ETF has 3x the Returns of QQQ - is a Horrible Investment?

ETF has 3x the Returns of QQQ

I've been getting a few comments about leveraged ETFs in particular TQQQ, which is a three times leverage on the QQQ. This is the culprit on my brokerage and I mean in terms of popularity, almost 15 billion in assets under management, and the performance is great. On paper, we can see in the past one year up 114. The description says the investment seeks daily investment results before fees and expenses that correspond to three times the daily performance of the NASDAQ 100 index. So I can see why this is attractive.

ETF has 3x the Returns of QQQ

They look at that description, they see the performance and they think this is a great investment. However, I have to say for most people this is not a good investment and I know that's very counterintuitive, and a lot of people like this, so I'm gonna get some hate on this article. But I would just say: allow me to explain my research because I love finding good investments, but I just don't think this is a good investment, and let me explain why also the obligatory go ahead. These are the base ETF that the leverage is based on now.

The first thing I want to look at is just the expense ratio, keeping it basic and with QQQ it's 0.2 percent. So if we come over to a basic fee, calculator with 10 000 bucks, 10 years of time, 0.2 percent expense ratio we're looking at just under 1 000 bucks in fees. In contrast to that, TQQQ is 0.5, which isn't massive. But if we put that in on the calculator 0.95 we're going to see a pretty drastic difference, almost four and a half thousand bucks. So that's the first con of these ETF. But of course, people are going to say that it's justified because the returns are so amazing and in my opinion, this is where the issue comes into play because people look at the graph.

This is TQQQ versus a QQQ and it looks like the leveraged ETF are doing significantly better over long periods of time. I'm going to go ahead and say that that may or may not be true, but there's a hidden risk that is not being shown in these charts and if I come to the official website, we can begin to understand what this risk is. So the ETF seek a return that is three times the return of the underlying benchmark for a single day. It'S even in bold right here. It says, due to the compounding of daily returns, holding periods of greater than one day can result in returns that are significantly different than the target return.

So right there, that's the major disadvantage with leveraged ETFs they're, not judged based on a month or a year. It'S on a daily basis that three times leverage is daily and what that means is over long periods of time. If you choose to do that, which is highly advised against the base index and the leveraged one can have drastically different returns in completely opposite directions too, and to dive a little bit deeper. Let'S begin with this article, so this is known as volatility. Decay doesn't hold leverage ETFs long term, and I want to begin right here, and it says, since stocks will almost certainly go up over the long term, 30, 20 10 years shouldn't long-term investors all invest in leveraged ETFs instead.

And the answer is a resounding no leveraged. ETFs are designed for short-term trading due to a phenomenon called volatility. Decay, holding leverage ETFs long term can be very dangerous, so this is the hidden risk with these leveraged ETFs and they have a few examples that go over different scenarios and how this volatility decay can affect returns and actually want to switch to this article because it Does a slightly better job with a few more examples, so the first point is that higher expense ratio, because you're paying for this daily rebalancing in order to keep the fund leveraged. There are tons of financial derivatives involved there's debt. So it's a much more complicated financial product and because of that they charge higher expense ratios, but because of this daily rebalancing and the volatility decay.

It's not a safe assumption to assume that all because the underlying index goes up 20 percent over say two years that the leveraged one is going to 3x. That, in fact, that's usually never the case over longer periods of time. So here's the first example. We have the days over here. This is over a seven-day period and the stock price begins at 100 bucks and every day it goes up by one dollar very basic and also very unrealistic.

But if we look at the returns, in this case, the leveraged ETFs will do better. It also says that the returns were 50 over a 50-day period, while the leveraged ETFs returned 234, which is significantly more than the leverage ratio, which should only be 150 percent. So taking it one step further to understand why this difference is happening. They have another example, so it's the same time period 10 days, but in this case, you begin with the same 100 bucks. Then it goes up to 110 back down to 100 and ultimately, you end with the same 100, but there's a lot of volatility.

And if we look at the returns here in red, the 3x leveraged ETF because of that volatility decay, has significantly worse performance. So this illustrates how, even though the base index can be flat for a period, the leveraged one can have massive losses, and I think this little bit here does a good job summarizing. How a lot of people view these leveraged ETFs. So it says, while most TQQQ investors accept the risk of significant underperformance during bear markets because they understand that with the leverage it will go down three times as much. They may not fully grasp the potential of volatility decay loss even during good or better times.

So I think this serves as a great example of why you need to do proper research into investments. Now, I'm not saying you should never invest in leveraged ETFs for the short term. If you're trading and not a long-term investor, they might have a place in your strategy, but I feel like a lot of people, just look at these charts. They see one line go up more than the other and they pile into the investment, and they just don't have a full grasp of how the investment vehicle is really supposed to be utilized and the true mechanics of it and things like volatility decay. I'm a big believer in just having a long-term strategy.

If I come to the growth section of my portfolio, I think funds like arc and WCLD are more than volatile enough on their own, and these are just pure equities. Focusing on high-growth companies. The arc focuses on innovative companies and WCLD has a very mathematical approach and a very high bar of entry, in fact putting WCLD against the QQQ. We can see this ETF does outperform the QQQ, so you have lots of options if the QQQ just isn't good enough. For you, without jumping into the derivative market, I mean - maybe I'm just too cautious, because I've been investing in the crypto market for years now, and the crypto market has a really big issue with over-leverage and the use of derivatives.

We'Re looking at the chart for BTC right now and a lot of these corrections and sharp declines are because of over-leveraged positions. In fact, this is a pretty nice chart of the price of BTC against the level of leverage in the market, and when things are riding high and people are confident, the leverage people are taking out is at an all-time high. And when the momentum changes tons of liquidations happen and that's actually, what exacerbates the sudden and massive declines we see in the crypto market, it's this domino effect of liquidations, because people are over-leveraging the market trying to 10x their returns. In fact, just the other day, we saw this exact phenomenon happen again in the market. Crypto took a massive dip from 52 000 bucks, all the way down to 42 000 bucks in a matter of just minutes, and again, that's simply because the price was going up.

People got bullish, they took out leverage to 10x their return, and then all of a sudden, the momentum changed. A ton of liquidations and people lost a lot of money because of excessive risk. Taking now I know, TQQQ and other leveraged ETFs are completely different than massive leverage in the crypto market. But I'm just trying to say I've seen the effects of excessive leverage in markets before and I'm very skeptical of it, and I hope that people just understand the fuller risk of assets like this, including things like volatility decay over time. 

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