Is buy and hold index futures a good idea
Graduating senior here planning for personal finance once I start making money. I started with thinking about putting 100% in low cost index funds (VTI/SPY) but then began to consider using leverage given my long investment horizon. I looked into leveraged ETFs but realized the decay that comes from the daily reset makes it a bad deal, which is when I turned to index futures. It seems like I can create 2-3x leverage by holding 3-month contracts and just roll them forward every quarter while I do some rebalancing. Given where interest rates are at right now rollover cost is pretty much zero, so I am struggling to see why this wouldn't work. If this works it should return >15% a year assuming equity market grows at 8% on average, but it seems too good to be true. What am I missing?
I know that the stock market has historically been down enough to theoretically wipe out a portfolio at 2-3x leverage, but that's only if the entire downtrend happens between two rebalances, and I feel like even this risk can be mitigated by setting hard stops, say getting out when market is down 20% from previous high.
Maybe I'm misunderstanding, but if you claim to be doing "rebalancing" every three months, that's too far apart. Look at COVID. We fell like 35% in the span of a few weeks. You're also forgetting that that "8% on average" is just that: averaged out to include all of the crazy ups and downs. Hell, in this century we've only had 4 or 5 years with a magnitude of less than 10% up or down. So for long term investing that's fine. But when you're playing with leveraged instruments, a single Black Swan event can totally wipe you out, whereas it would be a normal setback for a normal long term portfolio. Therein lies the problem. In order to reap the rewards of long term investing, you have to be willing to stay in through the downs. If we use your idea of stop loss at 20%, that means if it actually got to that point, you would be down 40-60%. You're probably thinking, I'll just buy the dip. Do you really think you'll have the guts to go 3x levered again when the market's in the shitter after half your portfolio is wiped out? So let's say you move your stop up higher to 10%. Well then you would be getting out at like every correction, which everyone knows is not what you do with a long term portfolio. Leverage in the public markets is for short-mid term trading not long term investing, because the variance will be a huge drag on your portfolio. The more you lose, the more it takes to gain it back. So no, I would not advise using leverage to try and create higher returns. The better alternative would be to have the majority of your money in SPY, and then use the remainder to play around with growth stocks, crypto, etc.. If the market falls, you'll be down a little more than the benchmark, but if it rises, you'll be up a little more (or if you have a combination of luck and skill, a lot more). Always a trade off of risk to reward. But in your case, the risk far outweighs the reward when there are better alternatives like the one I just mentioned.
OP here. Thanks for the detailed response. I agree with most of what you talked about, but why does risk-reward ratio change with increased leverage if my borrowing cost is near zero? Quarterly rebalancing does seem too slow, so maybe monthly makes more sense. However, I'm still thinking that with Fed's implicit backstop + my view on USD depreciating significantly in the long run I would want to be a debtor. The behavioral part you mentioned is def important and I'm trying to see if I can design some rules to impose upon myself so that I don't panic when the crash inevitably comes. Maybe what you're saying is it's very hard to stick to the rules?
I meant risk reward as in like I said, you could achieve the same results ("beating the market") by using a core satellite strategy, which carries slightly to moderately more risk than a basic index portfolio, as opposed to your idea which achieves the same results but with, by definition, 2-3x as much risk. So why would you undergo a riskier strategy when it will net you approximately the same result if it succeeds? And believe me, no matter how many rules you put in place, I can promise you that when that recession comes out of nowhere, you will not be able to adhere to them. As I mentioned in my previous post, your basic problem is this. Too big of a downside move and you get wrecked. But even a moderate 10% move, which is totally healthy and manageable in a normal portfolio, would stop you out and just keep setting you back. This is why like I said, leverage should not be used for long term public equities.
Much appreciated. Think the fact that I'm pretty much persuaded now in just one back and forth shows that I didn't have much conviction anyway. So like you said probably not gonna be able to stick to any rules made now. Thanks again and SB'd.
You're young so you can afford to take risks, given the fact that your time horizon is decades. That is why I would never recommend someone at that age to go for safer assets like bonds, because they won't give you the growth you need to outpace inflation or even keep up with the general market. So like I said, give core satellite a try. It gives the broad exposure that you need to an overall index, while still giving you the opportunity to do your own research (if you like that kind of thing) on certain stocks, cryptos, or even an alternative like baseball cards or something. If you make the right kind of picks and weight it well (think 5-20%, other 80-95% in SPY), you'll have slightly bigger drawdowns on the corrections, but the potential to make 20+% a year. Just make sure you have conviction in what you're holding so you don't sell at loss when the market drags it down. That's really the one advantage you have over Wall Street. You can be very agile and go into spaces that they (or at least most of them) can't.
I'm also considering investing in the 3x leveraged BEAR ETF (SPXL), can you elaborate more on what this^ means? I'm new into investing just like you and am not aware of what this means for leveraged ETFs. Thanks in advance!
My understanding is that in the background your exposure is being reset everyday to keep the same leverage ratio. The fund manager buys more if the fund is up and sells some if the fund is down, so you are always buying high selling low. Basically the more frequent the reset is, the less closely the fund would track the underlying index. Look into "path dependency" and "negative gamma".
For starters, SPXL is the bull version. A harmless typo, but worrying because 3x levered products are no joke to play around with. If you hit a massive, raging bull market like we have over the last year - you might look at the chart and get really excited about it because it keeps going day after day basically straight up - the issue, as always with leverage, is when that doesn't happen.
You lose, say, 6% in a day - reset to level - up 3% - reset to level - down 5% - reset to level... you get the gist of it - and should pretty quickly see what that will do over a 30 day or longer period. Setting aside the expense ration, transaction costs and other issues these have - you aren't 'tracking' the benchmark necessarily, you are taking a daily, levered position from a reset starting point.
These are designed, literally, to trade daily. You don't hold them. If you want to punt around - go for it. But buy and hold for these is... not recommended. There are better ways to get a 'levered' position on something if you want that via options or something.
>If this works it should return >15% a year assuming equity market grows at 8% on average, but it seems too good to be true. What am I missing?
If it was this easy, everyone would be doing it. Just invest in Vanguard Wellington or SPY and ride the ups and downs.
Just buy VT and forget about it.
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