But it was stupid, and not because of the leverage. I knew it was a leveraged bet. That’s exactly what I wanted. But I also knew that I was going to keep the position for several days, and a 3x ETF is simply the wrong tool for a multiday position.
The 3X ETFs use “total return swaps” to create the leverage. These swaps are settled each day. If the index (in this case, the Russell 1000 Financial Index) goes up consistently, then there’s a good chance that the total return of the ETF will approximate 300% of the return on the index.
But the concept falls apart in choppier markets. In a market that trades up-and-down for a few weeks, and ends up say 10%, a triple-leveraged ETF won’t be up 30%. It might not be up at all.
Consider the results of the FAS and its counterpart, the Direxion 3X Financial Bear ETF (FAZ) over the past six months. Incredibly, both are down over 75%.
So next time I want to use a little leverage, I’ll use the right tool — either futures or options spreads. From now on, the 3X ETFs are strictly for intraday.
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Since they maintain a fixed level of leverage, 3x ETFs eventually face complete collapse if the underlying index declines more than 33% on a single day. Even if none of these potential disasters occur, 3x ETFs have high fees that add up to significant losses in the long run.
Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.
In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.
Leveraged 3X Inverse/Short ETFs seek to provide three times the opposite return of an index for a single day. These funds can be invested in stocks, various market sectors, bonds or futures contracts.
A: The three main wealth destroyers are inflation, taxes, and investment fees. Inflation erodes the purchasing power of money, taxes can significantly reduce net income and investment returns, and investment fees can chip away at investment gains over time.
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