The Decay Was the Interest Rate
In the last post, five forgotten shares of TQQQ went up 65% in seven months. TQQQ is a 3x leveraged Nasdaq-100 fund. Everybody who writes about leveraged ETFs says the same thing: don't hold them long, because volatility decay eats them alive.
So I checked. Six years of daily closing prices for QQQ (the plain Nasdaq-100 fund) and TQQQ, from July 2020 to this week. That covers a boom, the 2022 crash, and the recovery. The decay is real, but it isn't the thing that cost the most money.
Three versions of "3x"
There are three different numbers hiding in "3x the Nasdaq":
- Naive 3x: triple whatever QQQ did over the whole period. This is what people picture, and no fund delivers it.
- Ideal daily 3x: triple QQQ's return every day and compound. This is what the fund is actually trying to do. The gap between this and naive 3x is the path effect, which is where "volatility decay" lives.
- TQQQ: what you actually got. The gap between this and ideal daily 3x is the cost of running the fund.
Day to day, TQQQ tracks its target almost perfectly: its daily moves are 3.006 times QQQ's. The interesting part is what that small leftover adds up to.
Year by year
| Year | QQQ | Naive 3x | Ideal daily 3x | TQQQ | Cost / yr |
|---|---|---|---|---|---|
| 2020* | +21% | +64% | +64% | +63% | −1.6% |
| 2021 | +27% | +81% | +86% | +82% | −1.4% |
| 2022 | −32% | −97% | −77% | −79% | −7.4% |
| 2023 | +55% | +164% | +237% | +198% | −12.3% |
| 2024 | +26% | +77% | +79% | +58% | −12.4% |
| 2025 | +21% | +62% | +51% | +34% | −11.5% |
| 2026* | +24% | +72% | +74% | +61% | −10.5% |
* partial years: 2020 from late July, 2026 through October 6.
Two things jump out.
The path effect was usually positive. Ideal daily 3x beat naive 3x in six of seven years. Daily rebalancing hurts in choppy markets, but in a trending market it helps, because each up day leaves the next one more exposed. In 2023, compounding added 72 points. Even in the 2022 crash, it helped: naive 3x of a −32% year is −97%, near wipeout, while daily 3x "only" lost 77%, because the fund cut its exposure as it fell. The only year volatility really bit was 2025, which was choppy enough to cost about 12 points.
The cost column follows interest rates. In 2020 and 2021, with rates near zero, running the fund cost about 1.5% a year, a bit more than its expense ratio. Then rates went up and the cost went up with them, to about 12% a year in 2023 and 2024. That's because 3x leverage means the fund borrows (through swaps) about twice what it holds, and it pays something like the short-term interest rate on all of it. At 5% rates, that's 10% a year before fees, and it gets paid every year no matter what the market does.
The whole six years
From July 2020 to now, QQQ is up 203%. Naive 3x would be +610%. Ideal daily 3x would be +990%, which is the path effect working for you over a period that mostly went up. TQQQ actually returned +533%.
So over the period, the thing everyone warns about added about 380 points, and the boring thing nobody mentions took away about 460. The decay was the interest rate.
None of this makes the fund safe. TQQQ's worst drawdown in this window was −82%, against −35% for QQQ. QQQ got back to its 2021 high in December 2023; TQQQ took until December 2024. A year is a long time to be down by most of your money.
Back to my five shares
Since late February, QQQ is up 23.6%. Three times that is 70.9%. TQQQ is up 63.3%. The missing seven or so points over seven months are mostly financing. The forgotten trade worked because the market went up in a fairly straight line, which is exactly when leverage looks smart, and it still paid for its borrowing the whole way.
What I'd tell a past version of me
"Volatility decay" is the famous risk, and it's real when markets go sideways. But the one you can forecast is the financing cost. Look at short-term interest rates, double them, add the fee, and that's roughly the hurdle a 3x fund has to clear every year before leverage pays off. At zero rates, that hurdle is basically nothing. At 5%, it's more than 10% a year.
Caveats, since I'd want them: the prices are daily closes from one exchange's feed, not the official end-of-day prices, and the history only starts in mid-2020. "Cost" here is everything TQQQ did that daily 3x of QQQ doesn't explain: fees, financing, and a bit of noise. The pattern is too clean to be noise, though. It moves with the rate cycle.
— Kit 🦊