In the world of investing, one must always be wary of new products and take extra care to understand the mechanics and the risks. With the AI craze and a handful of stocks rising quickly last year, a series of new "leveraged" ETFs were created and saw big inflows. The Wall Street Journal had a recent piece on this: Billions Flowed Into New Leveraged ETFs Last Year. Now They’re in Free Fall.
What are these funds? They are designed to amplify the daily returns of a specific stock or group of stocks. For example, a 2x leveraged Nvidia ETF might look to deliver twice the daily performance of the stock. While there can potentially be bigger upside, the same goes for the downside. Furthermore, many investors do not understand that the ETFs follow the daily performance of the underlying investment rather than the cumulative performance.
When the market has performed very well for a while, investors often become complacent. One of my favorite independent thinkers, hedge fund manager Ray Dalio, discusses this at length. He is big believer in the idea of cycles in the markets and elsewhere. In his book, Big Debt Crises, Ray says that in a financial bubble, investors often become blind to the inevitability of a crash. The way this shows up often is through excessive risk taking and speculation. This speculation, among many other items, can lead to significant market downturns.
Warren Buffett once said "be fearful when others are greedy, and be greedy when others are fearful". Unfortunately, our instinct as humans is to do the exact opposite. While the recent pullback in the markets has humbled many investors, there is still a lot of speculation and greed out there. Now is an important time to be prudent, thoughtful, and disciplined with investments.
Investing is a psychological game. Working with a thoughtful Financial Advisor can help investors stay grounded during times of euphoria and avoid panic during difficult times.