5

Strategy is outlined here:

Using Leveraged ETFs To Game The Roth IRA Maximum

Essentially, you keep 1/3 of your portfolio in a 3x leveraged ETF and 2/3 in cash. The author claims this combination (with sufficiently regular rebalancing) behaves the same as 100% in the underlying index of the ETF.

The advantage being that you can hold the 1/3rd inside an IRA and have the cash 2/3rds outside, effectively tripling your IRA contribution maximum compared to investing 100% in the unleveraged index ETF inside the IRA.

I'm wondering if there are any obvious problems with this strategy? The author outlines a few (transaction costs, underexposure to the index when it falls very rapidly) but they don't seem to outweigh the benefit of 3x contribution to a tax-free account.

2

It's a very interesting strategy, and the author has done a great job of detailing how it works.

There is one potential dilemma that I can think of that I don't think the author has addressed.

The key to this strategy is rebalancing between the leveraged ETF and the cash to ensure that the 1:2 ratio is maintained. When the ETF goes down, the investment in the ETF needs to be increased, and this happens by contributing to your Roth IRA. This means that some of your contribution limit is "used up" by rebalancing. Once this thing grows to a sufficiently large amount, you could find yourself in a situation where you cannot rebalance to where you want because the contribution limit is not high enough to do so. For example, if you have $300k in your Roth/ETF and $600k in cash outside the Roth, and the market goes down 10%, you would need to move $20k to restore your balance, which is quite a bit higher than the contribution limit.

This would be solved somewhat by keeping some cash in the Roth from years where the market was up. In those years, you sell some of the ETF, but the cash would stay inside the Roth, which could then be used for rebalancing in the future without using up the contribution limit. Because of this, I don't think the dilemma I described is really much of a problem.

That's the only possible downside I could think of. It sounds like a good strategy for people that want to invest much higher than the Roth limits. Thanks for posting it.

  • +1, but not understanding why the "triple leveraged effect" we've discussed here doesn't seem to impact this ETF. We've discussed how the daily 3X will result in far less than 3X over the long term, yet, the lifetime return of this ETF is 789% vs 124% for the S&P? – JoeTaxpayer Nov 26 '16 at 16:07
  • @JoeTaxpayer: Which ETF is "this ETF"? I don't see any particular ETF symbol or name specified in either the question or answer, and even knowing you're comparing to the S&P is not sufficient because multiple parties offer leveraged index ETFs. – Ben Voigt Oct 27 '18 at 15:09
  • It doesn’t matter, there have been multiple Q&A about leveraged ETFs and how they are not suitable for long term investing. That’s what I was commenting on here. – JoeTaxpayer Oct 27 '18 at 15:56
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It seems to me, that it's possible to implement a strategy that's a bit more lucrative than this. Instead of making the investment "inside" the Roth, purchase the ETF in a pretax IRA. Then convert it. At tax time, 15 months later, if the S&P had a positive performance the Roth should see nearly 3X that. You pay the tax on the conversion and move on. If the S&P was down you recharacterize that money, wait 30 days and start again.

Edit - The recharacterization of conversions to the Roth IRA is no longer permitted as of the tax code that went into effect for 2018.

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