If I believe index funds are going to have a positive return, why not try to lever it up as high as possible? For example TQQQ (triple leverage) looks pretty enticing compared to QQQ.
https://www.investopedia.com/articles/financial-advisors/082...
Can you explain why that is? I would have expected that your gain or loss from the leverage funds relates only to the difference in price between when you purchased and when you sold (multiplied by the leverage).
Hence why it's reset daily, as the other two responses explain.
And in case it's not been made clear enough: it's the very opposite of a sound investment. It's very much a risk management / trading instrument. It's something you would trade as a hedge or leg of a complex trade; not something you want to hold by itself.
SSO is 2x leveraged SP500
https://finance.yahoo.com/quote/SSO
Check out the chart since 2007 versus the SP500 index to today. I'm seeing 211% return for SSO, 113% for SPY.
Just remember that we've pretty much been in a full on bear market ever since the last recession. Whether or not terrible things would have happened to SSO if we experienced a true recession/crash and whether or not you would actually recover/beat SPY, I have no clue and am not qualified to say.
But, based on the cherry picked '07-'19, yes, SSO (2x SPY) beats SPY (1x SP500) 211% to 113%
https://smabie.github.io/posts/2019/10/04/vol.html
In short, assuming a normal distribution, your max leverage ratio should be the future expected returns divided by the expected variance.
I’m not at a computer right now so I can’t run the math on real S&P returns, but assuming 10% returns and 10% vol and a normal distribution, the highest leverage ratio you would ever be able to justify is 10/10^2 or 10x leverage.
In my blog post I looked at the beginning of 2018 up to present. The ideal leverage ratio according to my equation (I’m sure it’s not novel, but haven’t been able to find anyone else talking about it), is 2.99x.
Of course, the more skew or kurtosis the distribution has the less accurate this equation becomes.
Right now I’m working on a hypothetical S&P ETF that adjusts leverage bases on forecasted volatility and returns. Almost impossible to get right, but my preliminary model has outperformed (not risk adjusted) any fixed leverage I’ve thrown at it.
Second, my analysis was from the beginning of 2018 to present. Using that data, the ideal leverage ratio is 2.99x.
Third, the ret/var model put forth in the post assumes a log-normal distribution. The less log-normal the returns are, the less accurate it becomes. Excess kurtosis or skew will definitely affect the accuracy of the model. So the model would probably be fine if the market was up-up-up or down-down-down, I haven’t encountered any periods in which the non-normality of the distribution is so severe that it completely breaks the model.
Leverage is almost always the secret sauce to institutional strategies. And if we’re talking about quant funds, without leverage they wouldn’t exist.
This sounds like perpetual motion to me. It's like Moore's law - no matter how long it's gone on for, it can't go on forever.
If everybody believes that, and people who actually control trillions of dollars do it on a massive enough scale, just borrow money and invest in stock, then it has to break things down at some point, doesn't it?
Banks are a little different and while the rules are complicated, big banks need to have around 3% of their total book at hand. Or in otherwords, they have around 33x leverage. Because of the leverage, banks need a very diversified uncorrelated portfolio in order to reduce volatility. No bank would stuff all of their money into equities, the risk of ruin is too high.
Also, there’s another perspective to look at your question: the efficient market hypothesis. In short, EMH states that in general, all investments have the same or trend toward the same risk/reward profile. That is, the ratio or slope of the returns vs volatility should be the same. With debt/credit, there are two primary options: you get paid back with interest or you don’t (let’s ignore bankruptcy). With equities you are assuming a lot more risk, the stock could go up or down or whatever. Since you are assuming more risk with equities than credit, it would violate EMH if you weren’t compensated for the extra risk.
This however, doesn’t explain why equities perform so much better than everything else. This is called the equity premium puzzle [2].
So maybe you’re right? No one really knows. Maybe the jig will eventually be up? Or maybe not, no one really knows.
- I don't want to invest on margin unless the interest rate is significantly lower than stocks generally return
- as a rule of thumb, 7% is a conservative estimate for stocks in the long run, while a typical broker charges close to 10%. So it seemed like a non starter.
- however, it is possible to find rates as low as 3-4%, so then the question becomes how much leverage to use?
- my logic was, what kind of drawdown is plausible if you invest at a market peak? It appears based on known history that -70% could happen. Therefore it would be best to limit leverage so that more than a 70% decline would be needed to cause a margin call.
- which seems to lead to borrowing no more than 25-27% of one's equity.
and yeah, there are failures, and they lose their shirts, and the beat goes on. but you're probably not going to make very much money (=> last very long) if your rate of return is the same order of magnitude as the collateral you're taking out. it's just not worth it from the POV of the bank.