Investing in Leveraged ETFs, is it Worth it?

Is investing in leveraged ETFs worth it?  I’ve been listening to a lot of financial independence podcasts looking for ways to improve my own journey towards financial independence.  One thing I’ve found as a common thread among many personal finance bloggers is their view on investing.  Sure, there are a number of different ways to go about investing for the future, but most of these bloggers talk about keeping your costs low and achieving the overall market results by investing in index funds.  It took me a while to come around to the idea, but it makes sense. If you could get the average market returns over time and consistently save and invest, you can certainly reach your goals.

Here is my dilemma, I’m not a twenty or even a thirty-something getting started.  In fact, I’m pretty late to the game and am trying to catch up to where I should be for someone planning a normal (you know the age 65 or so) retirement.  Needless to say, I had started investing in broad-based index funds from Vanguard and Schwab.  Like always I’m looking for a little bit of an edge on how I might be able to speed things up and that’s when I found some leveraged exchange-traded index funds.

What’s an Index ETF?

Before we get into the leveraged ETF discussion, let’s first talk a little bit more about index ETFs and what the goals are.  Here’s the simple answer, an index ETF is an exchange-traded fund that tracks and tries to mirror the performance of a particular index, like the S&P 500 index or, in like in the case of many FI people out there, a total stock market index.  As I’ve read many blogs there are is one that comes up pretty often and it tries to achieve the same results as broad market indexes.  In this case when looking up more information they are benchmarking the Dow Jones US Total Stock Market Index.  So in this case, the one many people look to is the  Vanguard Total Stock Market ETF (VTI).

There are many convincing arguments as to why investing in total stock market index ETFs or funds makes sense.  First, you get the benefit of the entire market.  Second, you are more diversified than picking single stocks.  Third, there is no additional work involved once you invest.  Fourth, there are numerous reports that show over a long period most professionals can’t beat the market.  This last one is a trap many people can get caught in and I may be getting myself into one as well, but we’ll talk about that below.  This can happen especially if you get lucky or hit a home run early on in your investing.  You may gain confidence that you are one of the smart ones who can beat the market and off you go.  You have to try though, right?  I fall into that category sometimes.

So what’s a leveraged ETF anyway and why would I want to consider one?

Here’s the definition from Investopedia, “A leveraged exchange-traded fund (ETF) is a marketable security that uses financial derivatives and debt to amplify the returns of an underlying index. While a traditional exchange-traded fund typically tracks the securities in its underlying index on a one-to-one basis, a leveraged ETF may aim for a 2:1 or 3:1 ratio.”

OK.  So the goal with a leveraged ETF is not only to mirror the index it is based on, but to double or triple the results.  Generally speaking, a leveraged ETF is designed to achieve those double or triple results in a specific direction.  Not everyone believes indexes are always going up so there are ETF’s that will make money when the index goes down and there are also leveraged ETFs designed to make money when the index it mimics goes down.

Here’s a good example.  There are a lot of S&P 500 Index ETFs so let’s look at one of them.  Take VOO for example.  It’s one of the more popular S&P 500 ETFs. In 2020 it had a total return of 18.40% compared to the actual S&P 500 Index of 18.4%.  Because of the popularity of the S&P 500 Index, there are a bunch of companies that have ETFs based on it as well as leveraged ETFs based on it.

Leveraged ETF Examples

Proshares is a company that has a bunch.  In fact, it has one that is leveraged 2x and one that is leveraged 3x in the positive direction.  It also has one of each leveraged in the negative direction meaning that if the market tanks those last 2 should gain 2 to 3 times as much as the market is tanking.  Needless to say, those negative ones are not something I would like to focus on so let’s look at the others.  The first one leveraged at 2x is called the Ultra S&P 500 ETF with the symbol (SSO).  In 2020 this fund had a return of 21.60%.  Didn’t quite hit the goal!  In fact, there was a lot of extra risk just to get the extra 3% or so.  The other one that is leveraged at 3x is called the UltraPro S&P 500 ETF, symbol (UPRO).  In 2020 it only returned 10.21%, which is way under the actual S&P 500 Index.  Sounds kind of risky right.  It was supposed to earn 3 times the amount of the S&P 500 but barely got more than half.  So the question is, is it worth it?

A 10 Year History

Looking at just one year doesn’t give you a good picture of the risk and rewards.  In fact, using the past history to predict future returns is part of a disclaimer you’ll hear from almost every financial and investment firm, it goes something like this, “Please remember that past history may not be indicative of future results.”  You hear that all of the time, but for comparisons from one security to another it’s fun to look at.  So let’s check it out.

Here’s a quick little table of 3, 5, and 10-year results of the Vanguard S&P 500 ETF (VOO), the Ultra S&P 500 ETF (SSO) which is leveraged 2 times, and the UltraPro S&P500 ETF (UPRO) which is leveraged 3 times.

These numbers are based on 12/31/2020 information.

You can start to see the difference between each of the funds.  As I was looking these over I was thinking, if I really buy into the concept that the market will continue to go up over a long period of time, why wouldn’t having a fund that is designed to earn double or triple be the better option?

The Nasdaq-100 Index

I liked the idea.  It made sense to me.  I tend to be a little more on the aggressive side too so I was looking for a more growth concentrated index so I went to the Nasdaq-100 Index  I also like a lot of stocks in the Nasdaq 100 so and I’ve invested from time to time in a few of them.  If you are new to investing, the Nasdaq-100 Index is a large-cap growth index. It includes 100 of the largest domestic and international companies listed on the Nasdaq excluding financial companies like commercial banks, investment banks, and brokers.  Some of the more well-known companies in the Nasdaq 100 are companies like Apple, Microsoft, Amazon, Tesla, and Facebook.  So, investing in the index is like buying a little piece of each of those 100 companies.

 

I have invested in an exchange-traded fund for the index before so I thought I would look and see what was available there as far as leveraged ETFs too. Here’s what I found out.  There is a 2x leveraged ETF on the Nasdaq 100 and a 3x leveraged ETF on the Nasdaq 100.  Being somewhat of a risk-taker, I naturally looked towards the 3x version first.  Specifically, the one I was looking into was the UltraPro Nasdaq 100 ETF (TQQQ), but let’s look at both.  The 2x Nasdaq100 ETF by the same company is the Ultra Nasdaq 100 (QLD).  The first thing I did was to look up the historical performance of each ETF to see how they did and to do a quick comparison to how they fared against the index.  Here’s a quick chart of the performance similar to the S&P 500 chart.

These numbers are also based on 12/31/2020

Similar to the comparison chart of the S&P500 fund the leveraged ETFs for the Nasdaq 100 outperformed the benchmark index but did not quite hit the goal of netting a 2x or 3x return.  They did do well though.

Just being curious and seeing some of the high returns over a 10 year period I tried to find out what a $10,000 investment would be worth today.  I know, past results can’t be relied on to make money in the future, but I like to look anyway and found that Morningstar.com has a cool performance tab that shows exactly that.  Here’s a screenshot of what it looks like the day I’m writing this post.  Keep in mind we went through the big volatility swings during 2020 with the pandemic, political changes, and other stuff.

Not too bad right?  This looks like one of those one in million stock picks, you know the if I’d have known then what I know today types.  Of course, the first thing you might want to think is that the major run-up has already occurred and maybe it has This thought did occur to me too, but the concept was to invest in the Nasdaq 100 and over time I still believed that it would go up, similar to other major indexes. This is not quite as broad as some of the others though.  I have to admit, one of my thoughts was that if it only performed even half as good over the next 10 years it would be a great return.

What did I do?

So I decided to go for it.  I made my first investment in the TQQQ in April of 2019.  My initial thought was to keep putting additional funds in until I had reached a $10,000 investment.  I didn’t have ten thousand dollars just lying around, so I had to start with what I had, which was only about $1,225.  It was a start though.  It took about 2 months before I was ready with another $1,000.  things were looking good and everything was going according to plan.  The index was performing and the TQQQ was outperforming.  Then came 2020.

In February of 2020, I decided to make another investment.  This time it was about $975.  Share prices were still rising and I bought at $48.79(split-adjusted).  Then at the beginning of March, the price dropped a little lower than my previous purchase to around $40 that was a quick haircut of about 20% from just a few weeks earlier.  I thought this was a good test of my resolve.  Would I panic or would I see it as on sale for the long term?  I thought I was good and told myself I was in it for the long term so on March 4th I invested another $1,600.  Then the real test came.  It wasn’t just another little drop in the market, this was really BIG!  Here’s a screenshot from Yahoo finance of what happened.

Time to Panic

Time to panic, right?  Like I said this was the real test.  The ETF had been as high as $59.40 on 2/19 and by 3/20 it had hit a low of $17.75.  Yikes!  There goes more than half of my investment!  I had some serious things to consider.  I had already put a few thousand dollars into this idea and less than a year later I was showing a loss on paper.  This all happened right at the same time the covid 19 pandemic was surging.  People were scared.  Many local, state, and federal governments were mandating quarantines, shutdowns, and social distancing.  Schools and stores were closing while everyone waited.  Time to rethink the concept.  Sure leveraged ETFs were great when the market was going up, outperforming the index, but when the market turns down, guess what?  You get the same magnified results to the downside.  In this case, shares had dropped $41.65, or 70.11% in a matter of a month.  Ouch!

Well, like is mentioned before this was the real test.  Did I believe that the market would recover over time?  Was it going to get worse?  I’ll admit, part of me was pretty upset.  Things needed to work, but all of the sudden there was all of this uncertainty and a lot of fear and emotion everywhere you looked.  I decided again it was on sale.  Nerves of steel?  No way!  But I was determined to stick to a plan and the plan was to continue investing in index funds because over time my belief is that the market will increase in value.  At the same time i was investing in the TQQQ I had also been purchasing some non-leveraged ETFs.  So I went for it again and on March 25th of 2020, I bought some more.

Psychologically this was hard to do.  This was during the national toilet paper shortage.  For those of you who remember, it was kind of crazy.  People were mandated to stay home, so everyone was stocking up for the long haul.  A lot of stuff was out of supply at grocery stores everywhere and for some reason, toilet paper, along with disinfecting wipes and cleaners were nowhere to be found.  Doesn’t’ sound like the ideal time to add some more to the investment pot, right?

Warren Buffet once said, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”  (Hence the 10-year history I like to look at).  I needed to own this thing for at least 10 years!  There’s another one I like too, he said, “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”  It’s time to grab the bucket!

Over the following months, I continued adding to my investment.  Fortunately, during this same time, my Amazon business was starting to really pay off.  Since everyone was shut in they were all ordering stuff online, and we had been stockpiling inventory trying to do better than our prior year, so we had plenty to sell.  I purchased those shares on March 25th for $21.77 and then kept on adding when I could during May, September, and October, which was already back up to $73.03 per share.

How is it working so far?

I made it to my goal of investing $10,000.  In fact, I had put in a total of $13,620.10 over the past couple of years.  The real question is how’s it working.  Well right now my average cost per share is 40.77 and the current price is $107.31 which gives me a 163.15% gain on the investments.  Has it been a smooth ride?  No way, but as of today, things are looking good.  If I had decided to write this post last year I may have had a different point of view.

What’s next?

As the Mad Fientitst said in one of his blog posts, “The thing is, you never know what’s going to happen or what bad things are already priced into the market. The world could get worse but if investors already expect it to get worse, stocks could go up. Or, if investors think things aren’t improving as fast as expected, stocks could take a big dive even when things in the economy are getting better.”

I don’t know.  The market goes up and down.  My belief is that over time it will continue to go up, especially for major indexes.  After all, when you invest in an index fund you are usually investing in a large group of stocks.  In this case the 100 largest companies on the Nasdaq.  I know it’s not as diversified as the S&P 500, but if the entire index is tanking there are more problems than just one of those stocks.  It usually becomes a nationwide event and I’m betting that the nation can pull itself out and start to grow again.  If not, well there are probably worse things coming than whether or not the index is down.

For the long haul, I’m in.  I’m not sure yet whether or not to invest additional funds into this same investment or diversify my investment portfolio a little more.  I can say though, that as of the day I’m writing this post the QQQ has been my best investment and is outperforming the other investments I have.  I’ll touch back in a while with an update of the progress and how it’s turning out.