Compounding is the black magic behind the financial world. “Compounding is the financial equivalent of a snowball rolling downhill: With each revolution, the snowball gets bigger because it picks up more snow [Franklin Templeton Investment].” Below shows the effect of compounding (excluding inflation rate and assuming the S&P500 will bear 8.13% annualized return in the next 10 years). Annualized S&P500 return is provided by Morningstar. Without extra investment, your original investment of $10,000 will double to $20,000 in ten years.
Let’s take a hypothetical look at how compounding affects traditional exchange-traded funds (ETFs). My analysis will focus on three different scenarios: upward trending, downward trending and volatile.
Let’s use a 2x leveraged ETF to conduct our analysis. 2x leverage means the daily % return will double. Leverage in possible through the use of futures and other financial instruments which may expose these funds to dramatic potential gain and loss.
As you can see, both traditional and leveraged has the same criterias (both start with $10k and the market condition at that specific day/month is the same), but the second period return widely differs. Leverage ETFs can potentially maximize your gain or loss at any given time period. In my next post, I will focus on the decay associated with investing medium to long-term in leveraged ETFs.
Intersection notepad 