ETF Time Decay

Here at  my10000dollars.com i have realized that many people do not realize that ETFs tracks certain indexes (for example UYG tracking financial indexes long) by reflecting the daily % gain or loss of the index. Therefore, the ETF’s gain compounds up or down depending on the behaviors of its index being tracked.

For example, if a fictional “ETF Long” fund tracked 2x (double) the performance of a fictional bank called “Bank of Illusion”, this is how ETF would behave.

ETF-Time-Decay1

So what does this mean?  Well, the problem with ETFs is that they lose its value over a long period of time due to the volatility in the underlying index (or stock in my example) going up and down repeatedly.

Let me show you an example of how the different leveraged ETFs (1x, 2x, and 3x ETFs) lose the overall value long-term.  And the “time decay” effect worsens with more leveraged ETFs – for example 3x ETF (FAZ) is worse than 2x ETF  (SKF).

Click below to see enlarged image

ETF-Time-Decay2

Wow, you can see that in 10 days, the 3x ETFs lose the combined value by more than half.  Horrible deal right?  Well..the reality is that the index usually does not swing 10%+ every day.  So in the real world, it looks more like this.

 

As you can see, the ETF’s combined value did not lose so much value in a more stable market.

So to summarize, here are some of the key points to consider when getting into an ETF.

1) ETFs lose value over time

2) The more leveraged the ETF is, the worse its effect

3) The more volatile the index (or a stock), the worse the “time decay” effect

4) Don’t plan on holding ETFs long-term. Instead, play it when you want to ride the trend/momentum

5) Make sure you know what you’re doing before getting into a leveraged ETF

Good luck and happy trading!

 

 

Leave a Reply

Your email address will not be published. Required fields are marked *