Should You Leverage The S&P 500 In Your Portfolio


Recently I sat down to think of possible improvements that I can make that will enhance the performance of my Questrade retirement investment portfolio. Like most people, I have significant exposure to the greater U.S. equity markets with approximately 45% of my finance portfolio invested in large capitalization equities, which are components of the S&P 500 Index.

S&P 500

The S&P 500 Index tracks the combined performance of the 500 largest companies in the U.S.  So, buying a share in a mutual fund or Exchange-Traded Fund (ETF) that has an investment mandate to mirror the S&P 500 will give you returns equal to the index, less any fees and expenses related to managing the portfolio.  In other words, if I hear someone say “the S&P 500 went up 2% today”, then it is highly probable that about 45% of investment portfolio increased in value by 2% as well.

Now, I am quite certain that for the foreseeable future my portfolio will continue to have significant S&P 500 Index exposure.   Therefore, whether I know it or not, I am effectively saying, “I believe that investing in an S&P 500 Index Fund is going to give me the necessary long-term returns to fund a significant portion of my retirement!”

If I truly, genuinely believe this statement, then why in the world would I not want to use leverage to get two or three times (2x or 3x) the returns of the S&P 500 Index?

Clearly, there is greater reward if the index goes up, but if the index goes down you are looking at two or three times the losses.  Sounds scary…

BUT, let’s say you have 25 years until retirement. Do you believe that if you put $1,000 into an S&P Index Fund today that you will end up with less than $1,000 (on an inflation-adjust basis) in 25 years?  I think not….

Sure volatility, bad economies, inflation, tax hikes scare me, but I believe that 25 years is enough to smooth out the bad times and generate a decent return.  Although I should point out that exactly 25 years from today might happen to be a “bad day”, so maybe it is not ideal to cash out in year 25.  Maybe year 23 is better or maybe I need to wait until year 28 for half and year 30 for the second half.   The point is that the investment is going to grow; it’s all about giving it time to do so.  The more time, the better….

So, how do you leverage?  One approach is to purchase shares of Exchange Traded Notes (ETN).  ETNs are senior debt securities issued by a bank.  ETNs track a fixed multiple of the performance of the underlying index over a specified term.  There is also a stop-loss mechanism which results in automatic early redemption and an optional redemption feature for holders.  This means that if losses are high, a circuit-breaker is tripped and you can get your money back; less your losses of course. (there is no such thing as free lunch).

Here is a chart comparison of SPY, the unlevered S&P 500 tracking Index Exchanged-Traded Fund (ETF) and BXUB, the Barclays Long B Leveraged S&P 500 TR ETN.  This chart assumes you purchased $100 of each security in November 2009, the day BXUB launched.  As described above, BXUB has provided a greater return on equity due to the leverage employed in the security.


(It is important to point out that SPY is an ETF, which is equity instrument and different from an ETN, however both investment vehicles provide returns based on the S&P 500 Index).

Clearly, the results shown in this chart are by no means indicative of future performance.  However, if we are willing to assume that the relationship between these two securities holds over time AND that the structure of ETNs as a debt securities prevents the well-documented issues with leveraged-ETF decay, then we may have a solid way to leverage our retail investment portfolios. All without using explicit leverage in margin accounts, which I deem highly risky for the average-joe.

One approach I am considering is to take 25% of my S&P Index exposure (so 25% of the 45% of my portfolio in the S&P 500 exposure or 11.3% of my total portfolio) and purchasing ETNs.

Do you have a view on utilizing ETNs or other similar securities as a method to leverage your S&P 500 portfolio returns?

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