Leveraged ETF Funds Long-term returns lower than expected

I've been doing some research into leveraged ETF's as a way to gain leveraged exposure to certain areas of the market. As a short term trading tool they seem like a great idea, but as a long-term holding you may not exactly get what you might expect. 200% Leveraged ETF's over the long-term will not produce 200% returns over the indexes or items they track. This is not to say that I wouldn't hold them for longer periods. Also keep in consideration that some ETF's get taxed in odd ways, such as the gold ETF GLD which get's taxed at 28% long-term gains as opposed to the 15% we're happier with.


I'm going to quote from an article from IndexUniverse.com:FULL ARTICLE


"The ProShares ETFs promise to deliver 200% (leveraged) or negative 200% (inverse leveraged) of the daily performance of major market indexes. So far, the funds have delivered on that promise perfectly: daily tracking errors are almost too small to measure.

But here’s a pop quiz: If the Nasdaq- 100 index rises 10% next year, how much will the ProShares Ultra QQQ ETF (AMEX: QLD) go up?

20%? Wrong. The real answer is: There’s no way to know.

While ProShares ETFs successfully double the daily performance of the underlying indexes, they don’t come close to doubling the long-term return. The reason is simple—compounding.



Let’s imagine that we have an index trading at a value of 100. I invest $100 in a fund designed to deliver 200% of the daily performance of that index. On Day 1, the index jumps 10% to 110, and my investment jumps 20% to $120. Perfect.

But on Day 2, the index falls 10%, taking my investment down 20%. Here, the numbers start to get out of whack. The 10% drop takes the index down 11 points (110/10=11), to 99. My investment, however, drops $24 (120/20=24), to just $96. (See Figure 1.)

Look what’s happened: the index is now down 1% from where it started, while my investment is down 4%. Keep doing that kind of adjustment for a year or more and the discrepancies can get huge."

Images from IndexUniverse.com:




So don't be surprised when you get less than what you expected. These type of funds make no guarantees on long-term performance, only on the daily performance.

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Very nice find...

I knew about those leveraged index funds, but I didn't know exactly how they work, until today I though it was simple math... but I guess not... which is why I like futures for leverage and of course I don't recommend futures to anyone..
I will write a more detailed article about trading futures and its risks with rewards.

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