Do Leveraged and Inverse ETFs Converge to Zero? (2024)

FAQs

Do Leveraged and Inverse ETFs Converge to Zero? ›

Over the long-term, inverse ETFs with high levels of leverage, i.e., the funds that deliver three times the opposite returns, tend to converge to zero (Carver 2009 ).

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.

This shows that the potential for both profit and loss can be magnified with leveraged inverse ETFs. It is also important to note that leverage also means it is possible that a leveraged inverse ETF can go to zero or near zero with a large enough daily move in the price of the underlying asset or index.

"They all go to 0 over time." "If you hold them for more than a few days, you will lose money." The 3x Long Nasdaq 100 ETF (TQQQ) was launched in February 2010, over 8 years ago. Since its inception, it has advanced 4,357%, versus a gain of 378% for the unleveraged Nasdaq 100 ETF (QQQ).

Leveraged ETFs amplify daily returns and can help traders generate outsized returns and hedge against potential losses. A leveraged ETF's amplified daily returns can trigger steep losses in short periods of time, and a leveraged ETF can lose most or all of its value.

In a volatile market, where the underlying asset experiences large daily swings, the compounding effect of daily returns can cause the leveraged ETF to lose value rapidly. This is because losses are magnified over time, and gains are not enough to offset the losses.

Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.

Inverse ETFs aren't intended for long-term bearish movements or for hedging your portfolio against longer-term downswings because of the disadvantage of daily rebalancing.

Investors who wish to hold inverse ETFs for periods exceeding one day must actively manage and rebalance their positions to mitigate compounding risk.

"However, daily volatility can cause leveraged and inverse ETPs to behave in ways many investors do not expect," Emily says. "For example, if the market moves against you, losses are going to compound much faster than they would with a traditional ETP." Thus, holding such funds for longer than a day is very risky.

Why don't people invest in TQQQ? ›

Historical data shows that leveraged ETFs can experience significant losses during market downturns, and negative returns can accumulate over time. Indicators suggest that a bubble may be forming in the Nasdaq-100 and that a recession could be on the horizon, making investing in TQQQ too risky.

TQQQ seeks daily returns that are three times those of the QQQ (before fees and expenses.) QQQ experiences smaller price fluctuations and is considered to be less risky than TQQQ. Therefore, QQQ is best suited for long-term buy-and-hold investors, while TQQQ is better for active taders.

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.

These investors may not understand that a 200% or 300% leveraged ETF doubles or triples the underlying index returns only over very short holding periods and that these leveraged ETFs are likely to return substantially less than double or triple the underlying index returns over holding periods longer than a few days ...

BMO has launched the first quadruple leveraged ETN fund that tracks the S&P 500. The fund will trade under the ticker symbol "XXXX" and seeks to generate four time the S&P 500's return on a daily basis. The launch come as bullishness rise among investors and Wall Street predicts more gains to come in 2024.

By some estimates, returns generate up to 74% less rebalancing by leveraged and inverse ETFs once capital flows are taken into account. As a consequence, the potential for these types of products to exacerbate volatility should be much lower than many claim.

The daily rebalancing of leveraged and inverse ETFs creates a situation that for periods longer than a day or two the return of a leveraged or inverse ETF will deviate from the margin account benchmark.

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.

Q. How can the "reset" feature of a leveraged or inverse ETF affect suitability? A. Most leveraged and inverse ETFs reset each day, which means they are designed to achieve their stated objective on a daily basis.

Leveraged decay refers to the process by which leveraged ETFs strictly adhere to a "daily rebalancing" rule to ensure that they consistently achieve an N-times tracking effect by the end of the day or before the next trading day opens, resulting in decay.