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Specialized Funds

Beginner's Guide to Leveraged Mutual Funds

Chris Dumont Oct 07, 2014

How Leveraged Funds Work

The caveat, however, is that if the mutual fund falls, the investor will lose twice as much money, in addition to paying interest on the loan. That being said, for the more risk-tolerant investor, leveraged mutual funds offer more exposure on an otherwise traditional investment.

Be sure to also read the 7 Questions to Ask When Buying a Mutual Fund

How Leveraged Mutual Funds Can Be Used in a Portfolio

Types of Leveraged Mutual Funds

  • Index Funds
    Index funds invest in equities or fixed income securities that follow a specific index such as the S&P 500 or NASDAQ-100.
  • Money Market Funds
    These funds mostly invest in a combination of government securities, such as Treasury Bills.
  • Bond Funds
    Bond funds are anything fixed income, and can consist of treasury bills, debentures, mortgages and bonds.
  • Equity Funds
    Equity funds are broken down into the major sectors of the S&P 500, namely: consumer, healthcare, financials, industrials, information technology, telecommunications, utilities and materials.
  • Balanced Funds
    As the name suggests, balanced funds invest in a variety of equities and bond securities.
  • Specialty Funds
    Specialty leveraged mutual funds focus on specific investments that include sector funds, real estate, commodities, currencies, and other unique types like fund of funds.

Benefits of Leveraged Exposure

  • Diversification
    One of the main advantages of investing in leveraged mutual funds is that it allows individual investors access to a managed and diversified portfolio of assets within the capital markets which would otherwise be difficult to do with a small investment. Using diversification is arguably one of the better ways to invest, in that it will yield higher returns and pose lower risk than any individual investment found within the portfolio. All investments involve some degree of risk, but the reward for taking that risk can be reduced by diversifying the investment. Keep in mind that with leveraged mutual funds, while diversification does help, there is the additional risks from borrowing on margin so take that into consideration as well.
  • Cost Efficiency
    Having no per-trade costs means that investors do not have to worry about the costs incurred with buying and selling leveraged mutual funds, and with no performance fees allowed, mutual fund businesses are geared for scale. This allows them to invest smaller amounts over time instead of waiting to save up a chunk of funds to buy. This is called “dollar cost averaging” and is a recommended method of investing. Essentially, a young investor placing $5,000 in a leveraged mutual fund gets the same benefit as the high net worth individual who places $25,000,000.

Be sure to see The Cheapest Mutual Funds for Every Investment Objective

  • Tax Considerations
    The government generally allows individuals to deduct interest paid on money borrowed to invest in stocks, bonds and/or mutual funds holding the same. The test for deductibility requires that borrowed funds be used for income-producing purposes. Be sure though to keep a proper paper trail for the IRS; failing to deduct the proper interest expense and/or failing to keep proper records could be asking for a tax headache later down the line.

See the 7 Essential Tax Tips for Mutual Fund Investors

Popular Leveraged Mutual Funds

  • Biotechnology: Profunds Biotechnology UltraSector Fund (BIPIX)
  • S&P 500: Rydex S&P 500 2X Strategy Fund (RYTTX)
  • NASDAQ-100: Direxion Monthly NASDAQ-100 Bull 2X Fund Investor Class (DXQLX)
  • Emerging Markets: Rydex|SGI Series Fund Trust Emerging Markets 2X Strategy Fund (RYWTX)

It is important to note that previous performance is not a guarantee of future performance, but these give investors idea of what leveraged mutual funds are available and what to look for.

The Bottom Line

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