How THIS Unknown Factor Influences ETF Returns!

How THIS Unknown Factor Influences ETF Returns!

Many investors attempt to beat the market. But investors also know how hard it is to beat the stock market. The evidence is overwhelming that the longer investors play the game, the more likely they are to underperform the broad stock market. SPIVA research for instance highlights that over a 1-year period, for US large-cap stock pickers it’s almost a coin toss whether they can beat the market. If you extend the investment horizon, the number of investors who beat the market drops significantly. Arguably, investors’ long-term performance follows a power law distribution, where only a very small number of investors can beat the stock market, and 95% or more, will underperform the market. But nonetheless, investors use plenty of tricks in their attempts to beat the overall performance of the stock market. Leveraged ETFs as well as short ETFs seem to be particularly popular tools. But in this video, I will outline that both leveraged and short ETFs have some significant risks and drawbacks that both short- and long-term investors are often unaware of but should know about.

In my last video, I already discussed a common misconception about ETFs. And in this video I want to highlight another misunderstanding about ETFs that can be incredibly costly if you aren’t aware of the underlying process of ETFs. What’s important to understand is that not all ETFs attempt to match the performance of a broad-market index. For example, an instrument that attempts to multiply or boost the performance of an index with the help of debt are leveraged ETFs. And I believe that the average retail investor totally misunderstands how the underlying compounding rate of these kinds of leveraged ETFs can both positively and negatively impact returns depending on the market conditions.

ETFs are compounding daily. And what makes compounding so tricky is that over a period longer than one day, returns will be greater or less than the sum of the individual daily returns which is often overlooked or misunderstood by investors. The compounding effect can positively enhance returns in upward markets and may lead to larger returns than you expect. And for periods longer than one day, daily compounded returns of leveraged ETFs may not be equal to an unleveraged return (or the benchmark index) multiplied by the leverage factor. A similar, weird, and hard-to-understand dynamic can by the way also be observed in inverse ETFs also known as short ETFs. A short ETF is a type of ETF which aims to rise in value if the underlying index falls in value. So for example, if the S&P decreased 2% in value, an inverse ETF which tracks the S&P will increase 2% in value, and vice versa. But again due to the daily compounding mechanism, there are situations during which the underlying index goes down and an investor who investors in a short ETF loses money as well.

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Видео How THIS Unknown Factor Influences ETF Returns! канала René Sellmann