Leveraged ETFs such as UPRO and QQQ are typically used for day or swing trading. Most financial advisors swear against holding UPRO and TQQQ for long term investments. Recently I have been doing some research to try to understand if holding leveraged ETFs long term is a valid strategy to generate wealth.
What are leveraged ETFs?
Leveraged ETFs are similar to ETFs such as SPY and QQQ but offer 3 times the return (or 3 times the loss) of the underlying asset. UPRO is a 3x leveraged ETF of the SPY (S&P 500 ETF). TQQQ is a 3x leveraged ETF of QQQ (Nasdaq 100 ETF). For example, if SPY went up 1% today, it is expected that UPRO should have gone up 3%.
How do leveraged ETFs generate 3x returns?
Leveraged ETFs are able to generate 3x returns by using financial products and debt that magnify the movements in the underlying ETF. For example, it may use margin to acquire options or futures in order to magnify gains or losses of the underlying (SPY or QQQ). To be fair, this is a very complex topic and outside of the scope of this article. However, if you are interested in learning more about how leveraged ETF’s are designed to generate 2x or 3x returns, you can read more about it here.
Advantages of leveraged ETFs
The advantages are fairly obvious. We have been in a bull market for the last decade (and possibly longer). Over the last 10 years (as of January 2022), the S&P 500 has returned 16.42% / year. Over that same time period, UPRO has returned 40.98% annually. While not a direct 3:1 ratio, still about 2.5:1 returns compared to SPY. If we remain in the bull market, leveraged ETFs can be a way to pull in higher returns compared to typical S&P500 ETFs.
Disadvantages of leveraged ETFs
The reason why many are hesitant to hold leveraged ETFs long term is that when there is a correction or bear market, leveraged ETFs will see 3x to the downside. Most people would not be able to stomach a 50% drop (or more) in their account value.
Another disadvantage is the management fees. The management fee for SPY is 0.09% whereas the 3x leveraged ETF UPRO is 0.93%. It’s basically 10x as much for management fees and expenses. The same holds true for QQQ and TQQQ. The management fee for QQQ is 0.2% and TQQQ is 1.01%.
So is it worth it?
If you are type of investor who can set it and forget it, I think leveraged ETFs can and should make up a small portion of anyone’s portfolio. There is definitely risk to the downside but if we remain in a bull market, holding even a small position in a leveraged ETF can greatly increase your overall return.
On the other hand, if you are someone who checks your balance daily and can’t stand the thought of your portfolio balance dropping, you might want to stay away. Additionally, if you are near retirement and don’t have time to ride out any downturns in the market, it may be best to stick with regular ETFs or bonds.