Why Leveraged SP 500 ETFs Could Be a Risky Bet for Long-Term Investors

Leveraged SP 500 ETFs, while they may have higher expense ratios and interest expenses, do not necessarily outperform the SP 500 index in the long run. In fact, these ETFs come with significant risks that could make them unsuitable for long-term investors.

Risks and Decay in Leveraged ETFs

The main reason not to invest in leveraged SP 500 ETFs is that they are riskier than their non-leveraged counterparts. They naturally come with a decay rate, meaning their value decreases over time without a corresponding increase in the underlying index. This can be problematic for beginners who may not fully understand the dynamics at play.

An Example of Decay

For instance, the SPY ETF, which tracks the SP 500, and another leveraged version, SPXL, illustrate this risk clearly. When SPY hit a high of around 338 in February, SPXL also reached a high of 76. Today, SPY is trading at all-time highs at 373, while SPXL is at 73. This example shows how leveraged ETFs can lose value even if the underlying index rises.

The Nature of Leverage and Borrowing

Leverage, whether used in ETFs or in buying stocks with borrowed money, essentially amounts to borrowing. Therefore, it's important to recognize that trading with borrowed money inherently introduces more risk. This risk can be significant when you consider the steady degradation of the leveraged fund’s price over time, especially when the underlying price remains constant.

Negative Expected Value and Trading Objectives

The objective of trading and investing is to achieve a positive expected value through some kind of analysis—whether technical, fundamental, or market timing. Using leveraged funds in the long term can significantly reduce your chances of meeting this goal. The decay of the fund’s price means you’re starting with a negative expected value instead of neutral "50-50" odds. Therefore, using a leveraged fund for long-term investments is likely not a great strategy.

Expert Use and Short-Term Trading

While leveraged funds are generally unsuitable for long-term investors, they can be good for very short-term, high-frequency trading. However, even in these cases, it's crucial to have a high level of experience and precise trade setup to mitigate the negative impact of decay. The short trade period provides a window to avoid most of the negative price degradation.

Advisory Against Leveraged ETFs for Retail and Long-Term Investors

Retail and long-term investors should keep clear of leveraged ETFs. These funds are generally designed for short-term, intraday trading on an index or sector. When used outside of these parameters, leveraged ETFs can eat away at your capital through fees, rebalancing, and compound losses.

Capital Preservation Through Conservative Use

While leveraged ETFs can multiply gains when the market goes up, they present a double-edged sword. The same multiplicative effect that magnifies profits can also amplify losses when the market turns downward. This is a critical consideration for any investor, especially those who are not risk-tolerant.

Conclusion: A Note for Gamblers and Experienced Traders

If you're a gambler and believe the market will continue to rise, leveraging can seem like a smart move. However, it's essential to recognize that when the market inevitably turns, the same leverage that multiplied gains will multiply losses. For long-term investors, the best strategy is to steer clear of leveraged ETFs and focus on conservative, well-researched investment options.