Ouch.
Although you would think that owning a fund that protects against disaster is a safe bet long term, the opposite is true for a number of reasons.
Leveraged ETFs are like aircraft—complex products that need to be fully understood before you buy and "fly" them.
In "daily" leveraged products, for example, the portfolio is rebalanced or "reset" daily so that the securities and derivatives reflect the index. That may erode return due to expenses and other factors.
And you may not get the returns you think you should because the fund managers are holding imprecise derivatives such as futures and swaps, which are sophisticated bets on prices. Performance may not even closely track the underlying index, particularly in volatile markets.
Then there's the ongoing bugaboo of timing the market. How do you know when a bull market ends and a bear market starts? Most leveraged ETFs are best suited for those focused on jumping in and out of a market to either hedge a position or speculate. That's why the institutions are bigger, more sophisticated users.
Institutions may only hold leveraged ETFs for a few days to a few weeks, says Kevin Cook, a senior stock strategist who trades and advises on leveraged ETFs for Zacks Investment Research in Chicago.
"Daily-return vehicles should be a red flag for the small investor who doesn't know how they work," Cook says. "Don't think of them as a hedge—they are more of a trading vehicle."
Despite numerous warnings and disclosures posted by major inverse ETF firms such as Direxion and ProShares, individual investors are still getting into trouble with these volatile vehicles.
Earlier this month, Finra, the securities industry self-regulator, ordered Atlanta-based broker-dealer J.P. Turner Company, LLC, to pay more than $700,000 in restitution to 84 customers for "sales of unsuitable leveraged and inverse ETFs and excessive mutual fund switches." The company neither admitted nor denied the charges, but consented to Finra's findings.