7 Types of Investments Clients Should Avoid: Advisors' Advice

4. Leveraged ETFs

I recently met with a prospective client who wanted a checkup on his self-managed investments. I noticed an ETF that definitely did not belong in his portfolio. He had been invested in a triple leveraged ETF for over a year.

I recommend that all investors avoid these funds as the risk far outweighs the expected returns. First, most of these strategies are not intended to multiply the performance of a benchmark over time, but on a daily basis; the managers themselves will tell you they’re not intended as long-term holdings.

Down days quickly erode capital because it takes a much larger “up day” to recover from a “down day.” Second, to achieve the leverage needed to track a benchmark by a multiple, fund managers trade derivatives daily and close positions daily to meet their objective, which imposes implicit costs from trading well above the stated expense ratios, further eroding capital.

In general, leveraged ETFs are designed to be actively traded; with my financial planning clients, I discourage active trading in favor of widely-diversified portfolios that match their return goals with the minimum amount of risk possible.

— Drew Wessell, financial advisor, Fiduciary Financial Advisors