Securities Backed by Nothing

In a world of ubiquitous information and rapid computation, clever investment firms can create financial instruments that let you buy just about anything.  Bonds allow you to buy the future income of governments (taxes) and companies (profits).  Stocks let you buy actual companies and share in their fortunes.  Mutual funds and ETFs let you buy baskets of these things, providing the expected benefits while limiting the risks.  Some things in the markets, however, are based on nothing of substance.  You can buy volatility.  What is volatility exactly, and how does it make a profit?

Leveraged, inverse, and inverse leveraged ETFs seek to achieve a daily return that is a multiple or inverse multiple of the daily return of a securities index.  These ETFs are a subset of index-based ETFs because they track a securities index.  They seek to achieve their stated objectives on a daily basis.  Investors should be aware that the performance of these ETFs over a period longer than one day will probably differ significantly from their stated daily performance objectives.

These ETFs often employ techniques such as engaging in short sales and using swaps, futures contracts and other derivatives that can expose the ETF, and by extension the ETF investors, to a host of risks.  As such, these specialized products typically are not suitable for buy-and-hold investors.  “Investors” in these risky funds are also subject to being called a moron on national television by Jim Cramer.


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