage the trust.
• The beneficiary: The party who is entitled to receive financial benefits from the trust.

In many trust arrangements, the trustee and grantor communicate regularly regarding the administration of a trust. The beneficiary is typically aware of what’s in the trust or at least what trust assets they’re entitled to.

In a blind trust, the trustee alone knows where funds in the trust are being invested. A blind trust is a way to limit the beneficiary’s knowledge about what’s held in trust and how those assets are managed, says Patrick Hicks, head of legal at online estate planning company Trust & Will.

How does a blind trust work?

An independent trustee manages blind trust assets on the grantor’s behalf. The named beneficiary or beneficiaries have no knowledge of what’s in the trust or what decisions the trustee makes with those assets. Meanwhile, the trustee isn’t required to report to the grantor regarding trust activity. In addition, the grantor of a blind trust may choose to remain anonymous.

This doesn’t mean the trustee can do whatever they like with trust assets, however. As with all trusts, the trustees are fiduciaries, which means they’re required to act in the best interests of the trust beneficiaries.

Revocable vs. irrevocable blind trust: What’s the difference?

A blind trust can be revocable or irrevocable. The difference between the two hinges on whether you can change the terms of the trust once it’s established.

• Revocable blind trust: You have the power to change, revoke or terminate the trust at any time. For example, you may want to add assets to the trust while moving others out. Or name a different trustee or add beneficiaries to the trust.
• Irrevocable blind trust: This version is permanent. Once you’ve established the blind trust, named the trustee and transferred assets to his or her control, you have no further ability to make changes to the trust terms.

Whether it makes sense to establish a revocable or irrevocable blind trust depends on your reasons for creating the trust. If you don’t anticipate making further changes, then an irrevocable trust could meet your needs. On the other hand, a revocable blind trust gives you flexibility if you think the trust terms might need to be amended down the line.

Who needs a blind trust?

Technically, anyone could set up a blind trust. But typically they’re only used in situations where people need to separate themselves from their assets. A common scenario where that might be necessary is to avoid professional conflicts of interest.

Publicly elected officials may choose to set up a blind trust. The Ethics in Government Act of 1978 requires government officials to disclose assets unless they’re held in a qualified blind trust. Transferring assets to a blind trust can help lawmakers and other government officials minimize the potential for conflicts of interest by keeping their political and financial lives separate to a degree.

Hicks offers an example using a publicly-elected judge. If the judge is overseeing a case that could impact the value of the company in which he or she is invested, that could present a conflict of interest if their decision could affect the value of said investment. A blind trust would offer a legal safety net against that conflict.

Corporate executives and individuals who serve on a board of directors may also consider a blind trust to hold assets to avoid a similar scenario. Doing so could help them sidestep any financial dealings that could possibly create a conflict of interest.

Corporate insiders are subject to federal regulations that prevent insider trading and other illegal activity. With a blind trust, the trustee would have authority to buy or sell shares of company stock held in the trust allowing the executive to avoid violating any federal trading guidelines.

I just won the lottery, do I need a blind trust?

A blind trust is something you might be interested in creating if you win the lottery. When you have a blind trust, lottery winnings can be claimed in the trust’s name instead of your own. That means you can stay anonymous, which is something you might prefer if you don’t want a lot of people knowing about your windfall.

This might only be possible to do if you live in a state that doesn’t require lottery winners to disclose their identity. As of 2020, these states have laws or lottery board policies that allow winners to stay anonymous:

Aside from anonymity, a blind trust could also be helpful if you’re concerned about preserving your lottery winnings. By transferring the money into a trust, you can dictate when you and your beneficiaries should receive payouts.

How to set up a blind trust

The first step in setting up a blind trust is meeting with a qualified attorney, who can help you determine whether a blind trust is something you need and which laws in your state have to be observed for establishing one.

From there, you can go through the mechanics of creating and funding the trust, which includes:

• Determining which assets will be placed in the trust.
• Collecting relevant documents related to those assets, such as deeds to real estate or stock certificates.
• Choosing an individual or financial institution, such as a wealth management firm, to act as trustee.
• Deciding whether to create a revocable or irrevocable trust.
• Drafting the trust document and funding the trust by transferring assets to it.

Depending on where you live, the trust document may need to be notarized and recorded with your register of deeds or another state agency for it to be completely legal.

Do you need a blind trust?

A blind trust can help shield you from conflicts of interest related to your finances. That may be important if you have a high-profile job in the public sector or a private sector role that’s heavily regulated. A blind trust can also be helpful in managing lottery winnings if you’d rather you keep your newfound wealth under wraps or put safeguards in place to protect those assets.

The main challenges of blind trusts are the cost as well as the lack of transparency and control. First, setting up the trust usually means paying the blind trust attorney’s fees, which could be substantial since this type of trust tends to be more complex than other trust options. Beyond that, there are ongoing costs associated with maintaining a trust, including the administrative fee paid to the trustee for their services. Hicks says the initial setup costs can run in the tens of thousands, while annual management fees can run as high as 3% of trust assets.

On the transparency and control side, your beneficiaries won’t know what the trustee is doing but then again, neither will you. That could make a blind trust less than ideal if you’re more of a hands-on type when it comes to managing your assets.

Bottom line, blind trusts can serve a specific purpose in estate planning. Talking to an estate planning attorney can help you decide whether establishing one is the right move.