why are triple leveraged ETFs a bad idea?

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Edge215
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why are triple leveraged ETFs a bad idea?

Post by Edge215 » Wed Feb 12, 2020 7:47 pm

can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.

Thanks in advance.

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Phineas J. Whoopee
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Re: why are triple leveraged ETFs a bad idea?

Post by Phineas J. Whoopee » Wed Feb 12, 2020 8:03 pm

Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.

We have a highly accomplished and high-income salesperson advocating them in threads here. I personally will stay away.

PJW

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Re: why are triple leveraged ETFs a bad idea?

Post by MotoTrojan » Wed Feb 12, 2020 8:05 pm

From 1955-2018 UPRO (3x S&P500) basically matched the vanilla S&P500, but with a nearly 98% drawdown and >40% volatility along the way.

Held in a well constructed portfolio they can be useful, but alone they aren’t a sure fire way to beat the market.

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Re: why are triple leveraged ETFs a bad idea?

Post by lkar » Wed Feb 12, 2020 8:06 pm

They are highly leveraged. So, you can lose a lot of value very fast and potentially even all of it.

In hindsight, they have been a very good idea during the bull market, though in December-January 2018-9 many were probably tempted to jump ship. A 33 percent drop leaves you with nothing.

Leveraged ETFs are not a bad or good idea per se. They are a very risky investment if not combined with some larger plan to hedge your risk. But they can also be very rewarding if you guess right. Long un-hedged leveraged ETFs do not match boglehead philosophy.

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Re: why are triple leveraged ETFs a bad idea?

Post by mrspock » Wed Feb 12, 2020 8:10 pm

You should check the HedgeFundie’s excellent adventure threads. Epically long read, but you’ll learn a lot, and understand why and how you hedge the downside risk.

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Re: why are triple leveraged ETFs a bad idea?

Post by rockstar » Wed Feb 12, 2020 8:10 pm


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Re: why are triple leveraged ETFs a bad idea?

Post by typical.investor » Thu Feb 13, 2020 3:37 am

Phineas J. Whoopee wrote:
Wed Feb 12, 2020 8:03 pm
Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.

We have a highly accomplished and high-income salesperson advocating them in threads here. I personally will stay away.

PJW
I don't see daily reconstitution as bad. When the 3X ETFs do well, you need to reduce your exposure. When they do poorly, you need to increase it. Whether that is monthly or quarterly or yearly (or weekly or daily) depends on how close you desire to be to the 3X return.

What is bad though is how they might perform in a rising rate environment. Stagflation (as unlikely as it seems, we can't rule out something catastrophic happening to the global supply chain) would devastate the strategy - even if you balanced 3X stocks and 3X bonds. That is the real risk I believe.

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Re: why are triple leveraged ETFs a bad idea?

Post by Tamarind » Thu Feb 13, 2020 5:51 am

Phineas J. Whoopee wrote:
Wed Feb 12, 2020 8:03 pm
Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.
This. I'll also add that many of these funds explicitly state in their prospectus that they are not appropriate for holding periods longer than 1 day.

I got burned by TBT right after the 2008 crash and learned from personal experience. Luckily I didn't have much to lose at the time. Take a look at the chart of that one over the fund lifetime.... :oops:. And I got out relatively early, but it was still awful.

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Re: why are triple leveraged ETFs a bad idea?

Post by Chicken Little » Thu Feb 13, 2020 5:59 am

Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.

Thanks in advance.
Who says they're a bad idea?

Some people invest in Total Stock and Total Bond and plan to work for 40 years.

Other people run risk parity so they can FIRE after 10 years.

tomayto / tomahto

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Re: why are triple leveraged ETFs a bad idea?

Post by typical.investor » Thu Feb 13, 2020 6:01 am

Tamarind wrote:
Thu Feb 13, 2020 5:51 am
Phineas J. Whoopee wrote:
Wed Feb 12, 2020 8:03 pm
Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.
This. I'll also add that many of these funds explicitly state in their prospectus that they are not appropriate for holding periods longer than 1 day.

I got burned by TBT right after the 2008 crash and learned from personal experience. Luckily I didn't have much to lose at the time. Take a look at the chart of that one over the fund lifetime.... :oops:. And I got out relatively early, but it was still awful.
Again, if you adjust your exposure based on returns, they can be fine.

That said, TBT is inverse or shorting and I wouldn't hold that for even a second. Shorting is clearly market timing. Holding leveraged long positions and adjusting to maintain your exposure isn't.

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Re: why are triple leveraged ETFs a bad idea?

Post by chipperd » Thu Feb 13, 2020 6:11 am

I actually laughed out loud, really, when I read this question. Both in terms of the content and in anticipation of some of the responses that the OP would get from this crowd.
Personally, I don't think these are a bad investment for a tiny portion of the play money in your portfolio. Depends on your goals and if you can keep the percentage really low relative to the rest of your portfolio.
Not for me as I like to sleep at night, but for some, they like the adrenaline.

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Re: why are triple leveraged ETFs a bad idea?

Post by ARoseByAnyOtherName » Thu Feb 13, 2020 7:26 am

Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.
Because you'll make so much money that you physically won't have room to store it all in your house. There will be so many stacks of $20 bills piled on your bed that you'll have to sleep outside on the street. So it's a bad idea because we are helping protect you against having way too much money. :sharebeer :sharebeer

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Re: why are triple leveraged ETFs a bad idea?

Post by nisiprius » Thu Feb 13, 2020 8:14 am

edge215, investments are always a bad idea if the person making the investment doesn't understand them well enough. A potential problem with leveraged ETFs is that, despite seemingly adequate disclosures, it is easy for people to misunderstand what they do. FINRA and the SEC think this is a problem. Another potential problem is that so many of them are so new and have only existed during a fantastic bull market during which most US stock investments have experienced sustained growth, hiding the potential issues that surface in volatile markets.

I'm going to present a quiz. I would venture a guess that most of the people in this forum who like and use leveraged ETFs could all pass it easily without doing any checking, using quizmanship to guess the correct answer from among the choices presented.

If you actually bother to take the quiz, at the end of it I hope you will be convinced that triple leveraged ETFs are not easy to understand and that anyone using them really needs to dig beneath the surface of a name like "3X S&P" or "3X QQQ"

1) Which of these three phrases is a direct quotation from Direxion's web page presenting TECL? Hint

a) "You know that TRADING is different from investing."
b) "Direxion leveraged ETFs give you the most of the benefits of leverage without the risk of a margin call."
c) "Direxion: leading the ETF revolution for over a quarter of a century."

2) ProShares says "ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period." "Possibly direction" implies that it is possible that TQQQ could lose money over a period of time during which QQQ made money. But has this ever in history really happened? Answer

a) No, they just have to make the disclaimer because it is a theoretical possibility.

b) Yes, it has really happened.

3) XLK and TECL are both linked to the same index, the S&P Dow Jones Technology Select index. XLK holds a total of $28.7 in assets. How much in assets does TECL hold?

a) $31.9 billion
b) $5.8 billion
c) $1.6 billion

4) Direxion says "These leveraged ETFs seek a return that is 300% or -300% of the return of their benchmark index for a single day." They put the phrase "for a single day" in italics. Which is correct?

a) It is technically true, so they have to disclose it. But by simple math, over any number of days, if you get triple the return every day, you should get about triple the return over any number of days.

b) You will get something close to triple returns when the underlying index is in a sustained, fairly steady upward trend, but not when the index is experiencing volatility and trading "sideways."

5) One of the oldest leveraged products available is ULPIX, ProFunds UltraBull mutual fund, a 2X leveraged S&P 500 fund. Suppose that on 11/26/1997, investor U invests $10,000 into ULPIX and investor V invests $10,000 into the plain old unleveraged Vanguard 500 Index Fund, VFINX. They let it sit reinvesting dividends, and comparing notes. First investor U pulls far ahead. After the tech collapse, on 9/30/2002, investor U is behind, with $5,441 to investor V's $9,448. Investor U has about half as much. Eventually, though, with 3X leverage, investor U would have caught up. Of course, "catch up" means he has not achieved 3X or 2X, only 1X.

When would investor U have caught up? Answer

a) 12/31/2005
b) 10/31/2007
c) 2/12/2020

6) Direxion invites investors to "Go where there’s opportunity, with bull and bear funds for both sides of the trade" while reminding us that "the opportunity to take advantage of short-term trends is only won, if you get the direction right." From 1/1/2008 through 12/31/2010, an investor in the Vanguard 500 Index Fund would have lost, cumulatively about 9%, so the direction was down. Direxion had two funds available during that time period: the Direxion Monthly S&P 500 Bull 2X Fund, DXSLX, and the Direxion Monthly Bear 2X Fund, DXSSX. Imagine two investors, L and S, investing over this time period in DXSLX and DXSSX, respectively, while V invests in the Vanguard 500 index fund. Hapless investor V lost money, but investor S "got the direction right." What would have happened over this time period? Answer

a) Investor L--in the long fund, DXSLX--would have lost money. Investor S--in the short fund, DXSLX--would have made money.
b) Both investors L and S would have lost money, but investor S would have not have lost as much as investor V.
c) Both investors L and S would have lost more money than investor V.

7) The Bogleheads investment philosophy, as well as the advice from may experts, calls for retirement savers to invest in simple portfolios of index funds, and buy and hold them for the long term, staying the course without big changes. Leveraged ETFs can be used in more than one way, but we will only consider long-term holdings for retirement savers. For this purpose, which is true? Hint

a) If an investor is risk-tolerant, substituting a triple leveraged ETF in place of place of a conventional unleveraged index fund can be a good way to boost long-term returns.

b) Triple leveraged ETFs are unsuitable as long-term, unmanaged, buy-and-hold holdings.
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Re: why are triple leveraged ETFs a bad idea?

Post by Tamarind » Thu Feb 13, 2020 9:21 am

typical.investor wrote:
Thu Feb 13, 2020 6:01 am
Tamarind wrote:
Thu Feb 13, 2020 5:51 am
Phineas J. Whoopee wrote:
Wed Feb 12, 2020 8:03 pm
Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.
This. I'll also add that many of these funds explicitly state in their prospectus that they are not appropriate for holding periods longer than 1 day.

I got burned by TBT right after the 2008 crash and learned from personal experience. Luckily I didn't have much to lose at the time. Take a look at the chart of that one over the fund lifetime.... :oops:. And I got out relatively early, but it was still awful.
Again, if you adjust your exposure based on returns, they can be fine.

That said, TBT is inverse or shorting and I wouldn't hold that for even a second. Shorting is clearly market timing. Holding leveraged long positions and adjusting to maintain your exposure isn't.
Yes, this was before I found BH and I definitely did not understand what I was buying. The wrong "bet" AND the wrong instrument. But the role of leverage and the resetting of the ETF actually contributed more to my losses than interest rates. I neither bet nor utilize leverage anymore.

So let's take TQQQ as an example instead, since that's been a popular leveraged ETF for a while. How should one "adjust exposure based on returns" to remove the risk from long-term tracking issues of this ETF? Or, if it's not possible to remove that risk, is there information that would make these safe enough for a non-expert investor? I am not sure.

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Re: why are triple leveraged ETFs a bad idea?

Post by Stinky » Thu Feb 13, 2020 4:45 pm

ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 7:26 am
Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.
Because you'll make so much money that you physically won't have room to store it all in your house. There will be so many stacks of $20 bills piled on your bed that you'll have to sleep outside on the street. So it's a bad idea because we are helping protect you against having way too much money. :sharebeer :sharebeer
[sarcasm alert]
It's a GREAT day to be alive - Travis Tritt

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Re: why are triple leveraged ETFs a bad idea?

Post by ARoseByAnyOtherName » Thu Feb 13, 2020 8:25 pm

Stinky wrote:
Thu Feb 13, 2020 4:45 pm
ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 7:26 am
Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.
Because you'll make so much money that you physically won't have room to store it all in your house. There will be so many stacks of $20 bills piled on your bed that you'll have to sleep outside on the street. So it's a bad idea because we are helping protect you against having way too much money. :sharebeer :sharebeer
[sarcasm alert]
I heard Stinky made so much money it filled up his whole neighborhood! He had to sleep in a motel the next town over!

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Re: why are triple leveraged ETFs a bad idea?

Post by Stinky » Thu Feb 13, 2020 8:29 pm

ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 8:25 pm
Stinky wrote:
Thu Feb 13, 2020 4:45 pm
ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 7:26 am
Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.
Because you'll make so much money that you physically won't have room to store it all in your house. There will be so many stacks of $20 bills piled on your bed that you'll have to sleep outside on the street. So it's a bad idea because we are helping protect you against having way too much money. :sharebeer :sharebeer
[sarcasm alert]
I heard Stinky made so much money it filled up his whole neighborhood! He had to sleep in a motel the next town over!
[DOUBLE sarcasm alert] :D
It's a GREAT day to be alive - Travis Tritt

ARoseByAnyOtherName
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Re: why are triple leveraged ETFs a bad idea?

Post by ARoseByAnyOtherName » Thu Feb 13, 2020 8:30 pm

Stinky wrote:
Thu Feb 13, 2020 8:29 pm
ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 8:25 pm
Stinky wrote:
Thu Feb 13, 2020 4:45 pm
ARoseByAnyOtherName wrote:
Thu Feb 13, 2020 7:26 am
Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.
Because you'll make so much money that you physically won't have room to store it all in your house. There will be so many stacks of $20 bills piled on your bed that you'll have to sleep outside on the street. So it's a bad idea because we are helping protect you against having way too much money. :sharebeer :sharebeer
[sarcasm alert]
I heard Stinky made so much money it filled up his whole neighborhood! He had to sleep in a motel the next town over!
[DOUBLE sarcasm alert] :D
:sharebeer

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Re: why are triple leveraged ETFs a bad idea?

Post by Wiggums » Thu Feb 13, 2020 9:18 pm

Simply put: investors face the possibility of substantial loss. Even more so with triple leverage and the use of derivatives. The best form of investor protection is to clearly understand leveraged or inverse ETFs before investing in them. That doesn’t mean asking BHs what to do! Leveraged ETFs have higher expenses and are not very tax efficient. it’s not a buy and hold investment. Does that make the investor a day trader?

While returns can increase by three-fold, a loss of the same magnitude can occur, even within the same trading day. How many times have we seen a sharp decline, followed by computer driven buying.

Starting with an initial $100, assume the price of the benchmark index goes up 5% one day and down 5% on the next trading day. The 3x goes up 15% and down 15% on consecutive days. After the first day of trading, the initial $100 investment is worth $115. The next day after trading closes, the initial investment is now worth $97.75. This represents a loss of 2.25% on an investment that would track the benchmark without the use of leverage. Volatility in a leveraged fund can quickly lead to losses for an investor. There is no guarantee that the fund will meet their daily objective, which is yet another risk. You go up 5 and down 5, but yet you’re not back to even.

No thanks...
Last edited by Wiggums on Thu Feb 13, 2020 9:35 pm, edited 3 times in total.

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Re: why are triple leveraged ETFs a bad idea?

Post by Iridium » Thu Feb 13, 2020 9:30 pm

Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.

Thanks in advance.
The main issue is that over the long-term, they don't do what one would expect.

A triple leveraged investment will rocket up when you have consecutive days of gains in the underlying (to maintain leverage, the fund 'double downs' on any gains). Your bacon will be saved when the underlying drops over consecutive days (the fund sells off double the losses). You'll lose money every time the market changes direction (buy high, sell low). At a 2x leverage, these effects are not overwhelming. At 3x leverage, over the long-term, you are as much making a bet on how much momentum the market has, as anything to do with growth of the underlying investment. If you want to bet that the market doesn't reverse directions very often, go ahead. However, most investors aren't interested in placing such a bet, so such funds are unsuitable for their needs.

There are other ways to obtain leverage that will more closely match the long term performance of the underlying, such as futures and deep in the money calls. This is because the gearing on those is largely controlled by you and exposure changes won't happen more than monthly in most cases.
Last edited by Iridium on Thu Feb 13, 2020 9:38 pm, edited 2 times in total.

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Re: why are triple leveraged ETFs a bad idea?

Post by 1789 » Thu Feb 13, 2020 9:33 pm

Edge215 wrote:
Wed Feb 12, 2020 7:47 pm
can someone tell me why triple leveraged long ETFs are a bad idea? ie TQQQ and TECL? in contrast to something like vtsax or even qqq.

Thanks in advance.
If they are so good why is there no money in TQQQ? Are you aware how much money is invested in VTSAX?

QQQ itself is probably most horrible fund, that means TQQQ is three times worse than that.
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Re: why are triple leveraged ETFs a bad idea?

Post by patrick » Thu Feb 13, 2020 9:34 pm

nisiprius wrote:
Thu Feb 13, 2020 8:14 am
4) Direxion says "These leveraged ETFs seek a return that is 300% or -300% of the return of their benchmark index for a single day." They put the phrase "for a single day" in italics. Which is correct?

a) It is technically true, so they have to disclose it. But by simple math, over any number of days, if you get triple the return every day, you should get about triple the return over any number of days.

b) You will get something close to triple returns when the underlying index is in a sustained, fairly steady upward trend, but not when the index is experiencing volatility and trading "sideways."
Neither is quite right -- if the trend is steady enough the 3x leveraged funds will get much better than triple the base return over the same period.

As an example, consider what would happen if you invested $100,000 into an index that gained 10% each day. After just 5 days the leveraged ETF (gaining 30% each day) would come out way ahead of simply tripling the cumulative return in the base index.

Code: Select all

Day	Base return	3x cumulative	3x Daily
0	$100,000	$100,000	$100,000
1	$110,000	$130,000	$130,000
2	$121,000	$163,000	$169,000
3	$133,100	$199,300	$219,700
4	$146,410	$239,230	$285,610
5	$161,051	$283,153	$371,293
This doesn't only apply to gains. If the trend is steadily down, the 3x leveraged fund will do better (i.e. lose less) than tripling the base return.

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Re: why are triple leveraged ETFs a bad idea?

Post by corp_sharecropper » Thu Feb 13, 2020 9:41 pm

Why, exactly, do all these leveraged ETF's need to be reconstituted every day? Is there a reason no one makes an ETF that is basically one big margin account that buys an index using margin, and simply holds it (for 3x better or 3x worse)? Forget it throwing AA out of whack, let's say this is all clearly spelled out in the prospectus and fund summary. Why is the simplest form of leveraging equities not being used and instead all of these geared ETFs are designed for intraday holding periods? Would it increase the risk of the ETF going bust? Who cares? Isn't the point a matter of risk/reward anyway? Not sure how inflows/outflows would affect such an ETF (maybe go the VC/private equity route with a minimum lockup period. Obviously wouldn't be an ETF at that point).

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Re: why are triple leveraged ETFs a bad idea?

Post by EddyB » Thu Feb 13, 2020 10:03 pm

Phineas J. Whoopee wrote:
Wed Feb 12, 2020 8:03 pm
Here's our wiki article about them.

They reconstitute their holdings daily. They buy at market open and sell at market close. Yesterday's leveraged ETF is not today's leveraged ETF. Conceptually, there is no buy and hold. They're different each day the market is open.

We have a highly accomplished and high-income salesperson advocating them in threads here. I personally will stay away.

PJW
Are you implying that the unnamed salesperson is a seller of these products? Or just that he or she is engaged in sales of some unrelated thing? If the latter, what’s the relevance?

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Re: why are triple leveraged ETFs a bad idea?

Post by Iridium » Thu Feb 13, 2020 11:40 pm

corp_sharecropper wrote:
Thu Feb 13, 2020 9:41 pm
Why, exactly, do all these leveraged ETF's need to be reconstituted every day? Is there a reason no one makes an ETF that is basically one big margin account that buys an index using margin, and simply holds it (for 3x better or 3x worse)? Forget it throwing AA out of whack, let's say this is all clearly spelled out in the prospectus and fund summary. Why is the simplest form of leveraging equities not being used and instead all of these geared ETFs are designed for intraday holding periods? Would it increase the risk of the ETF going bust? Who cares? Isn't the point a matter of risk/reward anyway? Not sure how inflows/outflows would affect such an ETF (maybe go the VC/private equity route with a minimum lockup period. Obviously wouldn't be an ETF at that point).
There are some that reset monthly. For example: DXSLX. However, they don't seem to be all that popular for some reason. I would guess it is because the sophisticated investors that would be interested in long term leverage can get such leverage for cheaper through alternate means.

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Re: why are triple leveraged ETFs a bad idea?

Post by nisiprius » Fri Feb 14, 2020 12:00 am

corp_sharecropper wrote:
Thu Feb 13, 2020 9:41 pm
Why, exactly, do all these leveraged ETF's need to be reconstituted every day? Is there a reason no one makes an ETF that is basically one big margin account that buys an index using margin, and simply holds it (for 3x better or 3x worse)? Forget it throwing AA out of whack, let's say this is all clearly spelled out in the prospectus and fund summary. Why is the simplest form of leveraging equities not being used and instead all of these geared ETFs are designed for intraday holding periods? Would it increase the risk of the ETF going bust? Who cares? Isn't the point a matter of risk/reward anyway? Not sure how inflows/outflows would affect such an ETF (maybe go the VC/private equity route with a minimum lockup period. Obviously wouldn't be an ETF at that point).
Probably because the Investment Company Act of 1940 requires that any dollar that is borrowed by a mutual fund or ETF must be backed by three dollars' worth of securities. That is, leverage is limited to 1.33X. And that, in turn, is done to protect investors against the abuses of the 1920s and 1930s, when many investment companies were heavily leveraged and failed with catastrophic results for investors.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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