Many articles argue that one shouldn’t hold leveraged ETFs long-term. Like many things, it depends on the situation. For certain leveraged ETFs that have high volatility, that is prudent advice, but for underlying asset classes with low volatility and long-term positive returns (such as the S&P 500), 2x and 3x versions can be held long-term.
- very low volatility. The S&P 500 has a realized volatility of around only 6-9%, which significantly minimizes volatility decay. According to my calculations , this results in a a decay of only around 1.5% per year for UPRO.
- but also importantly, dividends are automatically added to the NAV. For UPRO, this is a 6%/year boost. This also has tax implications because it means you aren’t taxed for dividends.
- for periods of low volatility and strong returns, 3x ETFs can outperform. This means that a portfolio that is 2/3 cash and 1/3 a 3x version (such as UPRO) will generate excess returns than a portfolio that is 100% invested in the unleveraged ETF (such as SPY).
- the losses are capped. If you put 1/3 of your portfolio in UPRO and the 2/3 in cash, even if the market were to fall to zero, you would still ONLY lose 1/3 of your capital. Hence, leveraged ETFs when used as a substitute for non-leveraged funds, sorta have a built-in put option.
- cheap leverage. Brokers charge outrageously high margin costs. If you have a $20k account and you want to use 2x margin to buy $40k of the S&P 500 ETF SPY, you will be paying a whopping 5% a year on that $20k ($1000). What a ripoff. Leveraged ETF providers, due to high creditworthiness of the their issuer, can borrow at close to the 3-month libor (around 1.5%/year), which means instead of paying $1000, you may only pay $300 or so (this is automatically deducted from the NAV of the leveraged ETF).