Leveraged ETF Decay Explained with Interactive Examples

Leveraged ETF Decay is also known as volatility decay or beta slippage is a mathematical phenomenon that affects all investments, but is particularly noticeable in leveraged ETFs.

The concept is often misunderstood and used as the argument to avoid leveraged ETFs. In this guide, we'll explain what it is, how it works, and why it shouldn't be looked at in isolation.

The Basic Principle

When you're looking at a compounding investment, the order of returns matters more than the average return.

Let's look at two different paths that both achieve a +10% return over 6 days, but with very different daily patterns:

Path 1: Smooth Upward Move

Initial Investment: $100.00

Day 1: +10% → $110.00

Days 2-6: No change → $110.00

Final Return: +10%

Path 2: Volatile Path to Same Destination

Initial Investment: $100.00

Day 1: +10% → $110.00

Day 2: -10% → $99.00

Day 3: +12% → $110.88

Day 4: -8% → $102.01

Day 5: +10% → $112.21

Day 6: -2% → $110.00

Final Return: +10%

Key Observations:

Both paths start at $100 and end at $110 (+10% total return)
Path 1 is smooth - one move up, then stability
Path 2 is volatile - reaches the same destination through ups and downs

What happens with 2x leverage?

Path 1 (Smooth) with 2x leverage:

Day 1: +20% → $120.00
Days 2-6: No change → $120.00
Final return: +20.00%

Path 2 (Volatile) with 2x leverage:

Day 1: +20% → $120.00
Day 2: -20% → $96.00
Day 3: +24% → $119.04
Day 4: -16% → $99.99
Day 5: +20% → $119.99
Day 6: -4% → $115.19
Final return: +15.19%

This demonstrates leveraged ETF decay in action: even though both paths reach the same +10% return in the underlying investment, the leveraged version performs differently depending on the path taken. The volatile path results in a lower return (+15.19%) compared to the smooth path (+20.00%) - this difference of 4.81% is the cost of volatility, amplified by leverage.