We have discussed the two reasons why leveraged index ETFs will disappoint long term investors here and here. Now we will show that levered short ETFs are also bad for long term investment, if you believe in the long term the index will go up.
Let's look at some simple math. If you start at an index value of 100 and it drops 5% on the first day, a long ETF with a starting value of $100 will drop 5% to $95, while the short ETF also at $100 will increase 5% to $105. If on the next day, the index rebounds by increasing 5%, the short ETF will drop 5% to $99.75 [105 x (1-0.05)], and the long ETF will rise 5% to $99.75 [95 x (1+0.05)]. Both end up at the same value, and both have dropped 0.25%, when they are supposed to be inverses of one another.
Taking this over more extended periods can cause even more accentuated problems. In volatile markets, like those seen in 2008 and 2009, even unleveraged ETFs can show significant discrepancies.
Put simply, long and unleveraged ETFs will generally behave like you expected from its index, leveraged and short ETFs can lead to unexpected results, especially an investor buys it as a long term investment.
Let's look at some simple math. If you start at an index value of 100 and it drops 5% on the first day, a long ETF with a starting value of $100 will drop 5% to $95, while the short ETF also at $100 will increase 5% to $105. If on the next day, the index rebounds by increasing 5%, the short ETF will drop 5% to $99.75 [105 x (1-0.05)], and the long ETF will rise 5% to $99.75 [95 x (1+0.05)]. Both end up at the same value, and both have dropped 0.25%, when they are supposed to be inverses of one another.
Taking this over more extended periods can cause even more accentuated problems. In volatile markets, like those seen in 2008 and 2009, even unleveraged ETFs can show significant discrepancies.
Put simply, long and unleveraged ETFs will generally behave like you expected from its index, leveraged and short ETFs can lead to unexpected results, especially an investor buys it as a long term investment.
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