Leveraged ETFs are generally not a great investment for a long term investment since they do not necessarily behave as we might expect. One is a simple mathematical reason. Consider the 2 scenarios shown in the table below. The first scenario considers a stock that moves sideways by moving up 1% one day, down 1% the next and repeats this pattern. The second scenario is a bullish scenario where the stock moves up 1%/day for 2 consecutive days and then retraces 1% on the next day – the 3-day pattern is repeated.
In the first scenario we see that the loss on an unleveraged asset is $12 – so the double should be $24 right? but no – it’s $48!
In the second (bullish) scenario our unleveraged asset is up $820, so our double should be up $1,640, yes? but no – we’re up $1680 – nice but ??? For an inverse ETF simply change all the signs and we get the same result to the downside.
The reason is that the leveraged portfolio behaves like compound interest – it benefits us in a strong continuous move in one direction (greater than 2x returns) but generally hurts us in oscillating markets.
There are other considerations that do not work in our favor for inverse ETFs – these occur due to the fact that the allocation of shares in the ETF needs to be re-balanced every day (resulting in tracking errors) and that dividend payments need to be accounted for. However, the math is the easiest to understand.