Are you familiar with leveraged ETF? For those who don’t know, here is the description from Investopedia.com:
An exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.
These ETFs are usually double (2x) or triple (3x) the underlying index. For example:
- SSO is a double (2x) leverage ETF of S&P 500 from ProShares. It means, when S&P 500 goes up 1% on a single day; this ETF goes up 2% in price. On the other hand, when S&P drops 2%, this ETF drops 4%.
- EDC is triple (3x) leverage ETF of MSCI Emerging Markets Index from Direxion. It means when the index goes up 1%, this ETF goes up 3% in price. The same is true for the downside.
Is this an easy to way to get rich quickly? When these ETFs were pretty new in the market a couple of years ago, we think it is. We were dreaming that we could easily beat the index by investing in these ETFs. We didn’t do more research at that time. We invested *a lot* of money in a couple of leveraged ETFs. What happened then? We were totally doomed, especially during the recession.
These ETFs amplify the underlying index only on a single day. It doesn’t accumulate for longer period of time. Let’s take an example:
- Day 0: S&P 500 is at 1,000. Our triple leveraged ETF for S&P 500 is at $100.
- Day 1: S&P 500 goes down by 10% to 900. Our ETF drops 30% to $70.
- Day 2: S&P 500 goes up by 12% to 1008. Our ETF goes up by 36% to $95.2.
As you can see, after the second day, S&P 500 is higher than day 0; but our ETF is still below day 0.
The chart below the comparison of SSO and S&P 500 from June 2006 to today. As you can see here, the return of S&P 500 in this period is –11.66%. However, the return of SSE is –46.93%.
Be really careful when investing in leveraged ETFs. We don’t invest in any of leveraged ETFs today.
