Do leveraged ETFs Work?One of the biggest misconceptions about leveraged ETFs is that they double your long term results. If the SPY goes up an average of 10% a year then you only need to buy the SSO (leveraged SPY) to get an average of a 20% return in the market. Or better yet go out and buy a few triple leveraged ETFs and get a 30% return. Unfortunately it does not work like that. While it may be nice to simply buy an ETF and get a 30% return without even having to look at the market for years on end it doesn’t work that way. Leveraged ETFs only work on the day to day level, if you are investing into the long term it is a different story. Let’s compare the SPY with its leveraged counterpart the SSO. In the beginning of 2007 the SPY was trading at $133.87 and fell down to a low of 66.17 a 50.57% loss in one of the worst stock market crashes in history. It then rallied up to 111.32 for a 68.25% gain from the lows. During the same time period the SSO fell from $85.95 to $14.23 an 83.44% loss. Once again it rallied up to $38.18 a 168.3% gain from the lows. If you look at it from a purely percentage standpoint you may think that the SSO did better, because it lost just a little bit more then the SPY did during the crash and nearly made 3 times what it did when it rallied back up. But when you look at the numbers the SPY came down 16.84% while the SSO finished down 55.64% 3.3 times the loss of the SPY. Why so big? The difference came during the crash. When the SPY fell down 50.57% it needed a 100% gain to break even. On the other hand when the SSO fell 83.44% it needed to go up over 500% in order to break even. It needed to go up over 5 times what the SPY had to. This is really where the weakness of Leveraged ETFs as a buy and hold interment really shows. It may be going up faster than the regular ETF during a bulls market, but it also comes down much faster during a bears market and that is what matters. What Does it Mean? There are two different lessons to this. First of all, buying and holding a leveraged ETF is probably not going to work out very well in the long term. Second it shows how important it is to keep your losses as small as possible. |