Yesterday I wrote about the compelling benefits of buying the Covid bounce using a 3x leveraged ETF. No doubt the impressive 200% gains grabbed people’s attention. But no discussion about leveraged ETFs is complete without also discussing the negatives.
I often have people ask me why they shouldn’t just buy-and-hold leveraged ETFs. If 1x is good, obviously 3x is even better, right? Not so fast. There is a weird quirk in the compounding of leveraged ETFs that makes losses loom larger than gains.
I will dig into the math in a future post, but for now, we don’t have to look any further than the current market swings for a striking example of this damaging quirk in action.
The chart in yesterday’s post was a little deceptive because I truncated the timeframe to include very little of the Covid selloff. If we expand the timeframe to include the previous highs, as I did above, it becomes strikingly obvious what the problem is.
While the S&P 500 recovered all of the Covid selloff this week, the comparable 3x leveraged ETF is still down a shocking 29%!!!
Any patient, long-term investor that held a 3x leveraged ETF through the Covid collapse and subsequent rebound is still down a staggering amount of money. And that’s only if he had the tremendous courage required to sit through a 75% plunge during the Covid lows. I don’t know about you, but I would definitely have second thoughts if I saw my life savings shrivel by 75%.
Leveraged ETFs are wonderful tools when used for short-term swing trading. But holding them for longer time frames is a dangerous and foolish thing to do. If you only remember one thing from all of this, let it be:
Leveraged ETFs are ONLY suitable for short-term swing-trades.
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.