Leveraged and inverse ETFs

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Inverse and leveraged ETFs have goals like these: "ProShares Ultra S&P500 seeks daily investment results, before fees and expenses, that correspond to two times (2x) the daily performance of the S&P 500," "Direxion Emerging Markets Bear 3X ETF seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the performance of the MSCI Emerging Markets Index." They are not suitable for Boglehead investing. In fact they are not suitable for investing at all, only for short-term "trading" (speculation), and the companies that provide them say so.

Nevertheless, some investors become intrigued with seeming theoretical possibilities for improvements in long-term results though uses of leverage. Almost everyone understands that using leverage in the form of an actual loan or margin account is risking personal financial ruin and brokerages typically require you to sign a special disclaimer in order to open a margin account. However, some investors who have not done their homework mistakenly think that they can get the results of leverage without the risk of ruin, and without signing disclaimers, simply by purchasing shares of a leveraged ETF.

Anyone thinking of using an inverse or leveraged ETF needs to read and understand the fund company's factsheets and prospectus, which disclose the issues in language varying from veiled to clear. They also need to read the FINRA alert, Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors. "The SEC staff and FINRA are issuing this Alert because we believe individual investors may be confused about the performance objectives of leveraged and inverse exchange-traded funds (ETFs)." Remember that FINRA is basically part of the finance industry and does not tend to be alarmist about investment products--when they issue an "alert" there is good reason and one should take notice.

The purpose of this article is to illustrate exactly why inverse and leveraged ETFs do not do what some investors might hope they would do.

IN PROGRESS...