The Little Book of Safe Money by Jason Zweig

Author:Jason Zweig
Language: eng
Format: epub
Publisher: Wiley
Published: 2010-05-10T16:00:00+00:00

What a Difference a Day Makes

When you buy an ultra ETF, you can be sure what return you are going to get each day. An ultra ETF? Twice as much as the market! (A 5 percent gain in the index is 10 percent in my pocket.) An ultra-short ETF? Twice the inverse of the market’s return! (A 5 percent loss for the market is a 10 percent profit for me.)

And that is exactly what will happen if—but only if—you hold your ultra fund for one day and no more. If, though, you hold on for more than a single day, then you may have just chucked your assets into Pandora’s box.

Yes, you might hit the jackpot and double or triple your money. But it’s also possible that you will make next to nothing, lose money, or almost get wiped out. The long-term returns of ultra funds are a wild crapshoot that can distort the returns of the underlying markets beyond recognition.

What accounts for this helter-skelter divergence between the short term and the long term? I want to make sure you see exactly how things go wrong with these funds, so please indulge me as I toss some numbers at you.

Picture an imaginary ETF that I will call the UltraShort SunStocks Fund, which seeks to deliver 200 percent of the inverse of the daily returns of the SolarTruth index of companies in the photovoltaic business.

Remember, the ultra-short ETF goes up twice as far when the index goes down—but it also drops twice as much when the index rises.

And there’s the catch: Because the fund goes down twice as far on its bad days, it can wander farther and farther away from the underlying index over time.

Let’s say the Solar Truth index goes up or down exactly 2 percent on alternating days. Here’s what you’ll experience over the course of just four days if you hold either the index itself or the ultra-short ETF that moves twice as far in the opposite direction:

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