Avoid Double and Triple ETF’s

I cannot believe I never thought of this, but it is very straightforward.  Double and Triple ETF’s, or leveraged ETF’s, have a simple mandate: Double the performance of their underlying’s daily return.

Important note.  The mandate is not to double the performance over a longer period of time.  1 day.  That’s all you get.  Then it starts over.

In other words, these are bad long term investments.  The attraction to these products shown by the volume increases in the markets is a very bad signal.

The math is fairly simple, but often overlooked:

Let’s say you make a $100 investment in each of three funds. One is a simple investment in an index. Then you have two leveraged funds that compound daily; one is double-long and the other is double-short (returning twice the inverse of the index). After one day, the index returns 10%. The index value would then be $110. The double-long would add 20% and end at $120, and the double-inverse would lose 20% and end at $80.

On day two, let’s say the index loses 10%. That means that the average return [(10% -10%)/2] would be zero. However, the index itself would end at $99 because 10% of $110 is $11, and $110 minus $11 is $99. The fund that promises double the return of the index but compounds daily would end at $96. Remember, this fund started the day at $120. Its return for day two is -20% (double the index’s loss), and leaves it with a $24 loss for the day. So, $120 minus $24 is $96. The double-short fund would also end at $96 because 20% of $80 is $16, and $80 plus $16 is $96.

Now have a look at the performance of some of these double and triple ETFs.

Credit is given to Morningstar on this one. They make the argument simple. There is a reason they do not invest in these products. This is very important to understand as the volumes of these take off. Steer clear unless you are a true intra-day trader.

*image source: morningstar.com

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