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I'm 23, and in addition to my 401k at work, I have a few thousand saved in an IRA. Right now I have it sitting in Treasurys earning around 3%.

Over the past 50 years the S&P has averaged around 11% per year in total returns. I'm perfectly willing to invest it in an index (like the S&P) or in a few bellwether-style single stocks (think Warren Buffet: KO, BAC, JNJ, etc). Most mutual funds underperform the market, so I'm not really interested in trying to pick those out at this point (unless you have a convincing argument).

I'm looking for feedback on the idea of investing the IRA balance in a 3x leveraged S&P ETF, specifically UPRO. My thinking: If the S&P averages 11%, this should average ~33%, minus fees of about 1%. The balance of the IRA is about $5k, and I'm not drawing retirement for another 40 years, so if somehow I "lose everything" it's not going to ruin my life. My future contributions to this IRA will probably be put in something safer, but I'm willing to take a risk now.

Is my thinking on how this 3x leveraged ETF works correct, or am I missing something?

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No. Not risky. Just one of the stupidest ideas ever. You are guaranteed to lose money over the long term with daily-leveraged ETFs. If you really want to invest with borrowed money, bite the bullet and borrow it yourself. –  fennec Oct 20 '11 at 4:13
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This is why I asked the question before I did it, because I don't know that much about them. –  Travis Webb Oct 20 '11 at 15:18
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I just wanted that to be painfully obvious to anyone who found this question. :) –  fennec Oct 21 '11 at 1:53
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3 Answers

up vote 12 down vote accepted

Keep in mind, if the S&P were up 10% one day and down 10% next day, I am down 1%. But triple this, and 1.3 x .7 is .91, down 9%. This phenomenon is enough to make these 3x type ETFs not recommended for the long term.

Since you are considering this strategy with your hard-earned money, I respectfully suggest this exercise. Take an X day period, 10 days, 100, you decide. I'd go high. Create a spreadsheet with a column of the S&P index and next column its return for that day. In next column, triple it, and then calculate total return for the period. I may do this very thing for an article I plan to write, a follow on to my "ETF'd" which focused on the inverse ETFs out there.

My simple example was to exemplify one simple point, returns are cumulative. If the S&P can be down 1% over a 2 day period, but your triple ETF isn't down 3%, but a full 9%, what do you think you'll learn from the spreadsheet exercise? Be sure your time period includes the week the S&P moved over 50 points each day. Over a long period, those volatile days will happen with some regularity.

@chris thanks for the comments, it seems my original response was too simplistic, I added further thoughts with this edit.

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I don't care what it does in one day, I care what it does over 40 years. My holding period is forever. –  Travis Webb Oct 19 '11 at 11:52
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Supporting reference. Refer to proshares.com/3xetfs/index.html: "UltraPro ETFs seek to provide a return of 300%, or 3x, the return of an index for a single day [...]" –  Chris W. Rea Oct 19 '11 at 11:54
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@Travis, Joe is trying to tell you that these products are not designed for the long term. By design, they are more likely to fail to deliver you returns over the long term even if the market itself has performed admirably. Go here, read this, admire the comparison chart and allow your jaw to drop: seekingalpha.com/article/… (fixed the link) –  Chris W. Rea Oct 19 '11 at 11:57
    
Thanks for the reference, that makes much more sense. Thanks. –  Travis Webb Oct 19 '11 at 23:03
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Leveraged ETF's don't work that way. They only provide the expected leverage over the short term - maybe a few days or weeks. On time frames longer than that, they go down and do not track the index.

You can see for yourself by comparing UPRO and S&P 500 on the same chart. The longer the time frame, the greater the difference.

By the way, one solution is to buy the unleveraged S&P 500 index on a regular basis (like monthly). Look for the one with the lowest fees (like Vanguard).

Another solution is to buy when the market is down. Since you will not be using the money for 40 years, this strategy would (in theory) provide much better returns.

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Bottom Line: If the S&P is at 1600 now, then one year from now it is at 1600 still, you will be way down. Leveraged ETF's suffer from decay, so you have two weights pulling it down and only 1 pushing it up. Also, if you are looking at an ETF that uses futures, the you Must understand futures, contango, and backwardation. You're swimming with sharks don't forget.

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Can you elaborate as to why you have still suffered a loss, outside of inflation, if you have not exited your long position and the level of the security remains unchanged (or has re-attained the level it held a year ago)? –  John Bensin May 20 '13 at 23:56
    
Just overlay the SPY ticker with the UPRO ticker on a chart and its clear that over long periods when the price of SPY returns to its past previous price, there is significant decay in the UPRO ETF. –  scuzzlebuzzle May 21 '13 at 10:32
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