Index Concentration and Daily Leverage in Long-Term ETF Investing

# Why do better-performing index funds not get a higher weight?


# Why do better-performing index funds not get a higher weight?












Most financial advisors recommend to inexperienced investors to put a large part of their investment in broad index funds (e.g. SPY). They will usually reiterate that most actively managed funds underperform their benchmarks, that most day traders lose money, etc., in other words that beating the market is exceptionally hard and that therefore the inexperienced investor should not expect more than the CAGR of the S&P 500. But there are indices that have outperformed the S&P 500, e.g. the NASDAQ-100 (and the difference isn't small: CAGR 8% vs. 13% since the NASDAQ-100's inception). Prudent long-term investors should thus invest a large fraction of their money into a fund tracking those better-performing indices, e.g. QQQ.

But I rarely hear that recommendation. The assets under management of SPY are currently almost 2.5 times that of QQQ (and it was above 3x 3 years ago, when the outlook for QQQ was better). The most obvious counterargument to the recommendation is volatility, but I think this doesn't sound valid for a long-term investor. Since its inception, the NASDAQ-100 has gone through many downturns and it still outperformed the S&P 500 significantly. More importantly, the S&P 500 has gone through the same downturns (although not as pronounced), so this is not a strong argument in favour of the S&P 500. Similarly, I never hear a recommendation to put even a small fraction of your money into a leveraged fund like TQQQ (which even after this year's downturn has a CAGR of >30% since inception).

What am I missing? Is there something fundamentally wrong with QQQ, TQQQ and the like or are others just scared by the risk? The risk can be reduced by not throwing all your money at one asset, but compounding over a long investment time (I'm thinking of at least 30 years, i.e. from first salary to retirement) strongly suggests that at least one higher-performing asset should be in the portfolio.

Edit:

Some data: Given a 10-year investment horizon, the NASDAQ 100 underperformed the S&P 500 8% of the time, with the worst underperformance being 6.5% CAGR. Given a 20-year investment horizon, the NASDAQ 100 underperformed 0.75% of the time, with the worst being 0.7%. Given a 25-year investment horizon, it never underperformed.

## Answer by AKdemy (score 2)

https://quant.stackexchange.com/a/74225

This is a question better suited for money stack exchange.

In any case, QQQ is the fifth largest ETF globally, not too bad for ~ 100 stocks.

Also, it seems there are a lot of discussions about what the best passive investment would be. QQQ is almost always in the list:

- Enrepeneur.com: which ETF wins

- investopedia: The QQQ ETF is an excellent

- fool.com: 3 reason to consider the QQQ ETF, and 1 not to

- yahoo finance: should QQQ be on your investment radar

However, if you think of what the Nasdaq 100 is, you will come up with lots of reasons you should not consider this as your major passive investment vehicle. This morningstar article lists some. Essentially, if you want to be on the safe side, you do nott want to be in just one sector (you have no exposure to real estate, finance, energy and the like). Also, if most of passive investment would rely on ~100 stocks, I would say it's a very questionable "business model".

Yes, for a long time those large tech stocks did very well, but still, there is no guarantee that this will continue. With the benefit of hindsight, it would have been even better to just invest in the top 5 or so out of QQQ. Obviously, starting to try pick the better performing index, or sector etc is no longer passive investing.

With regards to TQQQ (any leveraged ETF). They are a lot more difficult to understand, and most layman do not know that due to daily rebalancing, leveraged ETFs will likely underperform the underlying during periods of volatility, even if the underlying itself rises. This is also called volatility decay and is best illustrated with a simple example. I will use Julia. Say we start with 100 and have two days. On the first day, we lose 1%. The next day we gain 1.02%. Therefore, we have an overall gain in the standard ETF. Yet, the leveraged ETF lost money.

```
start = 100
up = 0.0102
down = 0.01

function ETF(start, up, down, leverage) 
    return start*(1-down*leverage)*(1+up*leverage)
end
println("QQQ is worth $(ETF(start, up,down,1))")
println("TQQ is worth $(ETF(start, up,down,3))")
```

The larger the swings, the more likely it is that TQQQ will lose money, even if QQQ gains. Say we lost 10% on the first day, and gained 12% on the second. That is a nice gain on QQQ, but a hefty loss on TQQQ.

After all, there is a reason TQQQ has the following warning directly on the main page:

and there are news articles like Bloomberg: SEC may regret the day it allowed leveraged ETFs

In case you have access to Bloomberg, you can have a look at the following interesting news article: {NSN O7U8FS6TTDSX }

It is probably true that over 20 or 30 years, you may do well. Reality is that many people do not buy and hold for 30 years. Some may get some money as teenagers, that they want to use for university in two or 3 years. Others save for a house or appartment.

- It is quite unpleasent if you lost ~ 20% last year.

- It is very annoying if you lost ~33%

- and mind boggling if you lost ~ 80% .

If you planned to use your savings to buy a house in 2023, good luck! You probably end up selling before the market recovers - never again are able to afford a house, and get divorced after a year like this...