Many investors don't try to hand-pick market-beating stocks. With index investing, you can benefit from the wealth-building long-term trends of the stock market with a single ticker. Many will settle for the broad S&P 500 (^GSPC 0.80%) index, tracked by the efficient Vanguard S&P 500 ETF (VOO 0.87%) and SPDR S&P 500 ETF Trust (SPY 0.91%) exchange-traded funds (ETFs).
That's a robust strategy, mirroring the strategy of investing genius Jack Bogle and recommended in The Fool's primer for beginning investors. Given a few decades of value-building patience, you're almost guaranteed to make a lot of money this way.
But some investors want a little more, and place a heavier bet on the growth opportunity of the tech sector. In that case, the Invesco QQQ Trust (QQQ -0.19%) mirrors the gains or losses of the tech-heavy Nasdaq-100 index. It's a higher-risk, higher-reward idea, tracking a smaller basket of more volatile stocks.
Then, you can amplify the resulting returns again by picking a leveraged ETF. For instance, the ProShares Ultra QQQ (QLD) aims to double the daily returns of the Nasdaq-100 index.
Given the Nasdaq index's tendency to outperform the S&P 500 in the long run, that sounds like a slam-dunk winner. It might be a good investment for you, but there are some things you should know before taking that extra-risky plunge. After all, your stock brokerage will invariably warn you that it's a risky pick before letting you buy the ETF -- and for good reason.
Volatility decay: The silent killer of gains
Holding the leveraged ETF long-term is like trying to carry water in a sieve. Sure, it aims to double the daily returns of the Nasdaq-100, but it also doubles your exposure to the whims of the market. Over time, the daily resetting of leverage means you're not just amplifying gains, but also losses. The process was never meant to reflect the underlying index's returns over long periods of time, and the match gets a little less perfect at the end of each market day.
Think of it like this: If the Nasdaq-100 takes two steps forward and one step back, the ProShares Ultra QQQ ends up doing a wild dance that might leave you dizzy and with fewer dollars in your pocket.
But that's not the whole story. The ProShares Ultra QQQ fund also comes with a high expense ratio of 0.95%, compared to the unleveraged ETF's 0.2%. The basic Nasdaq-100 tracker is a highly automated stock portfolio that actually owns stocks. The ProShares version is mainly based on stock options and futures, with a dash of pure accounting tricks. The basic QQQ fund is cheaper to run because it takes less work.
And don't forget the leveraged fund's low dividend yield: 0.15% versus QQQ's 0.58%, according to YCharts. It may not sound like much, but these costs can add up over time. It's like driving a sports car with the anchor down -- great fun over short distances, but a real drag in the long haul.
Amplified losses: A wild ride down
Remember 2022? The S&P 500 fell 18% lower amid economic chaos and inflation-fighting fears. The Nasdaq-100 took a nosedive with a 33% negative return. Now, imagine the ProShares Ultra QQQ ETF doubling that steeper drop, because that's kind of what it did -- in a long series of daily steps. By the end of the year, it had taken a 61% haircut.
QQQ Total Return Price data by YCharts
There are other examples to consider. Holding a 2x leveraged Nasdaq-100 fund was also a painful adventure during the mortgage meltdown of 2008.
ProShares funds weren't around when the dot-com bubble popped, but I could imagine it roughly doubling the Nasdaq index's 36% drop in a year like 2000, followed by another 33% plunge in 2001. Taken together, the Nasdaq-100 fell 57% in those two years. The math starts to break down if you try to double that drop, highlighting the difference between detailed day-by-day moves and broad annual strokes.
I don't know when the next market meltdown will come, but it's only a matter of time -- and I sure don't want my nest egg invested in leveraged funds when it does.
Know when to hold
Trading leveraged ETFs like the ProShares Ultra QQQ requires sharp timing and market awareness. These funds are designed for short-term bets, capitalizing on daily market moves. If the market goes your way, it can yield significant gains, but you must be ready to exit quickly if it doesn't.
Unfortunately, that's the very definition of market timing.
At The Motley Fool, following the wise lead of master investor Warren Buffett, we generally don't recommend market timing. It's risky and often inconsistent. Even legends like Buffett will admit that they don't know what the market will do today, or next week, or next year -- only that it tends to rise over many years. Time in the market invariably beats trying to time the market.
Leveraged ETFs demand active management, contradicting the long-term, buy-and-hold strategy you see in The Motley Fool's fundamental investing lessons. But it's human nature to overestimate winners and ignore potential threats. Nailing the very top of the next market peak would be nice, but you can't count on it.
If you're not ready for high-stakes trading and quick decisions, leveraged ETFs might not be for you. Stick with well-chosen, diversified investments for long-term growth and stability. The Invesco QQQ Trust is one solid option, and you can't go wrong with the leading S&P 500 ETFs.