ETF investing done right

Money is pouring into exchange-traded funds. They can help your portfolio recover, if you choose the purest kind.

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4. Leverage? Are you nuts?
The premise of leveraged funds, designed for day traders, is tempting: They can magnify your gains by delivering two to three times the market's daily return. Inverse funds can deliver two to three times the market's opposite.

But you might lose money even if you're right about the market's long-term direction. Each day that stocks move differently from your bet - and even a powerful rally will have down days, and vice versa - these ETFs will register losses. It's simple math: When you lose money, you need a bigger percentage gain than you lost to get to even. Say you have a $100 investment that falls 20%. You need a 25% gain ($80 plus $20) to recoup.

As a result, over time they will probably lag their benchmarks, says Morningstar analyst Paul Justice - sometimes dramatically. Take the UltraShort MSCI Emerging Markets ProShares ETF, which aims to deliver twice the opposite of the MSCI Emerging Markets index. Last year the index fell 52%. But the ETF, instead of producing a gain, fell 25%.

NEXT: 5. Make sure you're scoring low costs
Last updated June 18 2009: 10:29 AM ET
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