The reason that UltraLong funds and the like are bad isn't because of the leverage ratio. It's because they're compounded daily, and the product of all the doubled daily returns is not mathematically equivalent to the double the long-term return. I'd consider providing big fancy equations using uppercase pi as the 'product of elements in a sequence' operator and other calculus fanciness, but that would be overkill, I don't think I can do TeX here, and I don't know the relevant TeX anyway.
Anyway. From the economics theory perspective, the ideal leverage ratio is 1X - that is, unlevered, straight investment. Consider: Using leverage costs money. You know that, surely. If someone could borrow money at N% and invest at an expected N+X%, where X > 0, then they would. They would borrow all the money they could and buy all the S&P500 they could. But when they bought all that S&P500, they'd eventually run out of people who were willing to sell it for that cheap. That would mean the excess return would be smaller. Eventually you'd get to a point where the excess return is... zero?
.... well, no, empirically, we can see that it's definitely not zero, and that in the real world that stocks do return more than bonds. Why?
Because stocks are riskier than bonds. The difference in expected return between an index like the S&P500 and a US Treasury bond is due to the relative riskiness of the S&P500, which isn't guaranteed by the US Government to return your principal.
Any money that you make off of leverage comes from assuming some sort of a risk. Now, assuming risk can be a profitable thing to do, but there are also a lot of people out there with higher risk tolerance than you, like insurance companies and billionaires, so the market isn't exactly short of people willing to take risks, and you shouldn't expect the returns of "assuming risk" in the general case to be qualitatively awesome.
Now, it's true that investing in an unlevered fashion is risky also. But that's not an excuse to go leveraged anyway; it's a reason to hold back. In fact, regular stocks are sufficiently risky that most people probably shouldn't be holding a 100% stock portfolio. They should be tempering that risk with bonds, instead, and increasing the size of their bond holdings over time.
The appropriate time to use leverage is when you have information which limits your risk. You have done research, and have reason to believe that you understand the future of an individual stock/index better than the rest of the stock market does. You calculate that the potential for achieving returns with leverage outweighs the risks. Then you dump your money into the leveraged position. (In exchange for this, the market receives information about anticipated future returns of this instrument, because of the price movement which occurs as a result of someone putting his money where his mouth is.)
If you're just looking to dump money into broad market indicies in a leveraged fashion, you're doing it wrong. There is no free money.
(Ed. Which is not to say there's not money. There's lots of money. But if you go looking for the free kind, you won't find it, and may end up with money that you thought was free but was actually quite expensive.)
Okay, so you don't like my answer. I'm not surprised. I'm giving you a real answer instead of a "make free money" answer. Okay. Here's your "how to make free money" answer.
Assume you are using a constant leverage ratio over the length of time you've invested your money, and you don't get to just jump into and out of the market (that's market-timing, not leverage) so you have to stay invested. You're going to have a scenario which falls into one of these categories:
- Over the course of your investment, the S&P500 outperforms the interest rate you pay to borrow money. Ideal leverage ratio: Infinite. Borrow all the money you can to buy all the stock you can (as an individual, I assume you're still not going to be dealing with enough money to substantially move markets.)
- The S&P500 does not outperform your interest rate, but it outperforms your bank account. Ideal leverage ratio: 1X. Invest the cash you have and don't borrow any.
- The S&P500 does not outperform your bank account, but its performance is flat or declines slightly. The magnitude of the rate of decline is less than your interest rate to borrow money. Ideal leverage ratio: 0. Keep your money in the bank account, earn interest on that.
- The S&P500 declines, and the decline is larger than the rate you pay to borrow money. Ideal leverage ratio: Negative infinity. Borrow all the stock you can, get money, put money in bank account to earn a little interest on the side.
The S&P500 historically rises over time. The average rate of return probably exceeds the average interest rate. So the ideal leverage ratio is infinite. Of course, this is a stupid answer in real life because you can't pull that off. Your risk tolerance is too low and you will have trouble finding a lender willing to lend you unsecured money, and you'll probably lose all your money in a crash sooner or later. Ultimately it's a stupid answer because you're asking the wrong question. You should probably ask a better question: "when I use leverage to gain additional exposure to risk, am I being properly compensated for assuming that risk?"