Why investors should stay away from highly leveraged ETF such as ProShares UltraPro QQQ (TQQQ)

ETF ProShares UltraPro QQQ (TQQQ) offers 3x (Triple) daily long leverage to the NASDAQ-100 Index based Invesco QQQ Trust (QQQ) ETF . Using 3x leverage means that fund manager invests another (borrowed ) $2 for each $1 investors put in. This results into 3 times of index return in boom times like last several years.

This all sounds great until market moves to crash territory. All those gains as well as principal could be quickly wiped out during a crash. For example a 10-20% market correction (which typically happens every alternate year) would result into 30-60% drop in TQQQ. If one had doubled one's money in last couple of years, all that gain is wiped out with just a mild 15% correction. With such outsized loss, one is likely to resort to panic selling and so would miss out further during quick recovery (typically 4-5 months for corrections).

I strongly suggest to stay away from such souped up leveraged investing. Savvy investing is all about meaningfully managing one's greed (during boom times) and fear (during bust time) which allows them to stay course with one's long term conviction in stock investing

Such leveraged investing leads to super charged greed followed by supercharged fear. In long term, such cycle is likely to produce sub par return as compared to that of simple buy-and-hold of solid index.

Anyone buying leveraged equities ETFs, such as TQQQ, should learn from what happened to margin provider banks Nomura and Credit Suisse in 2021, when hedge fund Archegos defaulted on margin call. Banks immediately cut their losses by foreclosing (fire selling) all the underlying leveraged securities owned by this hedge fund.

When we buy 3x leveraged fund such as TQQQ, we are in essence putting only 33% of our down payment money in it. Bank providing leverage of 66% has right to foreclose on the fund to collect it's stake. During sharp downturn, this is what bank tend to do to satisfy it's margin requirement. Fund is fully liquidated (similar to foreclosure on leveraged home) and investors lose all of it (similar to losing all their equity in home during foreclosure). 

One might argue that leveraged investing through TQQQ is very similar to other leveraged investing. For example, when we prolong our debt repayment by refinancing home mortgage for another long 30 years, in essence, we are increasing leverage. Such leveraging then enables us to invest more in stocks.

However, there is one major difference in above two approaches. In case of TQQQ, when position is fully wiped out after just 33% market downturn during a typical crash, the loss screams out loud. On one hand, margin provider bank keeps forcing ETF to liquidate holdings to meet margin call. On the other hand, investors resort to panic selling as they see three times losses than that of typical index. It's double whammy.

Those doing leveraged investing, by refinancing mortgage for longer stretch, are actually dollar cost averaging into an index fund. They wouldn't see triple losses the way TQQQ investors would see. It's likely that magic of cost averaging works it's way to even shield them from most of losses.

Other approach for better leveraged investing is to use HELOC to cost average (bottom fishing) during crash/correction and then sell high later and de-leverage HELOC when market recovers.

Sources:
But should ordinary investors buy them? The short answer is probably not. Certainly not if they're traditional buy-and-hold investors. Long term, you need to be very cautious going into any of these products...Institutional Investor: Leveraged ETFs Are Only for Day Traders

Indeed, ETFGuide noted in a recent article that clients with “a very short investment time horizon of just a few days” are probably best suited for “leveraged and short ETFs.” However, the article warned that “investors that want to bet on the long-term gains or losses of a particular asset class or industry sector should probably not be using daily leveraged and short ETFs. It’s that simple.”...Leveraged ETFs: What Brokers Don’t Know Could Cost Them | ThinkAdvisor

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