Opinion: Should You Put Your 401(k) In A ‘3X’ Retirement Portfolio?

It’s been more than a decade since the Securities and Exchange Commission warning Mom and Pop investors don’t put their funds in leveraged mutual funds designed to give them two or three times the daily performance of stocks and bonds, up and down.

It’s been over a year since I report that investors who ignored this wise advice made more money than Croesus and were laughing all the way to the bank.

Breaking news: They’re still acting like bandits, even though they’re not allowed.

Look, I’m not making suggestions, I’m just telling you what’s going on.

Basic Portfolio mentioned is 50% in ProShares UltraPro S&P 500
UPRO,
-2.63%,
designed to give you triple the performance of the S&P 500 stock index and 50% in DirexionDaily 20+ years Treasury Bull 3X
TMF,
+ 3.56%,
designed to give you three times the performance of long-term US Treasuries.

So far this year, this portfolio, which is rebalanced quarterly, has grown by a staggering 29% – although it shouldn’t be. The bond and stock markets are volatile, especially as bonds fall and then recover, and that is said to be toxic to these funds.

In contrast, the much more sensible portfolio omits these volatile funds and instead splits its money evenly between a simple US stock market fund and a pure long-term Treasury bond fund, which only 9% increase.

Professor.

This is not new.

Decades ago, this 3x portfolio, rebalanced quarterly, would turn an initial $1,000 investment into $15,100.

Simple, 1-time equivalent: $2,760, or less than one-fifth.

So much for the wisdom of the experts!

I increasingly suspect that one can get better financial advice from watching old Marx Brothers movies than you can reading an economics textbook. (Oh, and trust the Communists to make their economic analysis from the erroneous “Marx”.)

In theory, these leveraged funds are a disaster waiting to happen for long-term investors. These funds are only designed to give you 3x the performance of the underlying assets — stocks and bonds — per day. They do this by trading derivative products. Once you hold them for longer than a day, you will start playing the financial game of Russian roulette. Say, if the stock market rallied one day and rallied the next, you could, in theory, end up much worse than you started. You are affected by transaction costs. And you can run into a well-known percentage paradox — it simply has to be 100% to recover from a 50% loss.

The UPRO super bond fund has fallen 40% in the first three months of this year in a bond market trend, and is still down about 15% today.

I’m not making a point here, though I wouldn’t take this risk with my own money. But I was intrigued to take another look at this portfolio following Friday’s sharp stock market sell-off.

When the stock market is up, one asset that tends to do well is U.S. Treasuries — and the older the better. That’s arguably the main reason investors own some Treasuries, regardless of their view of the economy or the stock market. Treasurys provide a form of “insurance” in case the stock market crashes and things go awry in a handcart.

On Fridays PIMCO 25+ Year Coupons ETF
ZROZ,
+ 1.78%

and Vanguard Extended Term ETFs
EDV,
+ 1.58%

gains 3% or more, providing a useful stepping stone to portfolios while their stocks fall. But TMF has provided more than double the buffer, more than double or 7% increase.

(If you really want to get smart, the so-called “calls” on TMF, which give you a foothold on the fund’s shares in case they go up a long way, can go up to 50%.)

No, of course we shouldn’t hold a long position in this 3x Treasury Bond fund as a way to insure the rest of our portfolio. It may have worked in practice, and it may continue to work in practice for all I know, but it doesn’t work in theory.

Or, as Chico might say, who would you trust — the experts, or the market?