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Due to the way gains compound on one another, and the daily resetting of leveraged ETFs, a 3x ETF will yield MORE than 3x of the underlying asset (in a bullish market), sometimes up to 10x gains in a yearly period.

This makes the long-term investment look very tempting but any reward should come with risk.

I've investigated the risks, and have debunked a few of them myself:

  • In a stagnant market, a leveraged etf is subject to volatility drag and higher management fees, however the market has not been stagnant in the last 100 years. Any period of stagnation is short-lived, and similar to the principle of value investing, we would be looking to hold the asset for more than 5 years. Any sort of loss over some period (say 10% loss over 5 stagnant years) will be received again by only a 3.3% upswing in the asset. I feel like this "risk" is sort of moot.
  • If the tracked asset falls 33% in a day, the fund will be wiped out (assuming 3x etf) If we invest in a broad-reach etf (SPXL, TQQQ) we would effectively eliminate this risk, because the underlying asset, being the market, will need to fall 33% but there are limits on the US market so that the market cannot fall more than 20% in a single trading day.
  • If the underlying asset falls, a significant portion of the investment will be lost Underlying assets tend to rebound. If there is a drop of 10%, the asset tends to recover by at least 11% in the future and considerably more. Assuming the underlying asset is the market, it has always recovered and exceeded previous highs. Therefore this risk contributes more to timing than anything -- if I know I need to pull money out in exactly 5 months, the market could be down, but assuming I don't have a need to pull the money out at any specific point in time, i mitigate the risk of withdrawing during a low market, eliminating losses here.
  • Diversification is important so do not put all your money in one stock Something like the SPXL or TQQQ will track a diverse market, therefore diversification is built in.

With all of this, a 3x ETF tracking the market (SPXL, TQQQ) sounds like a clear winner. Historical records show a 15,000% gain over 11 years on TQQQ. If prior performance is any indicator of future performance then this would be an obvious choice.

Why is it that there is so much advice out there saying that I should not hold my money in a leveraged etf long term, what risks are they referring to that have not been covered, and is this a wise or foolish decision to put a significant portion of a portfolio into SPXL or TQQQ, compared to the underlying index (the market, which is generally considered a good investment)?

EDIT: the "market" referenced here is the US market

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    @user253751 ?? How about the leveraged ETFs that were actually suggested in the post? TQQQ recovered to previous highs last July, and SPXL this January. You are feeling awesome today even if you bought into either one last February. Jul 14 at 13:11
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    @user253751 Well, one good reason is that no ETFs at a higher leverage exist, as far as I know. Jul 14 at 16:12
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    @TylerM Ah, well apparently here in Europe there are 8x and 12x funds available. The trading platform I've used won't let you buy them without taking a test to show you are aware of the significant risk. Anyway, in March 2020, the 12x NASDAQ ETF dropped from about $200.00 per share, down to about $0.10. Not sure if this is a new incarnation now, because it should've been worth zero. Current share price around $15ish. That might be made up eventually, or it might not. If the NASDAQ crashes severely tomorrow, it may well go back down to $0.10.
    – user253751
    Jul 14 at 16:57
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    @user253751 I don't know what the optimal leverage factor is for most young reasonably secure people, but I'm pretty sure it's between 1.5x and 5x. Thanks for helping me out with understanding that metaphors are not literal, by the way! I always find that's so hard for me. Jul 14 at 22:03
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    @TylerM Surely if a 5x fund gets wiped out you may as well write it off and buy into the next 5x fund - what difference does it make whether you have $0 left over, or $0.0002?
    – user253751
    Jul 15 at 8:46
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Financial products should be "used as directed," unless you are an experienced finance pro. It's best to take the warning on the TQQQ webpage seriously, and avoid the product for long-term investment:

ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period

Long-term leverage for ordinary investors is still a dream, if not a pipe-dream, despite the obvious benefits. The authors of Lifecycle Investing advocate that young people lever up 50% by using the full margin privileges in a taxable brokerage account. But this means forgoing the tax benefits of an IRA. Leverage is not allowed in IRAs.

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  • Can you provide a source stating that the leveraged ETFs are not allowed in an IRA? I currently have a portion of my Roth IRA invested into TQQQ.
    – Tyler M
    Jul 14 at 16:38
  • As you pointed out, ProShares protects its self from liability by stating that the returns on any given period will almost certainly not be the same leverage as what it tracks daily. This is fine though, as it is what causes the highs to be so high due to the compounding. I don't see it as a risk, rather it describes the nature of how the fund behaves.
    – Tyler M
    Jul 14 at 16:40
  • Sorry i think i misunderstood -- you are saying the authors recommend buying on margin, which is not allowed in IRA - correct?
    – Tyler M
    Jul 14 at 18:00
  • @TylerM That's right. You can't use direct margin in IRAs, but you absolutely can access leverage via these ETFs. Jul 14 at 22:04

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