Why are 3X ETFs risky?
However, 3x exchange-traded funds (ETFs) are especially risky because they utilize more leverage in an attempt to achieve higher returns. Leveraged ETFs may be useful for short-term trading purposes, but they have significant risks in the long run.
Periods of volatility can cause leveraged ETFs to severely underperform relative to the asset or index they track. As with the first example above, a triple-leveraged S&P 500 ETF loses 60% when the underlying index only loses 20%.
- Market risk. The single biggest risk in ETFs is market risk. ...
- "Judge a book by its cover" risk. ...
- Exotic-exposure risk. ...
- Tax risk. ...
- Counterparty risk. ...
- Shutdown risk. ...
- ETF trading risk. ...
- Broken ETF risk.
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.
Some fees are a percentage of the amount traded but some fees are fixed, which can become a drag if you do numerous small trades over a high number of ETFs. In order to have a cost-efficient portfolio, you should seek an optimal degree of diversification while limiting the number of ETFs in your portfolio.
Importantly, the 4x leveraged S&P 500 fund is not an ETF, but is an ETN, or exchange traded note. The major difference is that ETNs carry credit risk and can shut down if the counterparty to the fund decides that they no longer want exposure to the fund.
If you own a leveraged ETF you can't lose more than your initial investment amount. You would never be liable for more than you invested; in a sense, the amount you could lose is capped.
Because leveraged single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself.
“And they are incredibly cheap.” However, there are disadvantages of ETFs. They come with fees, can stray from the value of their underlying asset, and (like any investment) come with risks. So it's important for any investor to understand the downside of ETFs.
- ProShares UltraPro QQQ (TQQQ) ...
- Direxion Daily Semiconductor Bull 3X Shares (SOXL) ...
- ProShares Ultra S&P 500 (SSO) ...
- Direxion Daily 20+ Year Treasury Bull 3X Shares (TMF) ...
- Direxion Daily Energy Bull 2x Shares (ERX) ...
- ProShares Ultra VIX Short-Term Futures ETF (UVXY)
Can 3x ETF go to zero?
This longer-term underperformance results from ill-timed rebalancing and the geometric nature of returns compounding. The author uses the concept of a growth-optimized portfolio to show that highly levered ETFs (3x and inverse ETFs) are likely to converge to zero over longer time horizons.
While the Fund has a daily investment objective, you may hold Fund shares for longer than one day if you believe it is consistent with your goals and risk tolerance. For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant.
Historically, SQQQ decays around 7-8% per month, though this would likely be around 4-5% per month during a flat market such as that experienced so far this year.
Generally speaking, fewer than 10 ETFs are likely enough to diversify your portfolio, but this will vary depending on your financial goals, ranging from retirement savings to income generation.
Company Act would allow investment companies to make investments in ETFs that exceed the 3% Limit, subject to the following conditions: (i) the acquiring fund does not exercise controlling influence over the ETF's management or policies, (ii) the acquiring fund may not redeem the shares acquired in reliance on the ...
For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.
Because they rebalance daily, leveraged ETFs usually never lose all of their value. They can, however, fall toward zero over time. If a leveraged ETF approaches zero, its manager typically liquidates its assets and pays out all remaining holders in cash.
Can an S&P 500 index fund investor lose all their money? Anything is possible, of course, but it's highly unlikely. For an S&P 500 investor to lose all of their money, every stock in the 500 company index would have to crash to zero.
Direxion launched its first leveraged ETFs in 2008. In November 2008 the company was the first to offer ETFs with 3X leverage, a move that was copied some months later by its competitors ProShares and Rydex Investments.
Triple-leveraged ETFs also have very high expense ratios, which make them unattractive for long-term investors.
How long can you hold TQQQ?
However, because of the structure of leveraged ETFs, the recommended holding period is from intraday to only a few days. Moreover, if the index drops, the TQQQ will lose 3x as much as the QQQ. Therefore, TQQQ may be better suited for day traders or swing traders.
"Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Emily says.
Investors can hold the ETF for longer than a day, but returns can vary significantly from 2x exposure over longer periods. That's because the ETF resets its leverage daily. In oscillating markets, the leverage reset can significantly erode returns.
Pay attention to the impact of volatility decay! When investing in leveraged ETFs like TQQQ, investors need to be aware of the impact of volatility decay. For example, in a volatile market, if the Nasdaq 100 Index drops by 10% in a day, TQQQ will drop by approximately 30%.
However, their complex nature and the impact of daily rebalancing make them unsuitable for longer-term investments. Investors should use caution, as these ETFs entail a higher degree of risk and volatility compared with traditional ETFs.