Investing and Saving
Why leveraged ETFs come with double or triple the returns—and risk
By Aparna Gill, CFA, CFP 22 January 2026 5 min read
Key takeaways:
- Leveraged ETFs are designed for daily performance. Don't expect their long-term returns to simply be a multiple of the underlying index.
- Volatility decay is real. Volatile markets can erode your capital even if the index finishes flat or up over time.
- These ETFs are trading vehicles, not investing tools. They have no place in a long-term investment portfolio.
Imagine a world where your investments could potentially double or even triple their daily gains compared to the broader market. Sounds exciting, right? This is the core promise of leveraged exchange-traded funds (ETFs). These specialized investment vehicles are designed to magnify the daily performance of an underlying index, offering the potential for outsized returns in a short timeframe. This promise is particularly alluring right now, given the strong market returns and momentum witnessed over the past year.
But here's the critical first takeaway: just as they can amplify your gains, they can also dramatically amplify your losses. And there's a unique characteristic called "daily resetting" that all investors must understand before even considering them. Let's dive in.
Source: ATB Wealth
How leveraged ETFs work: the daily multiplier
At their heart, leveraged ETFs are still ETFs—funds that hold a basket of assets and trade on an exchange like stocks. The key difference is their objective to deliver a multiple of an index's daily return. For example:
- If the S&P 500 goes up 1% today, a 2x leveraged S&P 500 ETF aims to go up 2%.
- If the NASDAQ falls 0.5% today, a 3x leveraged NASDAQ ETF aims to fall 1.5%.
It is also important to note that this same daily mechanism applies to inverse ETFs. Instead of aiming for a multiple of positive returns, inverse ETFs aim to deliver the opposite of the index's daily return. For example, if the S&P 500 goes down 1% today, an inverse S&P 500 ETF aims to go up 1%. Some funds combine these concepts, offering leveraged inverse exposure (e.g., a -2x or -3x daily return).
Leveraged ETFs achieve this magnification not by simply borrowing money, but by using complex financial instruments like futures contracts and swaps. Because of the complexity involved in managing these derivatives daily, these funds typically carry significantly higher management fees than standard index ETFs.
Here's where it gets tricky, and it's the single most important thing to grasp about leveraged ETFs: their leverage is reset at the end of each trading day. This means their performance is measured on a day-to-day basis, not over weeks, months, or years.
While this works perfectly for a single day, over longer periods, this daily resetting mechanism can lead to a phenomenon called volatility decay. If the market is volatile (moving up and down frequently) but ends up in the same place after a week, your leveraged ETF could still have lost money, even if the underlying index broke even.
It’s counterintuitive because our brains tend to average numbers over time, but the math of percentages doesn't work that way. Let’s look at a scenario where the market goes up one day and down the next, ending roughly where it started.
| Day | S&P 500 (Index) | 2x Leveraged ETF |
|---|---|---|
| Start | $100.00 | $100.00 |
| Day 1 | Goes up 10% to $110.00 | Goes up 20% to $120.00 |
| Day 2 | Goes down 10% to $99.00 | Goes down 20% to $96.00 |
| Total Loss | -1.0% | -4.0% |
On day two, the index only had to drop from $110 to get close to breakeven. However, the leveraged ETF was dropping from a higher peak ($120). A 20% drop on $120 ($24 loss) hurts much more than a 20% gain on $100 ($20 gain).
To be fair to these instruments, the math works in your favour during a strong, uninterrupted trend (streak). This is why traders use them for short-term bursts. Let’s look at another scenario where the market goes up 10% on day one and day two.
| Day | S&P 500 (Index) | 2x Leveraged ETF |
|---|---|---|
| Start | $100.00 | $100.00 |
| Day 1 | Goes up 10% to $110.00 | Goes up 20% to $120.00 |
| Day 2 | Goes up 10% to $121.00 | Goes up 20% to $144.00 |
| Total Gain | +21.0% | +44.0% |
Because of the daily reset, on day two you earned 20% on your new, higher principal ($120). The ETF actually delivered more than 2x the index return (44% vs 21%).
Given the daily reset, it becomes clear why leveraged ETFs are far from simple. Because markets are rarely perfectly straight lines (they wiggle up and down), the decay usually eats away at long-term returns. If you drop 50% (from $100 to $50), you need a 100% gain (from $50 to $100) just to get back to even. Leveraged ETFs can dig themselves into these deep holes very quickly during downturns, and the daily compounding makes it incredibly difficult to climb back out unless the market goes on a perfect, straight-line winning streak.
The chart below illustrates the damaging impact of volatility decay over a two-year period where the underlying index (S&P 500) experienced declines before gradually recovering. This highlights the significant losses for 2x and 3x leveraged ETFs during a multi-year period where the underlying S&P 500 index actually posted a small gain.
Volatility of S&P 500 leveraged ETFs vs the underlying index from January 2022 to December 2023
Source: YCharts
Important risks to consider
- Volatility decay: As illustrated above, even if the underlying index finishes flat over a week or month, a leveraged ETF can lose a substantial amount of value due to the daily compounding of returns, especially in volatile markets.
- Amplified losses: If the market moves against your position, your losses are magnified by the leverage factor. A 5% drop in the index means a 10% (for 2x) or 15% (for 3x) drop in your ETF value that day.
- Tracking error: Due to their complex structure and the costs of rebalancing, leveraged ETFs may not perfectly achieve their stated multiple, especially during periods of extreme market volatility.
Conclusion
Leveraged ETFs are powerful financial instruments that offer the potential for magnified daily returns. However, their unique structure, particularly the daily resetting mechanism and subsequent volatility decay, makes them exceptionally risky for all but the most experienced, short-term traders. They are fundamentally unsuitable for beginner investors or anyone with a long-term, buy-and-hold strategy.
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