{"id":58981,"date":"2014-08-19T20:29:54","date_gmt":"2014-08-20T00:29:54","guid":{"rendered":"http:\/\/countingpips.com\/?p=58981"},"modified":"2014-08-19T13:33:58","modified_gmt":"2014-08-19T17:33:58","slug":"stop-investing-in-leveraged-etfs","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2014\/08\/stop-investing-in-leveraged-etfs\/","title":{"rendered":"Stop Investing in Leveraged ETFs"},"content":{"rendered":"<div id=\"inves-1517539180\" class=\"inves-below-title-posts inves-entity-placement\"><div id =\"posts_date_custom\"><div align=\"left\">August 19, 2014<\/div><hr style=\"border: none; border-bottom: 3px solid black;\">\r\n<\/div><\/div><h4><span style=\"font-size: small;\">By Andrey Dashkov, <a href=\"http:\/\/www.millersmoney.com\/go\/v7iss-2\/PIP\">MillersMoney.com<\/a><br \/>\n<\/span><\/h4>\n<p>Bigger, faster, better. That\u2019s the turbocharged investment we all want. <em>Miller\u2019s Money Forever <\/em>subscribers who pay close attention to our portfolio, though, will notice that we <em>don\u2019t<\/em> hold leveraged ETFs\u2014those with \u201c2x\u201d or \u201cinverse\u201d or \u201cultra\u201d in their names, which some investors mistake for \u201cbetter.\u201d<iframe loading=\"lazy\" src=\"http:\/\/trk.caseyresearch.com\/f\/?content_id=962&amp;code=PIP&amp;editorial=stop-investing-in-leveraged-etfs\" width=\"1\" height=\"1\" frameborder=\"0\"><\/iframe><\/p>\n<p>Exchange-traded funds (ETFs) are a great tool for many portfolios. They allow investors to profit from movements in a huge variety of assets grouped by industry, geography, presence in a certain index, or other criteria. You can find ETFs tracking automobile producers, cotton futures, or cows.<\/p>\n<p>For our purposes, ETFs make it easier to diversify within a certain group of companies\u2014easier because you don\u2019t have to buy them individually. You buy the ETF and leave it to its managers to balance the portfolio when needed.<\/p>\n<p>We have several ETFs in the <em>Money Forever <\/em>portfolio, and they have served us well so far. They expose us to several universes, such as international stocks, foreign dividend-paying companies, convertible securities, and others.<\/p>\n<h3><strong>Why Turbocharged Isn\u2019t Always Better<\/strong><\/h3>\n<p>So, if we think the underlying index or asset class will move in our favor, why wouldn\u2019t we opt for the turbocharged version\u2014the versions that use leverage (credit) to achieve gains two times higher?<\/p>\n<p>First, because we\u2019re very cautious about volatility, and leveraged ETFs are designed to be less stable than the underlying assets. Second, there is a trick to leveraged ETFs that can make your investment in them stink <em>even<\/em><em> if<\/em> the underlying index or asset does well.<\/p><div id=\"inves-96103336\" class=\"inves-in-content inves-entity-placement\"><hr style=\"border: 1px solid #ddd;\">\r\n<div id=\"inpost_ads_header\">\r\n<p style=\"font-size:10px; float:left; color:#666;\">Free Reports:<\/p><\/div>\r\n<div id=\"inpost_ads\"> \r\n<p style=\"font-size:15px; float:left;\"><a href=\"https:\/\/goo.gl\/1ApBOV\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/investmacro.com\/wp-content\/uploads\/2018\/06\/graph_techs_PD.png\" align=\"left\" width=\"80\"  height=\"55\"\/><\/a>\r\n\t     <a href=\"https:\/\/goo.gl\/1ApBOV\"><b><u>Get Our Free Metatrader 4 Indicators<\/u><\/b><\/a> - Put Our Free MetaTrader 4 Custom Indicators on your charts when you join our Weekly Newsletter<\/p><br><br>\r\n<br>\r\n<br>\r\n<p style=\"font-size:15px; float:left;\"><a href=\"https:\/\/goo.gl\/f3RrHX\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/investmacro.com\/wp-content\/uploads\/2019\/01\/cot_pie_80.png\" align=\"left\" width=\"80\"  height=\"55\"\/><\/a>\r\n\t    <a href=\"https:\/\/goo.gl\/f3RrHX\"><b><u>Get our Weekly Commitment of Traders Reports<\/u><\/b><\/a> - See where the biggest traders (Hedge Funds and Commercial Hedgers) are positioned in the futures markets on a weekly basis.<\/p><br><br>\r\n<\/div>\r\n<hr style=\"border: 1px solid #ddd;\">\r\n<br><\/div>\n<p>Before we get to the details, let me pose two questions:<\/p>\n<ul style=\"margin-bottom: 2px;\">\n<li style=\"margin-bottom: 2px; margin-left: 36px; margin-right: 0px; text-align: left; text-decoration: none;\">If the S&amp;P 500 goes up by 5% over several days, how much would a 2x leveraged ETF based on the index earn?<\/li>\n<li style=\"margin-bottom: 2px; margin-left: 36px; margin-right: 0px; text-align: left; text-decoration: none;\">If the S&amp;P 500 goes up and down, then rises, and after a while ends up flat, will our ETF end up flat too?<\/li>\n<\/ul>\n<p>If you answer 10% to the first question, you may be correct, and that\u2019s the caveat: you won\u2019t be correct 100% of the time. You can\u2019t just multiply an index\u2019s <em>total<\/em> gain by the ETF\u2019s factor to gauge how much you\u2019ll earn, because leveraged ETFs track <em>daily<\/em> gains, not <em>total<\/em> ones.<\/p>\n<p>To show how that works, here\u2019s a brief example that will also answer question number two.<\/p>\n<div align=\"center\">\n<table cellspacing=\"0\" cellpadding=\"0\" align=\"center\">\n<colgroup>\n<col width=\"129\" \/>\n<col span=\"4\" width=\"128\" \/> <\/colgroup>\n<tbody>\n<tr style=\"color: #fff;\" bgcolor=\"#024A1A\">\n<td rowspan=\"2\" align=\"center\" width=\"100\">Day #<\/td>\n<td rowspan=\"2\" align=\"center\" width=\"100\">Index Price<\/td>\n<td colspan=\"2\" align=\"center\" width=\"256\">Daily Return<\/td>\n<td rowspan=\"2\" align=\"center\" width=\"100\">ETF Price<\/td>\n<\/tr>\n<tr style=\"color: #fff;\" bgcolor=\"#024A1A\">\n<td align=\"center\">Index<\/td>\n<td align=\"center\">ETF<\/td>\n<\/tr>\n<tr bgcolor=\"#F2F2F2\">\n<td align=\"center\"><\/td>\n<td align=\"center\">1,900<\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\">$100.00<\/td>\n<\/tr>\n<tr bgcolor=\"#E2E2E2\">\n<td align=\"center\">1<\/td>\n<td align=\"center\">1,800<\/td>\n<td align=\"center\">-5.26%<\/td>\n<td align=\"center\">-10.53%<\/td>\n<td align=\"center\">$89.47<\/td>\n<\/tr>\n<tr bgcolor=\"#F2F2F2\">\n<td align=\"center\">2<\/td>\n<td align=\"center\">1,870<\/td>\n<td align=\"center\">3.89%<\/td>\n<td align=\"center\">7.78%<\/td>\n<td align=\"center\">$96.43<\/td>\n<\/tr>\n<tr bgcolor=\"#E2E2E2\">\n<td align=\"center\">3<\/td>\n<td align=\"center\">2,000<\/td>\n<td align=\"center\">6.95%<\/td>\n<td align=\"center\">13.90%<\/td>\n<td align=\"center\">$109.84<\/td>\n<\/tr>\n<tr bgcolor=\"#F2F2F2\">\n<td align=\"center\">4<\/td>\n<td align=\"center\">1,900<\/td>\n<td align=\"center\">-5.00%<\/td>\n<td align=\"center\">-10.00%<\/td>\n<td align=\"center\">$98.86<\/td>\n<\/tr>\n<tr bgcolor=\"#E2E2E2\">\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<\/tr>\n<tr bgcolor=\"#F2F2F2\">\n<td align=\"center\">Total return<\/td>\n<td align=\"center\">0.0%<\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\"><\/td>\n<td align=\"center\">-1.1%<\/td>\n<\/tr>\n<tr bgcolor=\"#E2E2E2\">\n<td colspan=\"5\">Source: TheTradeSurfer<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>What you\u2019re looking at here is a hypothetical index with a value of 1,900 at the beginning of our period. It goes up and down for four days, and then is back to 1,900 by the end of day 4. There is also an ETF that starts with a price of $100 and doubles the daily gains of the index.<\/p>\n<p>On the first day, the index goes down to 1,800 for a daily loss of 5.26%. This forces the daily loss of the ETF to be 10.53% (including rounding error), and the resulting price of the ETF is $89.47. The next day the index is up 3.89%, forcing the ETF to grow by 7.78%, to $96.43, and so on.<\/p>\n<p>We designed this table to show that even though the underlying index is back to 1,900 in five days, returning 0% in total gain, the ETF is down 1.1% by the end of day 4.<\/p>\n<p>It works like this because ETFs are designed to track daily returns, not mirror longer-term performance of the underlying index, and because of how cumulative returns work. If one share of the ETF costs $100 at the beginning of the period and the market dropped 5%, we should expect double the drop. Our share would now be worth $90. If the next day it reverses and goes up 5%, we should expect double the increase. We would be right in doing so, but our share would be worth $99 now, not $100\u2014because it increased 10% above the $90 closing price the day before.<\/p>\n<h3><strong>Leveraged ETFs Are for Traders, Not Investors<\/strong><\/h3>\n<p>If a trader is smart and lucky, she or he would buy the ETF at the beginning of day 3 at $96.43, sell at $109.84, and realize a gain of 14%. But if one bought at day 0 and held until the end of our period, one would lose money even though the underlying index ended up flat.<\/p>\n<p>In general, no one can predict where an ETF will end up because it\u2019s impossible to tell in advance what pattern the underlying index will follow. In practice, it means that an ETF only partially tracks the underlying index; its performance also depends on its own past results.<\/p>\n<p>The ideal case for investing in an ETF (we assume it\u2019s long the market) would be to buy it at the beginning of a multi-day, uninterrupted uptrend. In that case, it would come very close to doubling the market\u2019s performance. But such winning streaks are impossible to forecast, and short-term trading like this is not our focus.<\/p>\n<p>We don\u2019t recommend leveraged ETFs in our portfolio because they\u2019re geared for traders, and we take a longer-term perspective. We are investors.<\/p>\n<p>The additional potential reward from a turbocharged ETF doesn\u2019t warrant the additional risk, particularly when you\u2019re investing retirement money. There are safer ways to maximize your retirement income. Learn more about our strategies for doing just that by signing up for <strong><em>Miller\u2019s Money Weekly<\/em><\/strong><em>, <\/em>our free weekly e-letter that educates conservative investors about timely investment strategies. You\u2019ll receive ahead-of-the-curve financial insight and commentary right in your inbox every Thursday. <a href=\"http:\/\/www.millersmoney.com\/go\/v7i4q-2\/PIP\" target=\"_blank\">Start building a rich retirement by signing up today.<\/a><\/p>\n<p>&nbsp;<\/p>\n<p>&nbsp;<\/p>\n<div id=\"xvMdV95u77zU\" style=\"clear: both;\">The article <a href=\"http:\/\/www.millersmoney.com\/go\/v7i7r-2\/PIP\" rel=\"permalink\">Stop Investing in Leveraged ETFs<\/a> was originally published at <a href=\"http:\/\/www.millersmoney.com\/go\/v7iss-2\/PIP\">millersmoney.com<\/a>.<\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n<div style=\"clear: both;\"><\/div>\n","protected":false},"excerpt":{"rendered":"<p>By Andrey Dashkov, MillersMoney.com Bigger, faster, better. That\u2019s the turbocharged investment we all want. Miller\u2019s Money Forever subscribers who pay close attention to our portfolio, though, will notice that we don\u2019t hold leveraged ETFs\u2014those with \u201c2x\u201d or \u201cinverse\u201d or \u201cultra\u201d in their names, which some investors mistake for \u201cbetter.\u201d Exchange-traded funds (ETFs) are a great [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-58981","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/58981","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=58981"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/58981\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=58981"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=58981"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=58981"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}