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, correct?
I've investigated the risks (risks associated with holding LETFs long-term), 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 underlying 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. (See trading curb ). Since LETFs re-balance each trading day, multiple -20% days will still never result in the LETF being "wiped out".
- 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 (i.e. SPY, QQQ, NDAQ), 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 (withdraw either 5yr, 6yr, 10yr.. all are valid), 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