As I was catching up on my Forbes reading, I came across this article about leveraged ETFs. Now I have shied away from any of the leveraged funds because their performance has confounded naive expectations. For example, when a particular index would be up 20% one year, one would expect the 2x fund based on that index to be up 40%. Experience showed us, though, that the fund might be up any where from 0% to 50%. when the index registered a single digit gain, the fund may actually have lost money. The key to the disconnect is in the mechanics of managing that leveraged exposure. The fund rebalances to its leverage target every day. That is the leverage on the initial NAV changes each day based on the cumulative gains realized since the inception of the investment. Thus if the index experiences a 50% increase, the fund will take on 50% additional leverage, but the performance will still be calculated on the original investment.
Inn strongly trending markets this can actually work in the investor's favor, delivering performance that is greater than the advertised leverage. In a directionless market with some volatility, the leveraged fund will tend to decline. This result can be traced back to the mathematics of loss and gain that we all learned early on: if an investment loses 50% of its value, it will take a 100% gain to break even.
The article acknowledges all of this and essentially says use them anyway. I would recommend against using any of the leveraged funds, suggesting instead to use a brokerage account and buying your index tracking fund on margin. The investor can maintain his leverage relative to his original investment, according to his own comfort. Also, you can probably find a cheaper fund in which to invest.
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