CMU: The real life dangers of holding leveraged ETFs

Cracked.Market University: 

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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