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Brett Arends’s ROI: Shhh! Nixed portfolio crushes Wall Street — again

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Will the retirement investors who keep breaking Wall Street’s rules and making out like bandits please stop? You’re embarrassing everybody.

We’re looking at you, Redditors (and others) who’ve been gambling your savings on high-risk, high-fee ‘leveraged’ stock and bond funds.

In the past year someone who held the S&P 500 stock index
SPX,
-0.12%

through an index fund, such as the SPDR S&P 500 Trust ETF
SPY,
-0.09%
,
has made about 50% on their money.

Someone who held a typical ‘balanced portfolio’ or ‘balanced fund’ of 60% US stocks and 40% US bonds has made about 30%.

Then there are the people investing instead of exchange-traded funds that use leverage and derivatives to give you three times the performance of stocks or bonds per day.  In other words, if the stock market goes up 1%, one of these funds is supposed to go up 3%. (And vice versa).

The best known: The ProShares UltraPro S&P 500
UPRO,
-0.26%

 which aims to give you three times the S&P 500 performance every day, and the Direxion Daily 20+ Year Treasury Bull 3X Shares
TMF,
-0.28%
,
which aims to do the same for an index of long-term Treasury bonds.

A portfolio consisting of 60% of the stock fund and 40% of the bond fund? In one year it’s up 89%. No kidding.

And that’s true even though long-term bonds have had a terrible time, especially since the recovery took hold.

The bond fund TMF has lost money in each of the last four quarters.

But the stock fund is through the roof, up more than 250% since the start of the second quarter last year.

Yikes.

This is not supposed to happen. Really. We even spoke to Direxion, the company that runs these funds, last summer. These funds are designed for short-term trading only. They are not supposed to work long-term.

And actually we’re understanding their success here. Realistically the typical ‘balanced portfolio’ doesn’t invest 40% in long-term Treasury bonds, which are more volatile, but in a more moderate collection of short, medium and long bonds.
A portfolio that held 60% in the leverage stock fund, and split the rest equally across the long bond fund and its medium term equivalent (the Direction Daily 7-10 Year Treasury Bull 3X fund
TYD,
-0.19%

would be up 100% and change over the past year.

It’s coming up for 12 years since the Securities and Exchange Commission told you not to do this. On Aug. 1, 2009, the Commission warned that these funds were designed only for daily trading. But some “confused… individual investors” were trying to use them for “long-term” investing instead, it said. These leveraged funds had “extra risks for buy-and-hold investors,” it said.

If you’d been sensible on that day and invested $10,000 in, say, an S&P 500 index fund and just left it there today you’d have about $53,000.

If you’d been even more sensible and invested that money in a balanced portfolio of stocks and bonds, like the Vanguard Balanced Index Fund
VBIAX,
+0.35%

you’d have just under $34,000. (I’m ignoring taxes.)

If you’d ignored the SEC’s wise advice and, say, put 60% of your money in the leverage stock fund, and 20% each in the leverage medium and long bond funds?
You’d have more than $180.000.

No, I’m not kidding. And that’s assuming you rebalanced the portfolio at the end of each year (selling some of the year’s winners and buying some of the year’s losers to restore the original portfolio balance. If you’d left the portfolio alone you’d have around $220,000).

Average annual return since the end of 2009: About 28%.

Even crazier? If you’d just put $2,000 in the leveraged S&P 500 fund, and left sitting risk-free in the bank, today you’d have nearly $80,000 — or way more than you got from risking everything in the stock market.

This is really embarrassing for experts, and people should stop doing this and making money. These sorts of returns make monkeys out of the smartest, highest-paid money managers in New York, Greenwich, Connecticut and other financial hot spots.

OK, nobody recommends these funds for long-term investing. A leveraged fund exaggerates your losses on the way down, and also loses you money if the markets just bounce around.

To give some illustration of what can go wrong: In last year’s crash the S&P 500 lost 33% in a month. The UPRO fund lost 77%.

In the fourth quarter of 2018, when the S&P 500 fell just under 20%, UPRO halved.

Possibly worse, look at what can happen in a dull market. For example from 2010 through the end of 2016 emerging markets went nowhere. An investor in the low-cost iShares MSCI Emerging Markets ETF
EEM,
-0.61%

over that period broke even. An investor in the Direxion Daily Emerging Markets Bull 3X fund
EDC,
-1.93%

? They lost about 70%. Buy and hold investors lost their shirts as the market whipsawed.

These funds only work if you’re in a bull market. On the other hand, if you don’t think we’re in a bull market, would you invest in stocks?

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