Leveraged and Inverse Leveraged ETFs Tracking The Same Index Can BOTH Lose Money

If you read the first post of this year you’ll have noticed I chose four securities as part of a friendly stock-picking game with some other personal finance bloggers. Fully three out of the four picks were leveraged ETFs. I need to point out that purchasing a leveraged ETF for a long term position can be a very bad idea as most people have no clue how they work. (My picks will really only work out if the market steadily marches in the right direction, volatility is a killer to these types of products. This should also be a good indicator as to just how seriously I’m taking the contest – i.e. not very! :) )

The key lies in the fact that they are designed to track 200% (or 300% or whatever the case may be) of the DAILY performance of the underlying index. So if an index has a 1 year return of 10%, it doesn’t mean you will earn 20% (or 30%) on your leveraged ETF. (In order to achieve this you would need to consistently re-balance the number of units you held – which can be done, and the leveraged ETF providers even provide the calculators to let you do it.)

Here’s the best evidence to show how this can work (can’t work):

The leveraged and inverse leveraged double exposure ETFs that track the S&P/TSX Capped Energy Index and the S&P/TSX Capped Global Gold Index ALL LOST MONEY for the 1 year periods ending November 30, 2008. Anyone want to venture a guess as to how this happened?

I also wrote about this a few months ago here with a more detailed explanation.