Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
Investing in the S&P 500 (SNPINDEX: ^GSPC ) is extremely easy, with a wide variety of index mutual funds and exchange-traded funds that give you exposure to the 500 stocks in the index. But if you want outsized performance and are willing to take on leverage in order to get it, then leveraged ETFs could be what you want. Historically, though, leveraged ETFs have sometimes left investors disappointed. Let's look at the performance of some leveraged ETFs tied to the S&P 500 to try to figure out whether that disappointment is justified.
ProShares Ultra S&P 500 (NYSEMKT: SSO )
Thanks to the largely straight-up move in the S&P so far this year, the ProShares ETF, which seeks to double the daily return of the S&P, has delivered very strong returns of more than 31%. That's actually slightly more than double the performance of the S&P, even when you consider the value of the dividends that S&P stocks have produced. That's due to the daily recalculation of the derivatives that the ETF owns, which can enhance returns during periods when the market moves in one direction.
But looking back five years, the ProShares ETF hasn't worked well as a long-term investment. Average gains of 6.6% seem respectable, but the S&P's 7.5% average return manages to beat the ETF even with its leverage.
ProShares UltraPro S&P 500 (NYSEMKT: UPRO )
The UltraPro version of ProShares' leveraged S&P lineup provides triple the daily performance of the index rather than double. Again because of the relatively lack of ups and downs in the market, this ETF has gained almost 50% so far this year.
The UltraPro ETF hasn't been around as long as the vanilla Ultra ETF, but even over the past two years, you can see some of the shortcomings of the ETF. A two-year average annual return of 27% isn't shabby, but it's just over double the 12.7% returns that the S&P has given over the same period.
Direxion's answers to ProShares
ProShares rival Direxion has its own leveraged S&P ETFs, and you'll find that the Direxion Daily S&P 500 Bull 3x (NYSEMKT: SPXL ) has put up similar numbers recently to those of its UltraPro counterpart. Unfortunately for Direxion, its fund only has about half the daily share volume as the ProShares version, even though the ProShares share price is higher. That's often a bad sign for an ETF provider, as being second-best with a similar expense ratio often isn't good enough to draw new investors away from the leader.
Should you invest in leveraged ETFs?
The downsides of leveraged ETFs disappear as long as the market doesn't oscillate up and down, and in fact, consistent moves can often lead leveraged ETFs to do even better than their promised multiples of returns. But the fact that markets over the long term rarely move in one direction still makes leveraged ETFs a risky call that most long-term investors can safely ignore.