The only risk of leverage is selling at the bottom

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techcrium
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The only risk of leverage is selling at the bottom

Post by techcrium »

That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
Last edited by techcrium on Tue Sep 23, 2014 12:37 am, edited 2 times in total.
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Re: The only risk of leverage is selling at the bottom

Post by Elbowman »

What does skill have to do with a margin call?
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Re: The only risk of leverage is selling at the bottom

Post by toto238 »

Well you also are getting charged probably between 5% and 7% interest on it... So you better be making AT LEAST that much.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

That was an analogy...based on leverage.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

toto238 wrote:Well you also are getting charged probably between 5% and 7% interest on it... So you better be making AT LEAST that much.
Of course I am assuming that the financially literate would attempt this with positive EV...

And no...margin debt interest can be as low as 2% to 3%

Heloc is 3%
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Re: The only risk of leverage is selling at the bottom

Post by ogd »

techcrium wrote:Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool?
People are not corporations, my friend. They don't start over when they run out of money, nor are they shielded from creditors like shareholders are.
techcrium wrote:Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?
Because you're not a skilled fighter. Nobody is.

About the best you can do is avoid what you call the "fear selling". Do that, whether leveraged or not. But if you invest in leveraged risk assets at all, you gotta worry about that margin call, always, and worry a lot. Saying it's the only risk is like saying that drowning is the only risk of swimming across the Channel: true, but hardly reassuring.

Many of us think of certain life events (possible or certain) as similar in nature to a margin call and we in fact de-leverage by holding less than 100% stocks.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

ogd wrote:
techcrium wrote:
About the best you can do is avoid what you call the "fear selling". Do that, whether leveraged or not. But if you invest in leveraged risk assets at all, you gotta worry about that margin call, always, and worry a lot. Saying it's the only risk is like saying that drowning is the only risk of swimming across the Channel: true, but hardly reassuring.
But that is the whole point. It is a simple yet complicated reason.

I will elaborate on your analogy.

Drowning is the only risk of swimming, which is true. If someone who is prepared wants to swim across the Atlantic, he can definitely do it. With a boat/helicoptor following after him 24/7, adequate supplies, training, various checkpoints, it is definitely possible.

Now is that feasible for the average person? Definitely not. Is leverage feasible for the average investor? Most definitely not either. But it can be done and used effectively.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

I would say that student loans is a leveraged investment.
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Re: The only risk of leverage is selling at the bottom

Post by ogd »

techcrium wrote:Drowning is the only risk of swimming, which is true. If someone who is prepared wants to swim across the Atlantic, he can definitely do it. With a boat/helicoptor following after him 24/7, adequate supplies, training, various checkpoints, it is definitely possible.

Now is that feasible for the average person? Definitely not. Is leverage feasible for the average investor? Most definitely not either. But it can be done and used effectively.
The analogy was meant to illustrate that just because there's only one way you can fail, doesn't mean you can marginalize it; that single risk might be the entire point of the issue. If you take the analogy further, it's problematic because while training for swimming actually works, training for avoiding the margin call with a highly leveraged portfolio is pretty much useless; it will come if it wants to. The only way to keep it away is to keep the leverage small; once again, for many of us that point is quite a bit below zero, as in we actually buy bonds instead of borrowing money (the polar opposite), to prepare for the margin calls of life.
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Re: The only risk of leverage is selling at the bottom

Post by Day9 »

Margin rates are floating rates. Sure Interactive Brokers offers 1.58% now but they will likely raise the rates during a time when you want to ride out an unrealized loss.

You have virtually 0% chance of being completely wiped out if you follow Boglehead principals. If you leverage by buying on margin the chance of being wiped out is very real. Once you lose all your money, you cannot participate in any recovery. It's game over.
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Re: The only risk of leverage is selling at the bottom

Post by 3CT_Paddler »

Sounds like you are in need of some MarketTimer reading... http://www.bogleheads.org/forum/viewtopic.php?t=5934

TL;DR - A very savvy investor tried to use leverage, and took a shellacking because of it... and documents it all in real time on this forum.
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Re: The only risk of leverage is selling at the bottom

Post by tadamsmar »

If you look at the Trinity Study (Table 3):

http://www.bogleheads.org/wiki/File:TrinityTable3.jpg

You will notice a number of scenarios where increasing your stock allocation to 100% will decrease your success rate somewhat. So, it's logical that leverage could decrease your success rate.

One of your assumptions is wrong. Turns out that fear and margin calls are not the only reasons people sell. Some save for planned future consumption, when the scheduled date for the consumption arises they sell on the planned schedule.

Even if scheduled consumption does not make leverage relatively riskier, there is the matter of inheritance. You'd need an estate plan that did not require selling. Is that easy to arrange?
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Re: The only risk of leverage is selling at the bottom

Post by placeholder »

There are various kinds of margin and one that is pretty common around here is home mortgage which has the advantage of being decoupled from the stock market directly (no margin calls) although of course the larger economic environment can cause something similar at times.
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Re: The only risk of leverage is selling at the bottom

Post by ogd »

techcrium wrote:I would say that student loans is a leveraged investment.
And a very good one in many cases. The problem is, it's once in a lifetime. It's not like I can get ten more student loans and get ten more rewarding careers in return on top of the present one. Perhaps it would have been possible in a (strangely financialized) version of ancient Greece with its scholar slaves, but not so in the modern world where people are generally speaking free to keep their earnings for themselves.
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Re: The only risk of leverage is selling at the bottom

Post by tadamsmar »

Ed Thorpe did a study using the Kelly Criterion that showed that ~140% exposure to the SP500 is the point where a investment becomes so risky that failure is certain in the long run. ~140% maximized growth for an infinite holding period. Given that it was based on Kelly, it defines the theoretical limits of leverage.

But, the assumptions of the model had to be exactly met, in particular the future SP500 has to perform to the estimate based on past performance and the long run had to be very long exceeding a lifetime. One needs a margin of safety against the assumptions and using half Kelly (140/2 = 70) is a typical margin.

Of course 70% exposure to the stock market does not require leverage.

Any way you cut it, there is just no good argument in favor of leverage. A 100% exposure is risky enough.
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Re: The only risk of leverage is selling at the bottom

Post by JoMoney »

The Kelly Criterion and some of the premises behind Modern Portfolio Theory demonstrate that taking the riskiest position is usually not the optimal choice for maximizing returns.
Consider the illustration from the below article
This particular scenario is contrived, but does demonstrate potentially real scenarios. The picture demonstrates the outcomes of several portfolios of different Cash/Stock positions. Under this simulation, the "optimized" portfolio of 18% Cash / 82% Stock has nearly the same return as the 100% stock position, whereas the levered -100 Cash /200% Stock position was an utter failure despite the overall positive results for stocks.
Image
http://www.cfapubs.org/doi/pdf/10.2469/cp.v2004.n2.3379
...the leveraged portfolio performs dismally. Why? Although it does have the highest monthly expected return, it has such high variability that the likelihood of losing a substantial proportion of capital is so high that it likely will cause the investor to rebuild from a low base and never really recoup losses...
Taking on greater risk in the form of more volatile/variable outcomes does not necessarily lead to higher returns then a less variable portfolio even if the expected return is higher. The sequence of those returns can be very important.
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Re: The only risk of leverage is selling at the bottom

Post by VA_Gent »

Why not use SP e-mini futures for your leverage? It only costs about 2% per year to rollover your position four times a year.
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Re: The only risk of leverage is selling at the bottom

Post by Valuethinker »

I am not sure if anyone has mentioned it but Margin Call.

One should see the movie. The investment bank in the movie is another Lehman, highly leveraged.

If you are leveraged then your margin provider can call the margin. Thus forcing liquidation at the worst possible moment. Consider the $70bn Texas Utilities buyout, where the equity holders have now walked away having lost c. $20bn. They could not extend their banking terms any further.

Can you remortgage your house and invest in stocks? Yes. But you'd better hope you have no reason to move/ you don't lose your job 3 years into this strategy.
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Re: The only risk of leverage is selling at the bottom

Post by Valuethinker »

JoMoney wrote:The Kelly Criterion and some of the premises behind Modern Portfolio Theory demonstrate that taking the riskiest position is usually not the optimal choice for maximizing returns.
Consider the illustration from the below article
This particular scenario is contrived, but does demonstrate potentially real scenarios. The picture demonstrates the outcomes of several portfolios of different Cash/Stock positions. Under this simulation, the "optimized" portfolio of 18% Cash / 82% Stock has nearly the same return as the 100% stock position, whereas the levered -100 Cash /200% Stock position was an utter failure despite the overall positive results for stocks.
Image
http://www.cfapubs.org/doi/pdf/10.2469/cp.v2004.n2.3379
...the leveraged portfolio performs dismally. Why? Although it does have the highest monthly expected return, it has such high variability that the likelihood of losing a substantial proportion of capital is so high that it likely will cause the investor to rebuild from a low base and never really recoup losses...
Taking on greater risk in the form of more volatile/variable outcomes does not necessarily lead to higher returns then a less variable portfolio even if the expected return is higher. The sequence of those returns can be very important.
Thank you for this. It shows the problem perfectly.

Hedge Funds. Private Equity. Infrastructure. Real Estate. They are all leveraged bets. In the latter two cases you are leveraging *lower* risk investments than the market as a whole, and in PE/ LBO you should be (major mobile phone retailer owned by PE has just gone broke in the UK, losing 4000 jobs, £600m debt writeoff-- so not always). But your are still going long on leverage.
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Re: The only risk of leverage is selling at the bottom

Post by nisiprius »

techcrium wrote:That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
Well, the margin call is not a negligible risk. Techcrium, didn't you ever read the long-running thread, A different approach to asset allocation? Market Timer, who still posts here occasionally, is a bright guy who was at that time a graduate student in economics, and he was following an approach recommended by two Yale professors in an article called "Mortgage Your Retirement." Another factor to keep in mind about margin is that margin requirements are set by regulations which could change.

The second question is: why are people so dismissive about the "fear" factor? How do you propose to deal with it? Unfortunately because fear is shameful, people do not talk about it much, but at least two sophisticated, experienced, knowledgeable adult investors--professional wealth manager and author Dan Solin, and behavioral economist and book author Cass Sunstein--have acknowledged panic-selling, Solin in 2008-9 and Sunstein in 2011. (I could add to that list a work colleague of mine named Dwight and a long-time friend named Nancy). Fear exists. Do you think you are fearless? Do you think you can become fearless by willing it?

And financial fear is different from physical fear; having one kind of courage does not necessarily indicate the other kind. An old British writer, Samuel Butler, observed correctly that "Suicide is a common consequence of money losses; it is rarely sought as a means of escape from bodily suffering." It's not a published paper but it appears that wealth shocks may directly affect the health of the elderly. Market Timer can speak for himself about the days when he was posting using a picture of Raskolnikov as an avatar, but I was not the only one concerned for his situation at the time.

Saying "fear is the only risk" is like saying "lack of intelligence is the only thing standing between me and a Nobel prize." Suppose it were true. What then?

The third question is: is the fear irrational? Larry Swedroe often says "Smart people know not to treat the highly unlikely as impossible." I believe that what happens is that most of the time, we do treat the highly unlikely as impossible. We know it is not really impossible, but we also know that there is no rational way to deal with it and we put it aside. For example, today, I would say that the chances of a financial collapse of the United States within the next few months are so small that it does not even make sense to estimate them. It might be one in a million. It might be one in ten million. (Though it's certainly more than a "ten sigma event"). But in 2008-2009 they were not that small. What's your guess? Around the time people like Ben Bernanke and Henry Paulson were appearing on TV with, I thought, fear visible in their face and audible in their voices, I'd have put it at maybe 5%-10%.

Certainly there is a huge psychological component to it--and incidentally one of the lessons of behavioral economics, as well as the personal testimony of Cass Sunstein, is that even when we know that our behavior is irrational we cannot necessarily control it simply by wishing we were rational. But there is also a rational component to it. Normally we drive down the road watching cars drive down the other side, at a combined closing speed of 110 mph and a separation of few feet, protected by nothing but a double yellow line and the driving skill of a stranger, and we do not feel any fear or regard the close approaches as "near misses." In a 2008-2009 we see that the approaching car is driving erratically and is slightly over the yellow line and we now feel a need to process that as a real risk and take action.

The reason why people don't think they will panic-sell and then panic-sell is that during "normal" times certain risks are so remote that it is irrational to consider them, and during crises the same risks are so present that it is irrational not to consider them. It is the difference between the potential risk that a car might cross the double yellow line and the present risk of an approaching car that is actually over that line.

The fourth question is: exactly how do you propose to deal with the fear, justified or not? Do you actually have a way to turn over your investing strategy to an algorithm and throw away the authentication token so that you are unable to log on again?
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Re: The only risk of leverage is selling at the bottom

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techcrium [OP] » Tue Sep 23, 2014 1:19 am wrote:That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
My "thought" is that if you decide to use leverage, you could also document the entire process since day 1.
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Re: The only risk of leverage is selling at the bottom

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.....
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

YDNAL wrote:
techcrium [OP] » Tue Sep 23, 2014 1:19 am wrote:That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
My "thought" is that if you decide to use leverage, you could also document the entire process since day 1.
Like: [url=Like...http://www.bogleheads.org/forum/viewtop ... =10&t=5934]A different approach to asset allocation[/url]
nisiprius wrote:
techcrium wrote:That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
Well, the margin call is not a negligible risk. Techcrium, didn't you ever read the long-running thread, A different approach to asset allocation? Market Timer, who still posts here occasionally, is a bright guy who was at that time a graduate student in economics, and he was following an approach recommended by two Yale professors in an article called "Mortgage Your Retirement." Another factor to keep in mind about margin is that margin requirements are set by regulations which could change.
3CT_Paddler wrote:Sounds like you are in need of some MarketTimer reading... http://www.bogleheads.org/forum/viewtopic.php?t=5934

TL;DR - A very savvy investor tried to use leverage, and took a shellacking because of it... and documents it all in real time on this forum.
Is this the only response?

MArket Timer was leveraged 8:1 I believe according to the thread. Obviously leveraged 8:1 is highly risky which is why he failed...and had to sell at the bottom.

I clearly pointed out that selling at the bottom is the risk of leverage and he was forced to sell at the bottom.

Imagine if he was leveraged 1.5:1 or 1.25 to 1 and what position he would be today.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

I clearly mentioned that the risk of leverage is getting wiped out at the bottom which was exactly what happened to Market Timer.


He had way too much leverage compared to his equity position. For someone taking a $200,000 loan to invest...he should have minimum $800,000-$1.2mil in invest-able assets.
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Re: The only risk of leverage is selling at the bottom

Post by tadamsmar »

techcrium wrote: Imagine if he was leveraged 1.5:1 or 1.25 to 1 and what position he would be today.
Ed Thorp showed that 1.5:1 is recklessly risky for the SP500 and any other stock portfolio of comparable risk. Now, it could be that least a theoretically acceptable risk over the long, long, run if you invested in a portfolio of stocks less risky than the SP500. But, that would amount to toning down the risk of the portfolio for the privilege of paying at least 3% in interest on your loan, and that seems like a bad idea. Bottom line: you can get sufficient risk to get yourself to the edge of recklessness by just investing in stocks, there is simply no need for leverage.

Younger folks are already in effect leveraged by having a mortgage while investing. There is no need for more leverage.

You need to get grasp of the fact that the Kelly Criteria shows that taking on more risk beyond a certain point does not increase return.

Read the book Fortune's Formula.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

tadamsmar wrote:
techcrium wrote: Imagine if he was leveraged 1.5:1 or 1.25 to 1 and what position he would be today.
Ed Thorp showed that 1.5:1 is recklessly risky for the SP500 and any other stock portfolio of comparable risk. Now, it could be that least a theoretically acceptable risk over the long, long, run if you invested in a portfolio of stocks less risky than the SP500. But, that would amount to toning down the risk of the portfolio for the privilege of paying at least 3% in interest on your loan, and that seems like a bad idea. Bottom line: you can get sufficient risk to get yourself to the edge of recklessness by just investing in stocks, there is simply no need for leverage.

Younger folks are already in effect leveraged by having a mortgage while investing. There is no need for more leverage.

You need to get grasp of the fact that the Kelly Criteria shows that taking on more risk beyond a certain point does not increase return.

Read the book Fortune's Formula.

Exactly. What about those who don't have a mortgage and are renting + investing?

http://www.bogleheads.org/forum/viewtop ... 2&t=143552


Why is it that in my other thread when I asked bogleheads...which is more risky: a mortgage or leveraged investing...and nearly EVERYONE pointed to mortgage.


Now that I made this thread, everyone is saying that leverage and margin debt is a real risk.


What is going on?
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Re: The only risk of leverage is selling at the bottom

Post by KyleAAA »

I don't think there is anything fundamentally wrong with leverage PROVIDED YOU DO IT RESPONSIBLY.

If you want to leverage up to 1.3:1, I say go for it. Please post regular updates here! I've sometimes considered doing the same, but my laziness has kept me from pulling the trigger. That and the fact that a strong small/value tilt achieves pretty much the same result at lower cost and less complexity.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

KyleAAA wrote:I don't think there is anything fundamentally wrong with leverage PROVIDED YOU DO IT RESPONSIBLY.

If you want to leverage up to 1.3:1, I say go for it. Please post regular updates here! I've sometimes considered doing the same, but my laziness has kept me from pulling the trigger. That and the fact that a strong small/value tilt achieves pretty much the same result at lower cost and less complexity.

There is the entire point of this thread. Leverage is absolutely fine provided you are responsible and aware of the consequences...which is selling at the bottom either forced or voluntarily.

If you had avoid that then you are fine.
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Re: The only risk of leverage is selling at the bottom

Post by denovo »

This is like the third or fourth time you've posted this topic; and the same arguments are being rehashed.
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

denovo wrote:This is like the third or fourth time you've posted this topic; and the same arguments are being rehashed.
And yet the only response is a link to Market Timer's thread which he was leveraged 8:1 and $200,000 in borrowed money...which I clearly said that he was overleveraged and thus forced to sell at the bottom.

In my OP I clearly highlighted that, that was the real risk. Selling at the bottom and that is what happened to Market Timer.
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Re: The only risk of leverage is selling at the bottom

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techcrium wrote:
denovo wrote:This is like the third or fourth time you've posted this topic; and the same arguments are being rehashed.
And yet the only response is a link to Market Timer's thread which he was leveraged 8:1 and $200,000 in borrowed money...which I clearly said that he was overleveraged and thus forced to sell at the bottom.

In my OP I clearly highlighted that, that was the real risk. Selling at the bottom and that is what happened to Market Timer.
Now, you're just not being fair. You've gotten plenty of responses; using logical and mathematical constructs showing you why your arguments are invalid. I believe in prior iterations you attempted to argue that buying stocks on margin is equivalent to purchasing a home or using credit cards to pay monthly bills. I think you eventually backed off those arguments, though I am not sure on that count.
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Re: The only risk of leverage is selling at the bottom

Post by nisiprius »

techcrium wrote:
denovo wrote:This is like the third or fourth time you've posted this topic; and the same arguments are being rehashed.
And yet the only response is a link to Market Timer's thread which he was leveraged 8:1 and $200,000 in borrowed money...which I clearly said that he was overleveraged and thus forced to sell at the bottom.

In my OP I clearly highlighted that, that was the real risk. Selling at the bottom and that is what happened to Market Timer.
Well, that is factually inaccurate.

Market Timer's margin call occurred on or shortly after January 21st, 2009 and his minimum net worth was reached at or about that time.

On January 22nd, 2009, the S&P 500 closed at 827.50.

The bottom was reached on March 9th, 2009 at 676.53.

Market Timer did not sell at the bottom.

Market Timer was forced to sell 20% above the bottom. That is not a negligible point.

If you want to say "the only risk of leverage is selling lower than you bought," that, of course, is perfectly true, and if you want me to concede that point, I gladly do so.

Indeed, the only risk of any kind of investing is selling lower than you bought.
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Re: The only risk of leverage is selling at the bottom

Post by market timer »

Techcrium, the answer to your question is clearly no, you can lose money on a leveraged investment even if you aren't forced to sell. There is no guarantee equities will return more than your borrowing costs. Just look at the Nikkei over the past couple decades.

The MYR thread is quite long and has many digressions. One thing that is worth emphasizing here is that I didn't initially set out to risk a large amount of money. The idea was born when I lost $5K in summer 2007 selling a few puts on financials. I gradually added more and more exposure as markets fell, hoping to break even on that $5K loss, and came up with MYR to rationalize what I was doing. That's another risk with leverage: it is a slippery slope. Don't underestimate the human tendency to average down or change course if markets do not cooperate. Don't underestimate how distracting a leveraged position can become. Don't rule out bad outcomes. Seven years ago, I would not have believed I was capable of such reckless behavior, nor could I have imagined how quickly my life would be uprooted. As I've opened up to friends over the years, I've been surprised how many of them have similar stories.
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Re: The only risk of leverage is selling at the bottom

Post by YDNAL »

techcrium » Tue Sep 23, 2014 8:32 am wrote:Is this the only response?
I can't speak for others, buy my response and "thought" - as requested in the OP - is clear and should be sufficient to ponder.
YDNAL wrote:My "thought" is that if you decide to use leverage, you could also document the entire process since day 1.
Like: [url=Like...http://www.bogleheads.org/forum/viewtop ... =10&t=5934]A different approach to asset allocation[/url]
FWIW, I should mention that posting about a strategy, which is not implemented and not documented, is what it is.

ps. I just noticed market timer posted while I posted.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
Valuethinker
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Re: The only risk of leverage is selling at the bottom

Post by Valuethinker »

techcrium wrote:That is the only risk. Selling at the bottom either involuntarily (e.g. via margin call/heloc call) or voluntarily (e.g. via fear)

If that risk can be mitigated then leverage is absolutely fine and would even be recommended.

Matter of fact..majority of companies start off via leverage so why shouldn't the financially responsible person utilize this tool? Leverage is a double edged sword...but if u are a skilled fighter why wouldn't u wield it?

Thoughts?
1. companies use leverage all the time. Look at any LBO. Look also at how many of them go bust. Texas Utilities comes to mind (50bn+ default).

2. if you make a lower return on your investment than your borrowing cost, you will lose money, and the leverage magnifies the loss. That's why it's not usually possible to leverage say the US 10 Year Treasury Note. Hedge funds *have* made a lot of money doing that, but then gone bust eg Long Term Capital Management-- $6.5bn of equity wiped out, $150bn of assets in total.

As an individual investor your borrowing rate is almost always above what you get on a fixed investment of the same maturity.

So if we leverage into, say, Japan in 1990, then it's unlikely we are still around. The mortgage came due in 2010 say, and we were wiped out.

There is nothing guaranteeing an asset class will have a positive return over any given period.
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zaboomafoozarg
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Re: The only risk of leverage is selling at the bottom

Post by zaboomafoozarg »

So if you like leverage, use it and let us know how it goes. I'd be interested to hear what the effect is in a moderate bear market.

I'm still not doing it though. 75% stocks is enough for me, without the leverage.
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Re: The only risk of leverage is selling at the bottom

Post by larryswedroe »

Well first the idea missing the important fact that leverage isn't free. You pay above riskless rate to get it. Thus you are by definition earning less than the market's required rate of return on the investment.

Second of course, is that if you leverage you might be forced to sell and then even if right in long time you might be "dead" before the long term.

Third, leverage of course increases the volatility of the portfolio and it just might force someone to panic and sell because they were overconfident of their ability to take risks. Bear markets often turn 30 year horizons into 30-day horizons as the stomach screams GET ME OUT.

IMO leverage is not a good idea in almost all cases. IF you need or want higher returns should simply tilt more to the factors that have demonstrated higher returns, that doesn't involve the risks of leverage, might be more effective diversification as well, and doesn't have the same type costs of leverage

Larry
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Re: The only risk of leverage is selling at the bottom

Post by HomerJ »

techcrium wrote:There is the entire point of this thread. Leverage is absolutely fine provided you are responsible and aware of the consequences...which is selling at the bottom either forced or voluntarily.

If you had avoid that then you are fine.
Okay, so how do you guarantee that you don't have to sell at the bottom?
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Re: The only risk of leverage is selling at the bottom

Post by technovelist »

I have a mortgage and consider it much less risky than almost any other kind of debt.
Why? Because it is non-recourse. Thus, it is effectively a put option on my house.

Note: I have no intention of defaulting on my mortgage, or on any other debt, and I have never done so in the past. However, to calculate my overall risk profile, I think it is only prudent to consider everything the way it is.

So in my case, if I were to use the money I got from mortgaging my house to buy an investment asset, I would never have to worry about a margin call. I haven't done that, but I do have both investment assets and a mortgage, so economically speaking it is the same as if I had done so.
In theory, theory and practice are identical. In practice, they often differ.
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Re: The only risk of leverage is selling at the bottom

Post by pkcrafter »

market timer wrote:Techcrium, the answer to your question is clearly no, you can lose money on a leveraged investment even if you aren't forced to sell. There is no guarantee equities will return more than your borrowing costs. Just look at the Nikkei over the past couple decades.

The MYR thread is quite long and has many digressions. One thing that is worth emphasizing here is that I didn't initially set out to risk a large amount of money. The idea was born when I lost $5K in summer 2007 selling a few puts on financials. I gradually added more and more exposure as markets fell, hoping to break even on that $5K loss, and came up with MYR to rationalize what I was doing. That's another risk with leverage: it is a slippery slope. Don't underestimate the human tendency to average down or change course if markets do not cooperate. Don't underestimate how distracting a leveraged position can become. Don't rule out bad outcomes. Seven years ago, I would not have believed I was capable of such reckless behavior, nor could I have imagined how quickly my life would be uprooted. As I've opened up to friends over the years, I've been surprised how many of them have similar stories.
A+.

This discussion reminds me of this saying: smart investors learn from their mistakes: wise investors learn from the mistakes of others. :happy
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Re: The only risk of leverage is selling at the bottom

Post by HomerJ »

pkcrafter wrote:
market timer wrote:Techcrium, the answer to your question is clearly no, you can lose money on a leveraged investment even if you aren't forced to sell. There is no guarantee equities will return more than your borrowing costs. Just look at the Nikkei over the past couple decades.

The MYR thread is quite long and has many digressions. One thing that is worth emphasizing here is that I didn't initially set out to risk a large amount of money. The idea was born when I lost $5K in summer 2007 selling a few puts on financials. I gradually added more and more exposure as markets fell, hoping to break even on that $5K loss, and came up with MYR to rationalize what I was doing. That's another risk with leverage: it is a slippery slope. Don't underestimate the human tendency to average down or change course if markets do not cooperate. Don't underestimate how distracting a leveraged position can become. Don't rule out bad outcomes. Seven years ago, I would not have believed I was capable of such reckless behavior, nor could I have imagined how quickly my life would be uprooted. As I've opened up to friends over the years, I've been surprised how many of them have similar stories.
A+.

This discussion reminds me of this saying: smart investors learn from their mistakes: wise investors learn from the mistakes of others. :happy

"There are three kind of men. The one that learns by reading. The few who learn by observation. The rest of them have to pee on the electric fence for themselves." - Will Rogers.
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techcrium
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Re: The only risk of leverage is selling at the bottom

Post by techcrium »

technovelist wrote:I have a mortgage and consider it much less risky than almost any other kind of debt.
Why? Because it is non-recourse. Thus, it is effectively a put option on my house.

Note: I have no intention of defaulting on my mortgage, or on any other debt, and I have never done so in the past. However, to calculate my overall risk profile, I think it is only prudent to consider everything the way it is.

So in my case, if I were to use the money I got from mortgaging my house to buy an investment asset, I would never have to worry about a margin call. I haven't done that, but I do have both investment assets and a mortgage, so economically speaking it is the same as if I had done so.
When you have a mortgage and you are investing...then by definition you are leveraged.


When you have student loans, by definition you are leveraged.

When you have no other debt except borrowed money and you are investing, by definition you are leveraged.
Last edited by techcrium on Tue Sep 23, 2014 10:04 am, edited 1 time in total.
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Re: The only risk of leverage is selling at the bottom

Post by Snowjob »

I have been a frequent proponent of responsible leverage and have been open about my use of it on these boards since the summer of 2008. It sucks on the way down, its great on the way up. Always nice to do this when asset prices are cheaper, I typically don't extend much these days. While I would like to consider myself an above average investor and spent most of my time in individual stocks and bonds, I can certainly attribute near 100% of my out performance to leverage employed during my 8 years of investing.

I will probably only use low levels of leverage tactically in the short / medium term given asset prices so I'm expecting only a small level of alpha for my portfolio. I would recommend the same if you are considering leverage at this juncture. I don't think you will find anyone here other than myself (or new posters?) who will actually support "unconventional" approaches.
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Re: The only risk of leverage is selling at the bottom

Post by technovelist »

techcrium wrote:
technovelist wrote:I have a mortgage and consider it much less risky than almost any other kind of debt.
Why? Because it is non-recourse. Thus, it is effectively a put option on my house.

Note: I have no intention of defaulting on my mortgage, or on any other debt, and I have never done so in the past. However, to calculate my overall risk profile, I think it is only prudent to consider everything the way it is.

So in my case, if I were to use the money I got from mortgaging my house to buy an investment asset, I would never have to worry about a margin call. I haven't done that, but I do have both investment assets and a mortgage, so economically speaking it is the same as if I had done so.
When you have a mortgage and you are investing...then by definition you are leveraged.


When you have student loans, by definition you are leveraged.

When you have no other debt except borrowed money and you are investing, by definition you are leveraged.
Yes, I am leveraged, and I can't get a margin call. Win-win!
In theory, theory and practice are identical. In practice, they often differ.
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Re: The only risk of leverage is selling at the bottom

Post by Valuethinker »

technovelist wrote:
Yes, I am leveraged, and I can't get a margin call. Win-win!
If your mortgage comes due then that can become a margin call. Particularly if you are in negative equity.

You imply from your other post that you are in a non-recourse state? This is not true in Canada, UK and perhaps some US jurisdictions. You can't 'walk away' from an underwater home (any deficiency at sale is still a borrowing by the borrower).

The idea that on 25 years your house price could go *down* is not entirely academic. Places like Germany since 1990 that is possible. And Japan is the canonical example. Housing price slumps can last a *long* time.
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Re: The only risk of leverage is selling at the bottom

Post by technovelist »

Valuethinker wrote:
technovelist wrote:
Yes, I am leveraged, and I can't get a margin call. Win-win!
If your mortgage comes due then that can become a margin call. Particularly if you are in negative equity.

You imply from your other post that you are in a non-recourse state? This is not true in Canada, UK and perhaps some US jurisdictions. You can't 'walk away' from an underwater home (any deficiency at sale is still a borrowing by the borrower).

The idea that on 25 years your house price could go *down* is not entirely academic. Places like Germany since 1990 that is possible. And Japan is the canonical example. Housing price slumps can last a *long* time.
Of course this varies by state, and I'm not a lawyer, etc. However, this is my understanding of the situation:

Texas is not a non-recourse state for purchase money mortgages. However, it is a non-recourse state for "home equity loans", which in Texas are defined as including ANY refinanced mortgage in which ANY new cash is taken out. Since I have refinanced my mortgage with cash out, my mortgage has been converted to a "home equity loan", which is non-recourse. I have also verified this by reading my mortgage document, which explicitly states that it is non-recourse.

This seemingly odd treatment is due to a provision in the Texas state constitution allowing home equity loans, which were forbidden until relatively recently.

My understanding is that my mortgage cannot become due for any reason other than non-payment, and if I fail to pay, their only recourse is to foreclose on the house. I would not be liable for any deficiency.
In theory, theory and practice are identical. In practice, they often differ.
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Re: The only risk of leverage is selling at the bottom

Post by greg24 »

OP, please, please lever yourself up. The only risk is that you won't be the richest man in the world.
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