Can I interest you in an exchange-traded fund (ETF) that is designed to outperform the S&P 500 index by three times? That’s the allure of the Direxion Daily S&P500 Bull 3X Shares (NYSEARCA:SPXL) ETF, which has been one of the best performing ETFs in the past few years.
But does SPXL stock deserve a place in your portfolio? To answer that question you need to understand what you’re investing in.
Exchange-traded funds that track an index are a simple and effective way to invest in the market. They can track the overall market. Or, in some cases, they track a specific sector (technology, utilities, biotech, etc.). And a type of ETF that is gaining popularity is a leveraged ETF.
To be sure, a leveraged ETF is more volatile than a traditional ETF, but with that risk comes the opportunity for big rewards. For example, the SPXL has an investment mix that is designed to generate three times the return of the S&P 500 each day.
Leveraged ETFs are all about risk and reward. They can go up. But they can go down as well. And that’s where the risk of these funds comes in. The fund may be designed to produce a 3X gain when the S&P 500 goes up, but it can also produce a 3X loss when the index goes down.
Going into Memorial Day weekend, the S&P 500 is down 8.74% for the year. However shares of SPXL stock are down nearly 44%. And that’s despite being up almost 17% in the last month.
Fair is Foul and Foul is Fair
The first reason to avoid SPXL stock is because of volatility. The stock market hasn’t been behaving like the global pandemic caused by the novel coronavirus is still on the loose. In fact, the S&P 500 index is up about 30% since the sell-off in March.
And according to Bank of America (NYSE:BAC) analysts, stocks are at a level that makes them the most attractive relative to bonds in 70 years. And they are suggesting that stocks may have higher to go.
This is supported by the CBOE Volatility Index (VIX). Although the VIX is down from a high of near 90 in March, it is still trading at a level that’s considered high. And a stock market adage is that “when the VIX is high, it’s time to buy.”
But do you necessarily believe that the market is going to continue to go up? I would hope that all Americans are rooting for a safe and uneventful re-opening of the economy. But one or two flare-ups, particularly in dense areas, would scare the market. And don’t forget that this is an election year, which typically adds a risk premium to stocks.
But volatility is not the only reason to avoid SPXL stock for the moment.
You Must to Pay to Play
Investors know to pay attention to an ETF’s expense ratio. In 2019, the average ETF expense ratio was 0.44%. The SPXL fund charged more than double, with its expense ratio of 0.95%. Many fund managers believe this is a bad idea.
“The idea of paying upwards of 1 percent in expenses for an ETF is absurd,” said Matt Hougan, then CEO of ETF.com, now CEO of Inside ETFs. “It’s a bad idea in a traditional mutual fund, and moving that into a quote-unquote ‘efficient ETF wrapper’ doesn’t make it any better. Just say no.”
And while investors may be justified in paying a higher expense ratio if there are no alternatives in the space, that is not the case with SPXL stock.
3X Doesn’t Always Mean 3X
Because of the way the SPXL ETF uses derivatives and other forms of leverage, the fund has to be rebalanced daily. That means that even though the fund is designed to deliver a 3X return, it may not deliver that over time.
In fact, if you owned the fund for the last five years, you would have had an impressive 54% gain. That’s higher than the 39% gain of the S&P 500, but a far cry from three times.
SPXL Stock’s Worth the Risk for Long-Term Investors
SPXL is a specialized type of ETF that uses leverage in the form of derivatives and options among other tools to generate an outsized return. And that’s why SPXL stock is popular among day traders.
If you have an appetite for risk, SPXL stock may present a nice trading opportunity. Leveraged ETFs love volatility. So with discipline and the willingness to enter and exit trades quickly, there will probably be options to profit in this environment.
But if you’re a long-term investor, these funds come with substantial risk, and a significant expense. There are simply better options even for speculating.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.