Learn how leverage boosts yields—and how to avoid overleveraged funds.
If you’ve ever explored closed-end funds (CEFs) for your retirement portfolio, you’ve likely come across the term leverage. It’s one of the main reasons CEFs can offer such high yields—often in the 7% to 10% range or higher.
But what exactly is leverage, how does it work in a closed-end fund, and is it a friend or foe to your retirement income?
Let’s break it down.
What Is Leverage in a Closed-End Fund?
In simple terms, leverage means borrowing money to invest more.
Just like a homeowner uses a mortgage to buy a house worth more than their cash on hand, a closed-end fund borrows money (or issues preferred shares) to buy more income-producing securities—like bonds, loans, or dividend stocks.
This borrowed capital can amplify returns. If the investments earn more than the cost of borrowing, the extra income gets passed along to shareholders in the form of higher yields.
For example, if a CEF earns 7% on its portfolio and borrows at 4%, the difference—called the spread—can increase the fund’s income. That’s why leveraged CEFs often pay investors more than similar unleveraged mutual funds or ETFs.
The Benefits of Leverage
When used wisely, leverage can be a powerful income-enhancing tool. Here’s what makes it attractive:
- Higher income potential – Boosts your yield without taking on exotic assets.
- Enhanced distributions – More income-producing assets mean more cash flow.
- Diversification – Allows funds to hold a broader basket of investments.
For retirees seeking income, that extra yield can be a game-changer—especially when traditional fixed-income products yield just 3% to 5%.
The Risks of Leverage
Of course, leverage cuts both ways.
When markets rise or interest rates stay stable, leveraged CEFs can shine. But during downturns or when borrowing costs rise, things can get rocky:
- Losses are magnified – Just as gains are amplified, so are losses. A 10% market decline might mean a 15%+ hit to a highly leveraged CEF.
- Volatility increases – Leveraged funds can swing more sharply during turbulent markets.
- Distributions can be cut – If income drops or borrowing costs rise too high, payouts may shrink.
- Forced deleveraging – In severe downturns, some funds may be forced to sell assets to reduce leverage, locking in losses.
How to Spot Overleveraged Funds
Not all CEFs use the same amount of leverage. Here’s how to evaluate a fund’s risk level:
- Check the leverage ratio – Most CEFs disclose how much of their portfolio is financed by borrowed funds. A ratio above 30% should raise eyebrows for conservative investors.
- Review the fund’s borrowing costs – If the cost of leverage exceeds the yield of its holdings, future payouts could be in jeopardy.
- Look at the fund’s historical NAV performance – How did it perform during 2020 or 2008? If it dropped dramatically and took a long time to recover, it might be too aggressive for your comfort.
- Read the manager’s commentary – Do they take a cautious approach to leverage? Transparency matters.
The Bottom Line
Leverage isn’t good or bad—it’s a tool. In the hands of skilled managers, it can help generate the higher income many retirees are looking for. But used recklessly, it can introduce unnecessary risk into an otherwise conservative portfolio.
A sensible approach? Limit your exposure to highly leveraged CEFs, diversify across sectors, and pair them with more stable investments like Treasuries, utility stocks, or short-term bond funds.
This post is adapted from my book: The 8% Solution: Double Your Retirement Income With High-Yield Closed-End Funds, available now on Amazon.com in paperback and eBook formats.
Disclaimer: This post is for informational purposes only and is not investment advice. Closed-end funds carry risks, including the risk of loss. Past performance is no guarantee of future results. Always consult a financial professional before making investment decisions.
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