These Investments Just Don't Work

That explains the appeal of exchange-traded funds
that let you multiply your returns over those of particular indexes or
sectors of the market. And while you might think that magnifying your
gains could only help your cause in the long run, the reality proves
much more disappointing.

Great for short-term plays

What's behind
this fundamental misunderstanding of these ETFs? The problem is that
while the leveraged ETFs hold themselves out only as delivering on
their promises over very short periods of time -- typically a single
trading day -- some investors misuse them by holding them for longer
periods.

At first, that seems to run counter to the Foolish idea of holding
investments for the long run rather than trading frequently. But to be
a good long-term holding, an investment has to be designed to be held for a long time -- and that isn't the case for these ETFs.

Heads I win, tails you lose

The results make these ETFs look like a no-win scenario for investors. Consider these returns since the beginning of the year:

Source: Yahoo Finance. As of April 20.

You'd think that by choosing a particular market or sector, you'd at
least stand a chance of making a winning bet. But even a relatively
short period of a few months is long enough to make an investment
that's designed to be held for only a day or so break down from what
investors might expect -- and it's quite possible that everyone ends up
a loser.

A closer look at how these ETFs work explains a lot. In order to
produce magnified returns, these ETFs often use a sophisticated
derivative known as a total return swap. The time period of those swaps
defines the appropriate holding period for the ETF. Theoretically, it
should be possible for an ETF to make transactions that would produce
two or three times the annual return of an index or sector -- although it might be more costly for the ETF.

In appealing to short-term investors, though, these ETFs aren't
targeting shareholders with that kind of long-term focus. So they
really only work well for day traders.

Get what you want

A good sign, though,
is that people seem to increasingly understand these trades. One
brokerage firm reports that many customers trade in and out of these
ETFs in just a matter of hours.

Nevertheless, these ETFs serve as another example of how you have to
research every investment decision you make. It's not enough to think
you understand how an investment works, or to take a brief glance at
the name or description of a particular security. Rather, you need to
be diligent in poring over your investments to ensure they'll behave as
you expect.

Obviously, everyone would like to make back as quickly as possible
some of the money they've lost recently in the market. ETFs that
promise double and triple returns, however, don't fit the bill for long-term investors
looking to make solid investments. While these ETFs may make a useful
tool for short-term traders, you'll be better served sticking to traditional funds and ETFs like the SPDR Trust (NYSE: SPY) ETF -- and the slower but steadier returns they offer over time.

For more on ETF investing, read about:

• What Warren Buffett thinks about ETFs.
• The most expensive ETFs you'll never need.
• ETF investing in a nutshell.
• © 2009 UCLICK, L.L.C.