Opinion: Must you put your 401(ok) in a ‘3X’ retirement portfolio?
Paging Chico Marx.
“Who will you believe – me or your own eyes?”, The comedian asked famous in “Duck Soup”. And we investors face a similar challenge from the experts and regulators who are here to serve us.
Today’s topic is the famously insane “3X” pension portfolio that we are kept telling us not to buy because sooner or later it will wipe us out.
It’s been over a decade since the Securities and Exchange Commission warned mom and pop investors not to put their mutual funds in leveraged mutual funds designed to give them the up and down performance of stocks and bonds two or three times a day.
It has been over a year since I reported that investors who ignored this wise advice had made more money than Croesus and laughed all the way to the bank since then.
The latest news: They still make out like bandits when they’re not supposed to.
Look, I’m not making recommendations, I’m just telling you what happens.
The base portfolio in question is 50% in ProShares UltraPro S&P 500 UPRO, -2.63%,
designed to give you three times the performance of the S&P 500 stock index and 50% of the DirexionDaily 20+ Year Treasury Bull 3X TMF, + 3.56%.,
designed to give you three times the performance of long-term US Treasuries.
This quarterly rebalanced portfolio is up an impressive 29% so far this year – although it shouldn’t. The bond and stock markets have been volatile, with bonds mostly falling and then rising again, and that’s supposed to be poison for these funds.
The much more sensible portfolio, which ignores these volatile funds and instead divides its money equally between a simple US equity market fund and a simple long-term treasury bond fund, is only up 9%.
That’s not new.
Over the past decade, this 3-way portfolio, rebalanced quarterly, would have turned an initial investment of $ 1,000 into $ 15,100.
The simple one-time equivalent: $ 2,760 or less than a fifth that much.
So much for the wisdom of the experts!
It reinforces my growing suspicion that watching old Marx Brothers films gives better financial advice than reading business textbooks, for example. (Oh, and trust that the communists get their economic analysis from the false “Marx”.)
In theory, these leveraged funds are a disaster waiting for long-term investors. These funds are only designed to give you three times the performance of the underlying assets – stocks and bonds – per day. You do this by trading derivatives. Once you hold them for more than a day, you will start playing the financial equivalent of Russian roulette. For example, if the stock market goes up one day and goes down the next, you could theoretically be far worse off than you started. You will be hit by trading costs. And you can suffer from the famous percentages paradox – it only takes a 100% gain to recover from a 50% loss.
Ultra bond fund UPRO lost 40% during the bond market for the first three months of this year, and it is still around 15% in the red.
I am not offering a view here, although I would not take that risk with my own money. But I was drawn to re-examine this portfolio after Friday’s sharp sell-off in the equity markets.
When the stock market falls, the only asset that tends to do well – the longer the better – the US Treasury bond. This is arguably the number one reason for investors to own some government bonds, regardless of their view of the economy or the stock market. Treasuries provide some form of “insurance” in case the stock exchange tanks and things in the handcart go to hell.
On Friday, PIMCO’s 25+ Year Zero Coupon ETF ZROZ, + 1.78% and Vanguard’s Extended Duration Treasury ETF EDV, + 1.58% rose 3% or more, providing a helpful cushion for portfolios as their stocks fell. But the TMF offered more than double the cushion and rose more than double, or 7%.
(If you wanted to be really clever, the so-called “call options” on the TMF, which give you a hold on the fund shares if they should go up sharply, have increased by up to 50%.)
No, of course we shouldn’t take a long-term position in this 3x Treasury Bond Fund to hedge the rest of our portfolios. It may have worked in practice and continue to work in practice as far as I know, but in theory it doesn’t work.
Or, as Chico might put, who do you believe – experts or the market?