HOW WOULD YOU FEEL about a stock market strategy that routinely invests more after prices go up and sells when prices drop? As someone who invests for the long haul, I’m skeptical—which is why the increasing popularity of leveraged exchange-traded funds (ETFs) puzzles me. A leveraged ETF aims to amplify the daily return of its stated benchmark. The fund’s benchmark might be a widely followed stock or bond index, a particular market sector, a single industry or one country. These ETFs are easily identified by their names, which often include terms like 2x, 3x, bull and ultra. For instance, ProShares Ultra S&P 500 (symbol: SSO) seeks to return twice the daily performance of the S&P 500-stock index, while Direxion Daily MSCI India Bull 3X Shares (INDL) tries to triple the daily return of Indian stocks. Leverage is a double-edged sword that exaggerates both gains and losses—often costing investors dearly. Yet a wrongheaded narrative keeps attracting inexperienced investor to leveraged ETFs. Consider ProShares Ultra S&P 500, mentioned above. It lost almost 20% in the five years following its June 2006 launch, including dropping more than 80% from peak to trough during the 2007-09 bear market. In the same five-year period, a low-cost S&P 500 ETF would have gained a cumulative 15% with half the volatility. Wasn’t the ProShares ETF supposed to double the benchmark’s gain, by rising 30% over the five years, instead of losing 20%? This is the dangerous misconception about leveraged ETFs—and the reason they shouldn't be used as long-term investments. Instead, leveraged ETFs are tools for sophisticated day traders and swing traders. They’re meant to be held for a day or so and kept under close watch. When market timers are firmly convinced about the market’s immediate direction, they try to use leveraged ETFs to make a quick buck. Fund companies emphasize that the stated performance goal of a leveraged ETF is strictly a daily target. A 2x ETF is structured to generate—before costs—twice the gain or loss that the benchmark experiences during the course of a single day. Its return over longer holding periods is anyone’s guess. To illustrate the effect of mandating a daily target, suppose we mimic a 2x S&P 500 ETF starting with $100. To double our market exposure, we borrow another $100, allowing us to buy $200 worth of S&P 500 stocks. By keeping the debt at the same level as our “net balance”—meaning our account value after deducting the debt—we can earn twice the market’s return for that day. As the market moves in either direction during the day, the portfolio’s gross value changes proportionally, but the debt remains constant, thus amplifying changes in our portfolio’s net balance. For instance, if the market goes up by 25% on the first day, the stocks rise from $200 to $250. Our net balance, after subtracting the $100 loan, is—voilà!—$150, a 50% gain on our initial $100 investment. At the close of that first day, the $100 debt is below our $150 net balance. As a result, we’re no longer positioned to generate twice the market’s return the next day, so we need to take on more debt. We do that by borrowing another $50 to buy more S&P 500 stocks, thus ensuring our debt is equal to our net balance of $150. In other words, if prices rise on day No. 1, the daily performance goal compels us to buy more stocks before day No. 2. Leveraged ETFs do the same thing. In practice, they don’t buy stocks with borrowed money. Instead, they use indirect leverage through derivatives. But conceptually, their rebalancing is the equivalent of buying more after prices rise. What if the market had gone sour on the first day and dropped 20%, instead of rising 25%? In our portfolio that mimics a 2x ETF, the value of our stocks would drop from $200 to $160. After subtracting the $100 outstanding debt, our net balance falls to $60, a 40% drop. Our portfolio is now overleveraged, so we need to make adjustments to set us up to earn twice the market on day No. 2. This time, we have to reduce borrowing to bring it to the same level as our net portfolio balance. That means selling stocks worth $40 and using the proceeds to bring down the debt from $100 to $60, so it’s the same as our net balance. In other words, we’d be obliged to sell stocks because their prices have fallen. Again, similar adjustments happen with a leveraged ETF. This daily rebalancing causes the leveraged ETF to buy stocks after prices rise and sell after prices drop, day in and day out. The continuous adjustment of the leverage causes the long-term performance to deviate significantly from the daily target. Indeed, thanks to the costs involved and the difficulty in recouping losses suffered on down days, a leveraged ETF can lose money over longer periods even when the underlying benchmark posts gains in the same timeframe. What would happen to a triple leveraged ETF if its benchmark dropped by a third in a single day? You guessed it: The ETF would be wiped out. But even if a leveraged ETF survives a big market drop, the underlying benchmark has to soar for the ETF to recoup its loss. A 20% drop of an unleveraged asset requires a subsequent 25% gain to break even. In the case of a leveraged ETF, a 20% benchmark drop leads to a 40% drop in the fund’s value. Result: The fund needs to go up by almost 67% to break even, which can only happen if the benchmark rises by more than 33%. Market volatility can be devastating for leveraged ETFs, even when the underlying benchmark recoups its losses. Suppose that Mr. Market goes up 10% on day No. 1 and down by 9% on day No. 2, and follows this whimsical pattern for a year. Despite the extreme volatility, the market would be up by 0.1% over any two-day stretch and, over the course of a year, its rise would exceed 13%. How does a 2x ETF fare in the same year? It experiences a 20% gain on day No. 1 and an 18% drop on day No. 2. Compounding the daily returns, the ETF loses 1.6% over two days. If this seesaw continues for a year, the ETF would lose almost 87% of its original value. Even on a profitable day, the pretax profit of a leveraged ETF is likely to be less than its stated goal. Why? The leverage isn’t free. If the ETF uses a total return swap—a contract that gives the return exposure of an asset without having to own it outright—it has to pay interest for the swap contract. The already high expense ratios of these ETFs, typically close to 1% and sometimes more, don’t include either the cost of leverage or the fund’s trading costs. The bottom line: If I could get my hands on a crystal ball that accurately predicts short-term market movements, I’d use leveraged ETFs in a heartbeat. Until then, count me out. A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Identity Crisis, Triple Blunder and Freedom Formula. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He's passionate about raising financial literacy and enjoys helping others with their finances. [xyz-ihs snippet="Donate"]

READERS MAY RECALL Laura, my acquaintance who didn’t need life insurance but was sold a policy anyway. Alarmed by her ignorance, she vowed to manage her own money. As a first step, she parted ways with her financial advisor. The advisor had her invested in 35 funds. She never fully understood what these funds owned or why she needed them. She had previously thought that investing had to be complicated and was best left to the professionals. She wasn’t so sure anymore. After spending days researching her funds and still getting nowhere, Laura figured that there must be simpler ways to invest. She broached the idea with me. What struck me about her investments wasn’t just the complexity, but also her overall asset allocation. More than half of her long-term savings was in cash and bonds. Why would someone in her 40s invest so conservatively? Apparently, Laura’s former advisor had recommended a moderately aggressive asset allocation. Indeed, 70% of her managed investments were in various stock funds. But she also had a pile of cash in her bank account. Did her advisor overlook this uninvested savings? Nope. It turns out that she was repeatedly asked to add the remaining cash to her investment accounts, but she declined. She didn’t want to pay yet more management fees. More important, she didn’t want to see her stable cash disappear into the mysterious jungle of managed accounts. There was an alternative. Laura could’ve left her cash in the bank, while shifting the allocation in her investment accounts away from bonds and more toward stocks. Her overall stock exposure would then have been closer to her desired asset allocation. Laura couldn’t tell why this wasn’t done by her old advisor, but she saw no problem in doing it now. Undeterred by the tax consequences, Laura sold all her previous holdings and replaced them with a few index funds. Between lower fund expenses and no more advisory fees, her annual investment costs fell almost two percentage points. The best part: She now understands her investments.

BACK IN 1989, AS I was finishing the final semester of my undergraduate degree in India, I managed to bag two decent job offers. The first was from a government organization in my hometown, and the second was from an out-of-state private company in western India. I had a few weeks to make up my mind. I was leaning toward the second offer. Not only did the idea of living on my own in a faraway town sound adventurous, but also the private employer’s compensation package was better. Still, my father suggested the other job. Being a government employee himself, he liked the job security of public sector employment. Frankly, I didn’t think that was important, but I went with the local job anyway because most of my friends were still in town. A decade and a few jobs later, I moved to the U.S. to work for a multinational software company. I’ve stayed with the firm ever since. My job has always felt safe and secure. But that began to change in recent months, when several tech companies announced plans to downsize. I got a phone call from an anxious friend who works at my company. My friend and his wife had their first child last November and were busy adjusting to caring for a newborn. He rejoined work when his parental leave was over and heard rumors from his teammates about upcoming layoffs. I didn’t know anything about any layoffs, so I advised him to ignore the rumors, and focus on his family and work. The rumors, however, grew louder and, over the next few days, started showing up in the media. Soon after, our CEO announced plans to reduce the workforce in the coming months. The anxiety and confusion were now official. Everyone seemed to have the same question: “Am I on the list?” I pondered what would happen if I was affected. I reflected on Dale Carnegie’s sage advice: There are some things you can’t control. Plan how to deal with them so you can move on. I figure laid-off workers might face five important consequences. 1. Immigration status. Many employers—particularly in the tech industry—hire foreign workers with employment-based visas. Losing a job can jeopardize a foreign worker’s immigration status, potentially forcing the ex-employee to leave the country on short notice. It can be stressful for those workers who fail to find alternative employment in the limited time available. My friend was worried because he’d be in that situation if he lost his job. 2. Financial hardship. Living paycheck to paycheck is surprisingly common, even for dual-income households with fat pay packets. Two out of three Americans worry about how they’d cover even a month’s expenses if their primary source of income stopped. Sudden loss of income is not only a source of stress, but also it’s a slippery slope toward spiraling debt. [xyz-ihs snippet="Mobile-Subscribe"] 3. Career speedbump. A layoff often means resetting our career progress and forcing a new start. While it may open up better opportunities for a few, most take it as a career setback. Having diverse skills and keeping up with industry trends can improve the odds of faster career repair, but the uncertainties and scrambling in the interim aren’t fun. 4. Unwanted relocation. People tend to settle close to their work. Losing a job might mean moving. Relocation is particularly hard for people with deep roots. They might own their home, have a working spouse and school-age children, and be involved in local activities. Moving costs time and money, involves emotional stress and requires many adjustments—some small, some large. 5. Damaged self-esteem. A layoff isn’t the same as being fired for poor performance. I’ve seen highly capable professionals with proven track records get the boot as often as average workers. Still, a layoff comes with the stigma that the person isn’t valued. We enjoy praise for doing good work, and a layoff is the reverse. It’s a reminder that no one is indispensable and, ultimately, we’re on our own. To be sure, not everyone is affected the same way. Some might be hit by all five consequences listed above and perhaps even a few more. But others may find it’s a blessing in disguise because their lives are improved by the change. How would I feel if I find myself on the layoff list? Fortunately, my current gradual retirement would minimize most of the financial and logistical challenges. Though I’m still working part-time, it’s for enjoyment and not because I need the paycheck. Still, I dread the thought of being laid off. Why? It’d surely hurt my pride, evoking a sense of failure and inadequacy. I don’t want my software engineering career to end with a layoff. This leaves me with the dilemma that I’ve been struggling with for the past few weeks. The only sure way to avoid the situation is to resign preemptively, but that feels extreme. I enjoy my work and took on a new project last year. Quitting would mean leaving behind unfinished work. My career would feel incomplete. I shared my anxiety with close friends. They all said hanging tight would be more financially sensible. Even if I’m included in a future layoff, the severance package would offer a decent windfall. To deal with the emotional fallout, they gave me the “it’s me, not you” argument. In other words, layoffs often reflect changing business priorities rather than an individual’s incompetence. I’ve decided to stay put and cross the bridge to retirement only if circumstances take me there. I know that, if I’m laid off, no severance package would be sweet enough to mask the bitter taste in my mouth. But I won’t let it ruin my hard-earned sense of career accomplishment. Sanjib Saha is a software engineer by profession, but he's now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Check out his earlier articles. [xyz-ihs snippet="Donate"]

I WAS FORTUNATE to find enough time during my working years to pursue various hobbies and other personal interests. My part-time work arrangement allowed me to have four-day weekends. I’d hoped that, after retirement, I would have even more time to take on personal projects. But surprisingly, I found myself with less free time. Not only was I failing to start new projects, such as writing software for the website of the nonprofit I cofounded, but also I was struggling to keep up with my current commitments. It stressed me out. An obvious explanation was travel. Since retiring, I’d taken several trips with friends and family, including a few multi-week vacations. I’d also devoted significant time to catching up with old friends. Yet this didn’t fully account for where my time was going, especially during the weeks I was home. I had a similar experience in my career when I first took on a managerial role. Once I became a manager, I found myself struggling to cope with a growing backlog of work. I began each day by preparing a to-do list, only to find that, by the end of the day, most of the items remained untouched. Frustrated and exhausted, I set out to address my time management issue. I resorted to a rather crude method to get to the bottom of it. I meticulously kept a detailed journal to record my activities hour by hour. After maintaining the time log for several weeks, I reviewed it and my problems became self-evident. The primary source of time leakage was my habit of frequently checking emails and rushing to respond to incoming messages as soon as they appeared in my inbox. The second major time drain was attending numerous meetings, many of which weren’t essential. My days were so fragmented between emails and meetings that I had little time to accomplish anything substantial. Once I identified the culprits, I brought more discipline to my daily routine. I shifted away from the compulsive always-on work style and blocked large segments of my daily calendar for important tasks. I minimized email interruption by turning off notifications for most of the day. I also went on a meeting diet, attending only those I deemed essential. These adjustments helped me reclaim much of the time I’d been losing, without any noticeable downside. I borrowed a page from my own playbook to solve my retirement’s time-crunch mystery. I kept detailed records of my activities for three weeks and then reviewed them. Unlike last time, I couldn’t pinpoint one or two factors draining my time. I was simply stretching myself too thin across multiple activities and goals. To address this, I decided to experiment with a budgeting technique. A humble confession: I’ve never found success with conventional budgets, especially those requiring detailed categorization and tracking of every dollar spent. I admire those who have the patience to meticulously monitor their expenses—I’m just not one of them. Instead, throughout my earning years, I adopted a reverse budget: I saved first and spent what was left. I applied this same technique to manage my time in retirement. I decided to allocate 50 hours a week for my personal use, and spend the rest on everything else. Why 50 hours? My rough calculation went like this: First, I committed the weekends completely for family time. I estimated that my basic needs—things like nightly sleep and occasional naps, showers and hygiene, meals, routine chores and so on—took almost 14 hours each day. If that sounds like a lot, it’s because I prefer things slow and easy. That left me 10 hours a day for five weekdays, or 50 hours a week, dedicated to my personal pursuits. To keep things simple, I decided to split this time evenly among my five different interests, spending roughly 10 hours a week on each: 1. Physical fitness. I exercise each day, but I don’t enjoy it. I dislike it so much that I spend nearly an hour each day mentally preparing myself to get started. The actual workout lasts barely 45 to 60 minutes. If you include a few minutes for cooling down, it turns into a two-hour task. Despite my dislike of physical exercise, I take it seriously. I want to stay fit, or at least slow the deterioration of my physical abilities. Listening to podcasts during my workouts helps reduce the boredom. I also mix up my exercise between swimming at a local community club, walking outdoors and strength training. Regardless of the form of exercise, it’s often the least enjoyable two hours of my day. 2. Hobbies. I enjoy acquiring or honing skills that align with my hobbies. Currently, part of my hobby time goes to practicing the flute, at least when my wife and daughter aren’t home to complain about the occasional squeaky or off-tune notes. I’m also learning Spanish. Sí, quiero aprender español para poder viajar a México y otros países de habla hispana con más confianza. Progress is slow but promising. 3. Social connections. I make a concerted effort to stay connected with people. This includes mentoring through our nonprofit to provide investment and financial education, catching up one-on-one with friends and former coworkers, giving informal music lessons to acquaintances, and so on. When I don’t feel like meeting anyone, I write online articles for audiences I care about. 4. Continuing education. I want to stay current on topics related to finance, economics, behavioral psychology and anything that catches my interest. Thanks to numerous sources such as Coursera, edX and MIT, there’s no shortage of online classes from reputed educators. If I’m not enrolled in a class, I’ll often read nonfiction. 5. Doing nothing. Finally, I reserve the remaining 10 hours a week for doing nothing, unless something unplanned comes up. I simply sit by the window with a pot of tea, look outside and let my mind wander. My new schedule is already showing results. While my days are busy, I’m no longer overwhelmed with dozens of things that have little significance. Sanjib Saha retired early from software engineering to dedicate more time to family and friends, pursue personal development and assist others as a money wellness mentor. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is the president and cofounder of Dollar Mentor, a 501(c)(3) nonprofit organization offering free investment and financial education. Follow his nonprofit on LinkedIn, and check out Sanjib's earlier articles. [xyz-ihs snippet="Donate"]

MY TAXES ROSE 50% in 2021. I've never paid so much before, not even during my peak earning years. I’m not upset about having to pay my fair share, but the extent of the increase puzzled me. After examining my tax return, I came away with a handful of insights. To be sure, I wasn't expecting a large refund. The reason: I suspected that a onetime employment windfall would cause me to owe money, so I withheld more taxes during the year. I wanted to avoid an underpayment penalty at all costs. While the workplace windfall and some employer stock vesting contributed to higher taxes, I made moves in my taxable brokerage account that increased the pain. I had rebalanced my portfolio in early 2020 to take advantage of the stock market swoon. The market recovered and soon my stock allocation exceeded my target portfolio percentage. I trimmed my stock holdings in 2021 to get them back to an acceptable size. Many of the stocks I sold last year had risen in value, so rebalancing increased my capital gains for the year. I’m not much bothered by that. Regular rebalancing is part of my investment process, and this was the expected result. Here’s where the unexpected happened: I invested the rebalancing proceeds in a short-term inflation-indexed Treasury ETF. I wasn’t planning on much income from this investment, thanks to the chronically low interest rate. But soaring inflation changed the dynamic, boosting the value of inflation-indexed Treasurys—and leading the fund to distribute a large sum that was taxed at the ordinary income rate. The most unexpected surprise came from capital gains distributions in my ETF portfolio. Vanguard International Dividend Appreciation ETF (symbol: VIGI), for example, distributed more than 6% of its net asset value in capital gains. Half of those gains were short term, so they were taxed at the ordinary income rate. It was an unfriendly reminder that the vaunted tax-efficiency of ETFs isn’t guaranteed. To prepare for the taxes we might face, we can keep a close eye on our portfolio. Our brokerage statements will list the dividends and interest we receive. Fund company websites will tell us what size distributions to expect. Sound like too much work? Alternatively, you might keep a little extra cash on hand—just in case you owe money when you file.

DURING MY SCHOOL days growing up in India, my exposure to English literature was confined to textbooks that reprinted essays and short stories, or portions thereof. One of them was a humorous piece by Stephen Leacock from his book Winnowed Wisdom. The excerpt was titled “Old Proverbs Made New” and it seemed funny even to a middle-schooler with a limited grasp of the English language. It argued, with examples, that proverbs get outdated and need to be rewritten. It recently dawned on me that Leacock’s contention also applies to personal finance. Here are eight popular sayings, along with my tweaks: 1. Hard work never hurt anyone. Yes, it does. In fact, successful investing requires so little effort that laziness is almost a virtue. Working too hard at investing can do more harm than good to our long-term performance. For instance, we might try hard to time the market, only to find that it doesn’t really work. We might expend too much effort finding the next highflying stock, only to watch our hard-earned money slip away. We might burn midnight oil overdiversifying our investments, only to end up with an unruly, complicated mess. On the other hand, a simple portfolio, consisting of a few low-cost diversified funds, needs nothing more than occasional rebalancing. Hard work can hurt investment results. 2. Proof of the pudding is in the eating. Intuitively, this sounds right, doesn’t it? The final result should be the only way to judge something’s quality. This is true for cases where there’s little room for uncertainty. It doesn’t, however, apply to financial and investment decisions. Why not? Because luck and randomness contribute to the outcome. It’s difficult to separate luck from skill. In her bestselling book Thinking in Bets, Annie Duke explains that the measure of a great decision isn’t whether the eventual outcome is great. Instead, it’s about the process and thinking behind the decision. A great decision increases the odds of a great outcome but doesn’t guarantee it. The proof of the pudding is in the making. 3. Slow and steady wins the race. I’ve always loved this lesson from Aesop’s fable. I try to practice it whenever I can. The slow-and-steady mantra works equally well in investments and financial success. Why, then, am I complaining? My objection is to the part about “winning the race.” Our financial life is not a competition. There’s nothing to win and nobody else to beat. It’s about getting there and enjoying the journey along the way. Slow and steady enjoys the race. 4. Curiosity killed the cat. I couldn’t disagree more. Whether we manage our own investments, or let our friendly financial advisor do it for us, or blindly assume a family member is making prudent money decisions on our behalf, curiosity can be our best defense against nasty surprises. [xyz-ihs snippet="Mobile-Subscribe"] How? Curiosity raises awareness, busts assumptions and reveals blind spots. Unless we’re curious, we may never know for sure if the family member is making good financial choices. We may overlook the hidden fees or risks associated with the investment and insurance products we bought. We may not question whether the advisor’s compensation model is the best one for us. Curiosity saves the cat’s wallet. 5. A penny saved is a penny earned. Lowering our living costs by a penny may indeed be the same as earning a penny more, assuming we ignore the pesky issue of income taxes. But what if we actually save that penny, so we can spend it at some point in the future?  That penny saved is the same as earning the future value of that penny, not its face value. Invest it wisely and we could end up with more than a penny. A penny saved beats a penny earned. 6. A bird in the hand is worth two in the bush. Not in finance and investments. We’re often better served by letting the bird in hand go and patiently awaiting a superior reward in the future. Take Social Security. The most popular age for claiming Social Security is 62. While some need to claim early because they have no other financial choice, most people are better off waiting until age 70. In reality, alas, very few people wait. They give up higher lifetime guaranteed inflation-adjusted income to grab whatever is available now. The “bird in hand” mentality proves unwise. Similarly, I’ve seen folks hesitate to contribute to a workplace retirement account, simply because they have to wait a long time before they can withdraw the money without penalty. They’d much rather pay taxes now and get their hands on the cash. A bird in the hand leaves many in the bush. 7. There’s no free lunch. Evidently, whoever coined this popular adage overlooked personal finance. No, I’m not talking about the dubious free meal investment seminars that regulators caution us against. I’m talking about genuinely free lunches. Looking to reduce your investment portfolio’s risk? Try combining investments that are loosely or negatively correlated with one another. The overall risk of a diversified portfolio will be less than the weighted average risk of its individual constituents. The reduced volatility is your free lunch. Can’t afford to make 401(k) contributions? At least put in enough to get the employer’s match. Even if you withdraw after vesting and pay a 10% penalty, you’ll still retain the remainder of your employer’s contribution—another free lunch. Trying to build a small emergency fund from a meager paycheck? If you’re eligible, stash dollars in a Roth IRA. You can take back the money at any time, while leaving open the option of tax-free growth. In investing, there is such a thing as a free lunch. 8. A little knowledge is a dangerous thing. Expertise and specialized training may be necessary in many situations, but not always. With a little knowledge and initiative, we can do many things ourselves. Not convinced? Consider our physical health. Elementary knowledge—eating balanced meals, avoiding junk food, staying physically active and so on—goes a long way toward a healthy lifestyle. We don’t need to be doctors or nutritionists to lead a healthy life. The ingredients of emotional well-being are also simple: Show gratitude and care, count blessings, nurture friendships and so on. A degree in psychology is missing from this list. Likewise, we don’t need a PhD in finance to be successful with money. Things like living within our means, keeping costs low and investing for the long term are the necessary and sufficient ingredients. A little knowledge can be a powerful thing. Sanjib Saha is a software engineer by profession, but he's now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Check out his earlier articles. [xyz-ihs snippet="Donate"]