No. of Recommendations: 5
I don't think those funds work this way. They work more like the following -
* You buy the fund, let's say $1000
* A month goes by, no big drop, no big gain, now you have $970 in the fund…
If the market stays the same, the fund loses you nothing - that’s not the problem. The real problem is that these leveraged funds take advantage of some mathematics that virtually guarantee losses, over any time reasonably long time period (like more than a month or two).
Here’s how it works:
With a non-leveraged fund that goes up a little and down a little, but basically stays even, this means that the days when there is a loss (say from $100 to $98, i.e. down 2%) are counterbalanced by days when it is up $2 from $98 to $100, i.e. up 2/98=2.04082%) But if you multiply those percentage changes by 3, you get a loss of 6% on one day ($100 goes to $94) and a gain of 6.12245% on the up day ($94 goes to $94*1.0612245=$99.755102.
As one can see from this example, an equal loss and gain that would have balanced out in an unleveraged investment can leave you well behind (a quarter of a percent in this example) after just two days. Theay’s a small loss, and it would be even smaller for smaller moves down and back to the starting point, (or the same thing in the reverse order), but there will always be a loss, and over time, those losses will be large, eventually (over several years) potentially losing you your whole investment.
If you look at how these investments have done in recent years. the typical answer is, remarkably well. That is because the last few years have seen very strong gains, and leveraging these gains has more than made up for the slippage described above. But in most markets, i.e. in periods where there are no strong consistent gains in the overall market, they will perform poorly.
If you want leverage (although the most sage advice is to avoid leverage), options are almost certainly a more economical way of obtaining it.
