3 Problems Leveraged Investments Solve

  • August 18, 2016
  • High Income Professional

What is a leveraged investment?

A leveraged investment is an investment that increases your money’s exposure to the stock market. For example an investment that provides 300% exposure to the S&P 500 is considered a triple leveraged investment.

Here’s what leveraged investments can do for you.

#1.  Market Timing

The easiest way to time to the market is to not time the market.  With a leveraged investment giving you 3X the exposure to the stock market you can scale down the amount of money you have invested to 1/3rd of what you currently have.  This allows you to get more of your money out of the market when you believe the market has topped – but aren’t quite sure.

If you’re wrong you can always buy more shares at a higher price, but you still win b/c you were never completely out of the market so you you’ll get the market return and then some.  Conversely if you were right and the market falls you simply have to buy lower than where you sold to benefit from selling high and buying lower.   You don’t have to buy at the absolute bottom for your strategy to have succeeded.

#2.  Investment selection

The only investment better than one that tracks the market (i.e. an S&P 500 index fund or ETF) is one that beats the market – period.

So when choosing an investment other than an index fund of index ETF, the justification is that it beats the market.  Leveraged funds that leverage the market will beat the market over time (see SSO vs. S&P) even after steep losses.

Why? Because they are tripling the daily return of the market, if the market goes up over time, tripling the daily return will outperform the market over time.

It’s that simple.

#3.  Risk

There are a lot of funky names for risk out there – standard deviation, sharpe ratio, volatility, etc.  Skip them. Risk is simply how much money you have invested in the market. If you have a $100,000 invested, you can lose $100,000. Your risk is $100,000.

Wall Street and insurance industry have worked very hard to create solutions to protect you from risk and they work, but for a price. The price is usually limited upside or higher fees.

With leveraged products you can simply reduce your risk by reducing the amount invested. If you’re using a product that gives you 3X the exposure to the stock market then you only need 1/3 invested.

Ex: A $90,000 portfolio invested in an S&P 500 index fund can get the same performance with $30,000 invested in a triple leveraged (3X) S&P 500 fund.

This gives the investor a fixed amount of risk – 33% or $30,000 with an uncapped amount of gain. Also he can use the un-invested funds to buy bonds, CDs, or simply remain in cash to buy when the market falls.

This can be done without some complicated insurance product like an annuity

Investors struggle with market timing, investment selection, and risk.  By using leveraged investments they can mitigate these problems.