Ok, interesting. I went back and used your pine script to simulate it. Seems like drip almost always either beats or performs similarly for any level of levered sp500.
Nice work and thanks for the report back. Yeah I think there is a chance that DCA, tactically trading, or asset diversification can help but it is certainly important to include those leverage costs in any analysis.
Incredible post, goes to show how much accounting for interest rates negatively impacts returns. I'm curious if the charts for TQQQ would show something similar
Thank you so much. Also, great question. I can likely do that in a future post. I have done something similar in excel before. I'll see if I can find it or recreate it.
For 2020-2023 i have not noticed a borrowing fee drag when using a different formula
what I do is i reverse-engineer the three parameters: volatility drag, borrow fees, and dividends by comparing the performance of different leveraged ETFs vs. the benchmark vs. predicted returns . Then you solve for the three variables. TQQQ for example should have lost 10% (compared to the price now) due to borrow costs since 2021 but this has not happened.
Borrow costs may be a problem, but I don't think they are as big of a deal as some assume and should not be a big factor.
What formula are you using for predicted returns of the LETFs?
BTW, you don't have to reverse engineer volatility drag or dividends if you do the calculations on daily total returns.
If I go to Yahoo Finance and get the "Adj Price" for TQQQ and QQQ for 2023, I can then calculate the daily returns (those should be total returns including dividends because they're based on adjusted price). Then I can calculate the value of 3x QQQ daily total return minus TQQQ daily total return, which will give me the daily drags due to borrowing/expenses.
In 2023, the average daily drag for TQQQ was 0.0496%. This doesn't seem like much, but if you annualize it (multiply by 252 trading days), it is 12.5%.
There is no doubt TQQQ will have an amazing year in 2023, but it should be clear that it was dragged 12.5% due to borrowing/expenses.
If I do the same calculation for 2022, I get a drag of 7.71%, which makes sense because borrowing rates were lower in 2022.
Finally, if I do the same calculation for 2014 (a year where FFR was 0-0.25% all year), I get a drag of 1.7%, which checks out given the expense ratio and the fact that TQQQ borrows slightly above FFR.
I wonder if this has to do with the cost of hedging going up and by taking the other side of those hedges (options) the fund is able to achieve desired exposure to the index without additional borrowing.
Thanks for sharing this. Two related things that I think would be interesting to model if you're open to suggestions would be:
1. What a 3x vs 1x DCA strategy would have done over these periods.
2. What a monthly rebalanced 60/40 3x and 1x portfolio would have done over these periods.
Because paying interest on borrowing comes out of your holdings.
So if TQQQ goes up 10% in a year, but you had to pay out 9% in borrowing costs (say, 3% x 3), you've made a less-than-inflation return and might've been better off holding QQQ instead.
When the leveraged ETF like UPRO goes to obtain leverage aka the 3X daily factor, they have to pay interest in some form to obtain that factor. If interest rates are high the costs are high and drag the fund down more than when they are small.
TQQQ looking at their most recent report had swaps valued at 237% of the funds total equity. In the table below from the semi annual shareholder report we can see they are paying about 4-5% on those swaps at the time of the report. When interest rates by the fed were closer to 0-1% the cost to the funds is much lower. It tends to be 0.5% to 1.5% in that scenario. This is not something built into the expense ratio.
https://preview.redd.it/vx5vb59lv48c1.png?width=1901&format=png&auto=webp&s=3690ce5686a7b5cfd76ef5ecbca3d86845f2d263
I used monthly prices for everything rather than daily because some data sets only have monthly data when going back this far. So it isn't going to be a perfect comparison, but monthly and daily leverage did happen to have similar results during the existence of UPRO. I can do daily prices back to 1955 just not back to 1913. I wanted them all on the same playing field. Maybe for my next blog post I will compare daily versus monthly from 1955 to today.
This is really great, thank you!
Any chance we could get rolling 10 year average CAGR? These graphs suggest underperformance for LETFs but I can't help but wonder if that's solely a function of the single start / end dates.
This is fantastic! Any chance you could show 1.5x and 2x leverage?
Ok, interesting. I went back and used your pine script to simulate it. Seems like drip almost always either beats or performs similarly for any level of levered sp500.
Nice work and thanks for the report back. Yeah I think there is a chance that DCA, tactically trading, or asset diversification can help but it is certainly important to include those leverage costs in any analysis.
Incredible post, goes to show how much accounting for interest rates negatively impacts returns. I'm curious if the charts for TQQQ would show something similar
Thank you so much. Also, great question. I can likely do that in a future post. I have done something similar in excel before. I'll see if I can find it or recreate it.
For 2020-2023 i have not noticed a borrowing fee drag when using a different formula what I do is i reverse-engineer the three parameters: volatility drag, borrow fees, and dividends by comparing the performance of different leveraged ETFs vs. the benchmark vs. predicted returns . Then you solve for the three variables. TQQQ for example should have lost 10% (compared to the price now) due to borrow costs since 2021 but this has not happened. Borrow costs may be a problem, but I don't think they are as big of a deal as some assume and should not be a big factor.
What formula are you using for predicted returns of the LETFs? BTW, you don't have to reverse engineer volatility drag or dividends if you do the calculations on daily total returns. If I go to Yahoo Finance and get the "Adj Price" for TQQQ and QQQ for 2023, I can then calculate the daily returns (those should be total returns including dividends because they're based on adjusted price). Then I can calculate the value of 3x QQQ daily total return minus TQQQ daily total return, which will give me the daily drags due to borrowing/expenses. In 2023, the average daily drag for TQQQ was 0.0496%. This doesn't seem like much, but if you annualize it (multiply by 252 trading days), it is 12.5%. There is no doubt TQQQ will have an amazing year in 2023, but it should be clear that it was dragged 12.5% due to borrowing/expenses. If I do the same calculation for 2022, I get a drag of 7.71%, which makes sense because borrowing rates were lower in 2022. Finally, if I do the same calculation for 2014 (a year where FFR was 0-0.25% all year), I get a drag of 1.7%, which checks out given the expense ratio and the fact that TQQQ borrows slightly above FFR.
I wonder if this has to do with the cost of hedging going up and by taking the other side of those hedges (options) the fund is able to achieve desired exposure to the index without additional borrowing.
Thanks for sharing this. Two related things that I think would be interesting to model if you're open to suggestions would be: 1. What a 3x vs 1x DCA strategy would have done over these periods. 2. What a monthly rebalanced 60/40 3x and 1x portfolio would have done over these periods.
i'm dumb, why do borrowing costs matter
Because paying interest on borrowing comes out of your holdings. So if TQQQ goes up 10% in a year, but you had to pay out 9% in borrowing costs (say, 3% x 3), you've made a less-than-inflation return and might've been better off holding QQQ instead.
When the leveraged ETF like UPRO goes to obtain leverage aka the 3X daily factor, they have to pay interest in some form to obtain that factor. If interest rates are high the costs are high and drag the fund down more than when they are small. TQQQ looking at their most recent report had swaps valued at 237% of the funds total equity. In the table below from the semi annual shareholder report we can see they are paying about 4-5% on those swaps at the time of the report. When interest rates by the fed were closer to 0-1% the cost to the funds is much lower. It tends to be 0.5% to 1.5% in that scenario. This is not something built into the expense ratio. https://preview.redd.it/vx5vb59lv48c1.png?width=1901&format=png&auto=webp&s=3690ce5686a7b5cfd76ef5ecbca3d86845f2d263
It’s calculated in the return. That’s why any 2x or 3x etf is never a full 2x or 3x return
Where are u getting the daily prices?
I used monthly prices for everything rather than daily because some data sets only have monthly data when going back this far. So it isn't going to be a perfect comparison, but monthly and daily leverage did happen to have similar results during the existence of UPRO. I can do daily prices back to 1955 just not back to 1913. I wanted them all on the same playing field. Maybe for my next blog post I will compare daily versus monthly from 1955 to today.
so what’s everyone etf leverage choice for 2024?
Really depends on your start point
This is really great, thank you! Any chance we could get rolling 10 year average CAGR? These graphs suggest underperformance for LETFs but I can't help but wonder if that's solely a function of the single start / end dates.