“It’s pretty easy to understand why some investors would be attracted to funds that promise double returns. For example, let’s look at the uninitiated investor that is considering a purchase of the NASDAQ 100, to which investors can easily gain exposure by buying PowerShares (QQQQ).
Here’s the typical (misguided) thought process:
1) I’m convinced that QQQQ will go up 10% a year, so I’d like to own it;
2) But there is a fund, Ultra QQQ ProShares (QLD) that promises 2X the Nasdaq’s return;
3) And 20% is more than 10%;
4) So I’ll just buy the leveraged fund (QLD) and be twice as happy.
Seems like a reasonable conclusion, right? After all, the fund’s literature clearly promises twice the daily return of the index. But the key word is daily. Daily is not monthly, and it’s definitely not annually.”
If you were prescient enough to predict the collapse of real estate last year, you could have earned a savory 40% return by shorting iShares Dow Jones US Real Estate (IYR) So logic would hold that owning UltraShort Real Estate ProShares (SRS) would have produced a positive 80% return, right? Absolutely wrong. I say absolutely because, in absolute terms, you would have lost even more money using the double-short fund—which is supposed to go up when the index goes down. The disappointing truth: the funds worked like they were supposed to. Before you declare my last statement as blasphemous, the fund did indeed perform as the prospectus declared it would. It is the investor that held the leveraged or inverse fund for more than a single day that erred in practice.