Volatility decay

The effect

Volatility decay is the loss a leveraged fund suffers when prices move up and down, even if the index ends where it started. It comes from compounding daily returns.

A worked example

The index alternates +10% and -10% days:

After four days the index is down 2%. The 3x fund is down 17%, more than eight times as much.

The approximate formula

Over a year, a fund with leverage L on an index with return r and volatility s grows at roughly:

L x r - (L^{2 - L) / 2 x s}2, minus costs.

At 3x leverage the drag term is 3 x s^2. With 20% index volatility, that is 3 x 0.04 = 12% a year. With 35% volatility, it is about 37% a year: the index has to rise a great deal just to break even.

What it means

• Leveraged funds need trending markets with low volatility.
• High volatility, not just falling prices, destroys value.
• This is why many leveraged strategies step aside when volatility rises or the price falls below its The 200-day moving average.

See also

• Leveraged ETFs explained How leveraged ETFs like TQQQ and UPRO work, why they reset daily, how volatility decay erodes them, and what their historical drawdowns look like.
• Standard deviation and volatility What volatility means in investing, how standard deviation of returns is calculated and annualised, and typical volatility for stocks, bonds and leveraged funds.
• CAGR (compound annual growth rate) What CAGR means, the formula for compound annual growth rate, a worked example, and why it differs from the average annual return.
• Maximum drawdown What maximum drawdown is, how to calculate it, why losses need bigger gains to recover, and historical drawdowns for stocks and leveraged funds.

Pages that link here: 6 Sig, 9 Sig, Compound interest, HFEA (Hedgefundie's Excellent Adventure), Inverse ETFs, Investing FAQ, The 200-day moving average, VIX tier allocation

Last updated September 30, 2026. Education only, not investment advice.