Time and time again it has been said that leveraged ETFs are only suitable for short-term investments, and that any gains would be erased over the long term.
I tried to do some backtesting to compare the performance of an index fund tracking S&P 500 with the performance of a daily rebalanced funds containing 2x and 3x leveraged S&P 500. All three funds start out with 100 USD invested in them. I also assume that I start investing when the market peaks (in my case, I did most of the testing on March 24, 2000 and October 9, 2007) to determine what is the worst-case scenario.
Since I invest funds once every 6 months or so to minimize commission fees, I also added 100 USD to each of the portfolios on the first trading day of each April and October in the simulation (except for April 2000).
Start year 2000:
| Date | Significance | 1x | 2x | 3x |
|---|---|---|---|---|
| October 9, 2002 | Market low | 421.10 | 290.15 | 201.63 |
| January 5, 2004 | 2x overtakes 1x for the first time | 828.76 | 831.46 | 829.62 |
| January 7, 2004 | 3x overtakes 2x for the first time | 831.80 | 837.55 | 838.75 |
| May 16, 2005 | 3x takes the lead and holds it until the peak | 1,166.23 | 1,190.40 | 1,192.55 |
| October 9, 2007 | Market peak | 2,142.67 | 2,736.33 | 3,362.49 |
| March 9, 2009 | Market low | 1,033.81 | 464.85 | 163.86 |
| February 19, 2013 | 2x overtakes 1x for the first time | 3,408.40 | 3,410.09 | 2,843.03 |
| March 6, 2014 | 3x overtakes 2x for the first time | 4,409.81 | 5,319.20 | 5,323.95 |
| June 30, 2016 | 3x takes the lead and holds it until the peak | 5,462.38 | 6,891.21 | 7,003.87 |
| June 2, 2017 | 6,556.06 | 9,457.92 | 10,995.94 |
Start year 2007:
| Date | Significance | 1x | 2x | 3x |
|---|---|---|---|---|
| March 9, 2009 | Market low | 150.87 | 64.90 | 23.98 |
| March 23, 2010 | 3x overtakes 2x for the first time | 520.62 | 516.24 | 522.57 |
| April 5, 2010 | 2x overtakes 1x for the first time | 627.30 | 629.46 | 642.56 |
| November 19, 2012 | 3x takes the lead and holds it until the peak | 1,277.67 | 1,357.33 | 1,359.24 |
| June 2, 2017 | 3,376.71 | 5,292.94 | 7,615.49 |
A thing that I noticed is that it took a longer time for the leveraged funds to recover after the 2007–2009 recession in the first scenario even though the leveraged funds started at a higher level than the regular S&P 500 index tracking fund. This is because the amount that is invested every 6 months is higher relative to the total amount that is in the fund at that point. Although I didn't do any calculations for this, as my wage increases I would be able to increase the amount that I would invest, thus decreasing the problem.
What matters is that since I do not intend to cash out for decades, even if I lose money during a bear market, I can wait for a few years in a bull market until I'm better off than if I had invested in an unleveraged fund and cash out even if it means missing out on further increases in stock prices. If I haven't made any mistakes in calculations and assumptions (please point them out if I have), I believe this proves that leveraged index funds' overperformance in bull markets outweighs their underperformance in bear markets.
One thing that I hear often about leveraged ETFs is that their price decays due to borrowing costs. Again, this is something that I do not observe: I compared UPRO, which is a 3x leveraged ETF tracking S&P 500, to the fund that I used in my calculations. I expected UPRO to underperform somewhat, when in fact it overperformed: if you put 100 USD in UPRO on October 23, 2015, that investment would be worth 160.28 USD on June 2, 2017. When I tried the same thing with my imaginary S&P 500 portfolio, it reached 150.59 USD. Of course, this is a short period and only shows the performance during a bull market, but I am still curious about this discrepancy.
I feel like I am either doing something wrong with my calculations, misunderstanding something about how this works or simply forgetting something – please point out any mistakes you notice. Also, feel free to share your long-term investment strategies for leveraged ETFs.
Submitted June 11, 2017 at 10:59AM by shparty http://ift.tt/2rjHVOY
