A week ago, I wrote on how holding SPXL, a 3x leveraged ETF of the S&P 500, longer term (1 year) can be a viable strategy that beats holding the S&P 500 in most cases. I used past daily return data from the S&P 500 to simulate a 3x leverage like SPXL going back to 1990. In summary, while holding SPXL does outperform the S&P 500 71% of the time, the other 29% of the time was extremely painful for investors where the S&P 500 was already down nearly 50% in one year and SPXL went down 90%.
I wanted to extend the same analysis to a close cousin of SPXL, the ProShares UltraPro QQQ (NASDAQ:TQQQ), which is a 3x leveraged ETF of the Invesco QQQ ETF (QQQ) which represents the NASDAQ-100 index. QQQ and TQQQ has grown in popularity in the past decade due to the emergence of big tech in our markets and also their resilience during the COVID-19 pandemic. Also, the 2000 tech bubble presents a very interesting and important time period to study for leveraged ETFs like TQQQ where the underlying holdings were the core of the bubble and its subsequent pop.
A Historical Back Test
Instead of just looking at a 1-year forward return, I wanted to also analyze a longer hold period of 5 years. QQQ data goes as far back as 1999 which is right as the tech bubble begins to form and where I start with the analysis. TQQQ wasn't created until 2011, post major protracted bear markets, and so I rely on QQQ price data to simulate TQQQ returns.
Some model details to note:
- I calculate a daily return by taking the close price of the current trading day divided by the close price of the previous trading day which assigns any after-market movements to the current day.
- A 1-year forward return is the compounded daily returns of the next 253 trading days (the average number of a trading days in a year).
- A 5-year forward return uses the next 5 x 253 = 1265 trading days. The 5-year forward returns are annualized to be comparable with the 1-year forward return.
- Each data point is one day that an investor started investing into QQQ or TQQQ and the associated return is the annualized return a year (or 5 years) later.
- For simplicity, dividends and fees are not accounted for.
1-Year Holding Period
Source: Author's own calculations, QQQ price data 1999-2020 from Yahoo Finance
Looking at the 1-year forward returns, the results are fairly similar to the SPXL vs. S&P 500 results. The triple leverage helps TQQQ generally outperform QQQ though it really depends on investor timing. The best opportunities for investors in TQQQ to outperform QQQ is during the beginning of major bull runs after a large market crash (2002 and 2009). However, even if investors missed the timing exactly, TQQQ still outperformed QQQ during the secular bull markets in 2003 to 2007 and 2010 onwards.
The absolute best time for investors to begin investing in TQQQ was before the major run-up of the tech bubble in 1999. Investors would have had over 7x their investments in a single year with TQQQ vs. only about 2x for QQQ. However, this only would have worked out if investors timed the market perfectly and stopped investing prior to the 2000 tech bubble bursting.
Throughout the extended bear market for tech stocks in 2000-2002, investors in QQQ were losing around 50% annually. Investors in TQQQ were losing nearly 100% of their portfolio for nearly three straight years. Similarly in late 2007 through 2008, TQQQ investors also saw nearly 100% wipe out of their portfolios.
Source: Author's own calculations, QQQ price data 1999-2020 from Yahoo Finance
Rather than looking at timing the market, which most investors have a difficult time doing, looking at the distribution of performance delta between TQQQ and QQQ shows that TQQQ should outperform about two-thirds of the time (blue, 64%). The average outperformance is 23%. The distribution has an extremely long tail, which means if an investor is particularly lucky with timing they can out-perform by a significant amount (300%+).
However, this is all not without significant risk to investors. Looking at the underperformance part of the distribution (red, 36%), the most common outcome is underperforming by between 40% and 50%. This underperformance typically already happens while QQQ is down significantly and so losing an additional 40%-50% basically means your portfolio would be nearly completely wiped out.
5-Year Holding Period: Worse Performance Than 1-Year
With unlevered ETFs and stocks, most investors abide by the adage that investing and holding solid positions long term is how you ride out market fluctuations and create wealth. One may think that this would work similarly for levered ETFs such as TQQQ. However, due to the asymmetric effect of magnifying losses more than gains, holding TQQQ for too long can actually have disastrous effects, especially since the longer you hold, the more likely you are to encounter a major protracted bear market. Let's examine the same charts but for a 5-year holding period (with annualized returns).
Source: Author's own calculations, QQQ price data 1999-2020 from Yahoo Finance
Using a holding period of 5 years creates a much worse picture for TQQQ. Prior to the long secular bull market post 2009, it was actually rare for TQQQ to even have positive annualized returns, let alone outperform QQQ. In contrast, investors in QQQ only lost money over a 5-year holding period if they bought at the very top of the tech bubble or exactly 5 years before the 2008 crash.
During the secular bull market between the two major crashes of the 2000s, where TQQQ 1-year forward returns generally outperformed, 5-year forward returns floundered. The few exceptions were where an investor began in 2002-2003 because the 5-year period ends prior to the 2008 crash. Otherwise, the 5-year period included the financial crisis crash which wiped out all gains and more. Investing with a 5-year holding period also completely wipes the huge outperformance in 1999 during the tech bubble run-up and instead turns it into the worst annualized loss in the whole two decades.
In contrast, post-2009 continued to favor TQQQ due to the extended bull market. Even if an investor bought exactly 5 years prior to the COVID crash, TQQQ still outperformed QQQ. This is explained by the rapid recovery in the price in the COVID crash as opposed to the drawn out bear markets in the tech bubble and the financial crisis. Source: Author's own calculations, QQQ price data 1999-2020 from Yahoo Finance
Moving over to the return delta distribution for a 5-year holding period, the results are a bit surprising. Now TQQQ only outperforms 52% of the time, barely above a coin flip. The majority of these cases come from the extended secular bull market post-2009. The positive side annualized outperformance also no longer has a fat tail, meaning there's not even as large reward to compensate. The average outperformance is now only 5%. Given the significant increase in risk for TQQQ, just getting a coin flip to outperform QQQ makes TQQQ not a great extended long-term hold.
Holding The Entire Time Period
If you held QQQ starting in March 1999 and held until today, you would have 6x your initial investment despite all of the protracted bear markets. If you held TQQQ instead, you would only have a measly 27% more than you had 20 years ago. Most of this is caused by the tech bubble crash nearly completely wiping out your portfolio.
Obviously, had you started investing in a better place such as right after the financial crisis crash, things would be much different. Investors starting in March 2009 and holding until today would have an 11x return with QQQ but a 300x return with TQQQ. However, market timing is incredibly difficult, so it is better to view things from a risk-reward perspective.
Conclusion
Leveraged ETFs such as TQQQ can be reasonably held long term but requires incredibly good market timing. Holding TQQQ for too long almost always guarantees you will eventually hit a major protracted bear market that completely wipes out the previous several years of gains. However, if you can avoid major protracted bear markets such as buying anytime since 2009 and today, TQQQ can outperform its underlying significantly.
TQQQ and other leveraged ETFs should only be held long term by investors with very high risk tolerances and great market timing. It is unclear how much longer this secular bull market will continue and when another tech bubble or financial crisis like crash will come. For most investors, holding unlevered versions of higher risk ETFs are probably better for their portfolios long term.
Dean Young
B.A. Economics and Mathematics, Software Engineer@LinkedIn. Ex-Facebook. I focus primarily on investing in the tech sector where I have domain knowledge. I'm a big data geek that forms data-backed analysis of stocks.
Analyst’s Disclosure: I am/we are long QQQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am not a financial advisor. All recommendations here are purely my own opinion and is intended for a general audience. Please perform your own due diligence and research for your specific financial circ*mstances before making an investment decision.
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