aarc

ETFs: Yes, They Have Their Drawbacks Too

I prefer SSO than most other funds.

SSO is a 2x ETF for the SnP500. It only has 1.48% yield but should double in price incremental or decremental percentages than that of the main index on the daily basis.

That way, I will gain a little dividend but a huge price appreciation over the long term due to it's 2x nature. Furthermore, I assume that over the long run, the effect of price compounding will be the bigger factor towards SSO going much faster than a linear 2x performance.

Assuming SPX and SSO goes back to their Oct 2007 highs at the same time:

- SPX would appreciate 137% from the low of 667 to 1576.

- SSO would appreciate 617% from the low of 14.16 to
the high of 101.48

That would result in 4.5x ETF performance for SSO instead of just being a 2x ETF. That is the nice effect of price compounding over the long run. The 2x performance is good only for daily runs upside or downside.

I expect the last high of Oct 2007 will be recovered in less than 5 years after the bottom has been set. If the SPX 667 is the true bottom; then we should be at 1576 or higher no later than March 2014.

SPY on the other hand would appreciate same as the SnP500. So even if SPY can provide 5% dividend; it can't possibly perform as good as SSO, being a 1x ETF.

How many high dividend funds will be able to perform better than SSO over the long run? And then, you will have to re-invest the dividends back into the fund in order to take advantage of compounding.

Investing in SSO is less of a hazzle since there's not much need to re-invest the tiny dividend percentage accruals each year. Let the 2x price appreciation alone do the compounding. And it does it in the daily, weekly, and monthly, quarterly and yearly basis, etc. Millineum, if you will.

As SSO price doubles and quadruples and what-have-you, the monthly dividend acruals will also get bigger and bigger in dollar terms and will accelerate a lot faster than a normal 1x high dividend fund. Over a longer time period, the monthly or quarterly acruals of SSO can become much bigger than that of high dividend fund on a dollar capital basis due to the multiplying effect of price appreciation assuming constant yield percentages.

Unlike fixed dividend funds, SSO yield applies to the most current share price and will more likely can go up a few percentage digits or points every year as the economy recovers and more companies make more money. While that of a high yield fund with fixed dividend will have a lower percentage of future share prices as the share price increases.

Since the companies in SnP 500 who provide dividends will declare different rates at different times, the yield of SSO will be constantly changing and unpredictable.

Since SSO has no long term history; I will have to assume that it will not give me instant gratification vis-a-vis quarterly dividend acruals unlike high yield funds with 3, 7, 10, or ever 15 percent dividend yields at the present. They are able to achieve high yields due to the annihilation of their share prices while their dividend dollar amount per share remains basically the same. Many have even reduced or cut off their dividend allocations for varied reasons but mainly caused by this recession.

But 5 years, 10 years, 20 years from now, SSO might as well keep me happy every month with huge monthly acruals (as compared to today's money, inflation will make it small) at least as compared to fixed dividend funds with shrinking dividend percentage of future appreciated share prices in a healthy economic environment.

No need to do stock or fund picking. The 2x factor will more than exceed any stock picking achievements in most cases.

Price compounding exagerates the price appreciation or destruction over a longer period of time. SSO suffered 87 dollar loss from its high of $101.14 to $14.18 in less than 2 years. I doubt if many investors who bought at the highs will have the stomach to buy it again even at current prices of 30 dollars.

So the disadvantage of SSO is that it will suffer mightily during downturns unlike fixed dividend high yield funds that seldom go crazy during panic times. They did this time, anyway. But not as bad as SSO. Thus making them extremely attractive with high fixed yields to current share prices. That will change in the future as their prices appreciate and the yields on the most current future prices dwindle.

Investors with weak intestinal fortitude better not look at SSO price during meltdowns if they want to keep it over a long period of time. And never ever try to use margin with SSO otherwise it can easily destroy margined accounts in a short period of time if we have another prolonged meltdown.