The SEC and FINRA have both put out special warnings about the risks to investors in leveraged and inverse ETFs.

While these products do what they say they do, many have made assumptions that aren’t true.

At the heart of the issue is the time frame the ETF tracks. At first glance, an investor may assume that an ETF that says its goal is to double the return of the index it's tracking would mean that if a year from now the index was up 10% that the leveraged ETF would be up 20%. However, that would be missing a key detail of how the fund works, namely that it’s tracking the index only on a daily basis, not the longer term.

The SEC provides a good hypothetical of what could happen to buy and hold investors.

On Day 1 an index starts with a value of 100, and a leveraged ETF seeking to double the return of the index starts at $100. If the index drops by 10 points on Day 1, it has a 10% loss and a resulting value of 90. Assuming it achieved its stated objective (it should be noted that this isn’t a given) the leveraged ETF would therefore drop 20% on that day and have an ending value of $80.

On Day 2, if the index rises 10%, the index value increases to 99. For the ETF, its value for Day 2 would rise by 20%, which means the ETF would have a value of $80 times 1.2, equaling $96. On both days, the leveraged ETF did exactly what it was supposed to do – it produced daily returns that were two times the daily index returns. But let’s look at the results over the two-day period: the index lost 1% (it fell from 100 to 99) while the twice leveraged ETF lost 4% (it fell from $100 to $96). That means that over the two-day period, the ETF's negative returns were four times as much as the two-day return of the index instead of two times the return.

Take this beyond two days and it’s easy to understand how volatile these leveraged ETFs can be over time. An example provided by the SEC showed that in the period from December 1, 2008, and April 30, 2009, one ETF that was seeking to deliver three times the underlying index fell 53%, while the index rose 8%, and an index seeking to deliver three times the inverse of the index fell by 90%.

As with any investment you must understand what you are actually getting into and the only real way to do that is to dig into the details. In this case, the time frame is easily assumed to be longer than one day. Leveraged and inverse ETFs may sound good -- after all, who doesn’t want to make twice the market return?

But if you are a buy and hold investor, you need to realize that these leveraged and inverse ETFs aren’t buy and hold securities.