I took S&P data from 1950, got the daily % change, multiplied by 3 and let that represent a 3X portfolio from 1950. I then tested different withdrawal rates for 30 year periods - 1950-1980, 1951-1981, etc. Here are my results.
I want to reiterate what ILIKEDIVIDENDS highlighted in his post.
Those 3x funds reset daily so I don't know that your excel maths works.
Since aajack is using the daily % change, their results should indeed be correct (aside from the difference in expense ratios between regular funds and leveraged funds).
Essentially the issue with daily leveraged funds is the same reason "averaging" return isn't an informative number and we have to use CAGR instead.
Imagine the stock market goes up 10%, down 30% and up 20%.
The average return is zero (10%-30%+20%)/3.
$100 invested in a stock market index becomes $100->$110->$77->$92.4 for an overall loss of 7.6%.
$100 invested in a 3x leveraged fund becomes $100->$130->$13->$20.8 for an overall loss of 79.2%
So in this particular example the 3x leveraged ends up with more than 10x the losses of the unleveraged underlying index.
Yep. An easy way to understand why those reset-daily leveraged ETFs suffer from drag if you hold them long term is to imagine that the tracked index is essentially doing a random walk (daily noise) around a slight upwards trend, as does the S&P. The problem is that whenever that noise is up, you'll effectively buy more shares the next day (because your new market value is still 3X leveraged by the ETF); when the index is down, you'll buy less shares. Over time, you tend to buy high and sell low, thus the drag.
The way to defeat this drag is to increase your reset horizon, i.e. reset at a lower frequency than daily, e.g. yearly. To do this you can buy
term leveraged shares, or leverage yourself in a brokerage account with a base investment that is fixed over the entire duration of the term. If you do this, there is a margin call risk, but there is no drag. Compared to a reset-daily ETF, you are effectively doubling down when the index is down, and easing up when it is high.
I haven't seen this published elsewhere, but there is a way to simulate term leverage or DYI leverage using only daily ETFs. To do this, you need to actively buy/sell at the start of each trading day so that your invested base remains constant. Example with a 3X ETF:
You start with a $100 investment. Under the hood, the ETF invests $300 on your behalf. You need to keep that $300 ± market gains constant, as if you had a DYI leverage in a brokerage.
Day 1
start: index value=100, ETF value=100, under the hood invested assets=300
end: index value=101, ETF value=103, under the hood invested assets=303 (not reset yet)
Day 2
If you hold:
start: index value=101, ETF value=103, under the hood invested assets=309 (too much!)
Under the hood investment must stay at 303, so you must sell $2 of your ETF to get:
start: index value=101, ETF value=101, under the hood invested assets=303 (just right!)
In other words, make sure that at the start of each day you have the same amount in your ETF as you would have had if it was invested in the index! Then, you'll suffer no drag.
Of course, to do this you need another account (which could be invested in the index) to use to buy more when the 3X ETF goes down, and sell into when the ETF goes up. This acts as your margin account. You can't 3X leverage 100% of your portfolio. Further, the smaller this "margin" account (that you manage), the higher the chance of a "margin call" to yourself where you'll be unable to double down on the ETF when its value drops too much, but no one will force you to liquidate the account, you'll just suffer (a lot of) drag.
Mind doing your simulation again so we can see how this method works out in practice? Long-term performance of daily-reset ETFs is expected to be poor.
