ETFs have been advertised as one of the best investment tools for the retail investors to easily take advantage of investment themes. With its low expense fees, high liquidity and flexibility, what’s not to like right?
Ever since the original ETFs came on the market (SPY, QQQ, DIA just to name a few), tons of ETFs have been created for virtually every way of investing you can think of. There’s one for investing in gold (GLD), another for investing in Hong Kong index (EWH), and there’s even one to short markets like the financials (SKF).
Be careful with ETFs
If you are like most people, then you probably invest in ETFs just based on the name. This is extremely dangerous! Let me explain by using the UltraShort Real Estate ProShares (SRS) as an example.
You’d think that with housing down huge this year, this ETF that uses leverage to short the market will be up big right? Wrong! In fact, with the Dow Jones US real estate index down about 40% this year, SRS is down almost 50% YTD!
Reading the Fine Print
So what’s the deal? Well, if you read the fine print, you will see that SRS aims to double the real estate index’s daily performance, not double the long term performance! So, if volatility is high, virtually all gains are wiped out!
The funny thing is that this ETF actually has a yield which doesn’t make sense at all! Dividends are supposed to be paid by investors shorting that particular stock, so why would an ETF that short a market be able to provide a yield when it should be paying a yield back?
Takeaway for Investors
It’s unclear why so many of these ETFs are allowed to exist because it does nothing to help investors gain confidence in this market. Before you seriously consider any ETF from now on, it is crucial to examine the fund profile and to fully understand how each ETF makes or loses its money before putting your hard earned money into the market.
Don’t ever buy into an ETF based on its name ever again!
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{ 5 comments… read them below or add one }
I just saw some guy at CNBC talk about the same thing today after the close so great timing! He was talking about the DIG and DUG ETFs but same idea! It’s very dangerous out there and thanks for the heads up!
Yup, leveraged ETFs, whether they’re long/bullish or short/inverse/bearish are NOT good long-term plays. Buying an inverse NON-leveraged ETF and a regular NON-leveraged ETF that both cover the same market/index simultaneously would get you close to even/breakeven over a period of time. Buying an inverse LEVERAGED ETF and a regular LEVERAGED ETF that cover the same index simultaneously is virtually guaranteed to be a losing strategy over time. Both the long AND the short will lose ground.
If one is up and the other is down, the one that is down will be down more than the one that is up, over time. But it’s also probably they will BOTH be down over time. This of course means SHORTING both Leveraged ETFs in a margin account is a *relatively* low risk strategy that is virtually mathematically guaranteed to make money.
Bottom line, do your homework people. I own a couple of non-leveraged ETFs as long-term investments. I also make small day trades on occasion with leveraged ETFs (2X and the new 3X ones), but I never mix the two up. Investing and trading are very different things.
The fees are creeping up with some of the odder ETFs out there, too.
Leveraged ETF’s should only be used for trading purposes and never held long term in a portfolio. They also have the potential to expose you to massive losses.
Kevin: Thanks for the insight! I was wondering about shorting both leveraged ETFs as a good strategy, but that might be too complicated for the average investor (shorting a leveraged bear fund).
Monevator: I really hope that the ETFs won’t become another set of mutual funds with high fees down the road!!
Mark: Definitely agree with you about the massive losses as some of those funds are down big this year. I guess if you know what you are doing, these funds can give you quick gains but we all know what happened to people that leveraged to no end!
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