Question: What does the Bogleheads community think of buying a balanced fund on margin while early in the accumulation phase?
For purposes of discussion, can we agree to the following constraints:
- Retirement is 30+ years away, and these funds will not be needed for 30+ years
- Use of margin will decrease as assets approach target, think of this as "paying off the home mortgage"
- Investor is already contributing max to 401k and Roth IRA
- Investor and DW have stable jobs and emergency funds for 12 months of expenses
- Investor is in the middle of the 25% tax bracket, 5% state tax, married filing jointly
- Initial investment is $200k cash
- Initial leverage starts at $200k
- Annual cash addition is $12k ($1k/month) -- "monthly mortgage payment"
- Margin account is with a discount broker like Interactive Brokers with margin rate around 1.5% (Fed Overnight Rate + 1.5%)
- Investor will stay the course
- 2x and 3x leveraged ETFs. (UPRO, SSO, etc.) They don't work the same as one would want in a buy-and-hold portfolio.
- Rebalancing (this is done inside the fund)
The wiki on Leverage links us back to a conversation from 2010 titled Ayres and Nalebuff: Young people should buy stocks on margin. The discussion goes on for 400+ posts. Without rehashing the entire conversation, sscritic's comments resonated with my thinking:
sscritic wrote:G-Money wrote:sscritic wrote:So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?
"Age in bonds" achieves that goal without the possibility of getting completely wiped out.
We agree a common strategy is to start with higher risk (low bonds) early and lower risk (high bonds) late. In fact, many people "leverage" this by borrowing money to buy a house and invest in stocks for retirement at the same time. Assuming you start at age 25, you can save $25,000 a year for 10 years and put nothing into retirement. Then at 35, you buy your house for cash and start your retirement investing, putting 35% into bonds. Most people however, use "negative bonds" so they can start investing for retirement earlier and own a house at the same time. (They also have read the stories about investing from 25 to 35 and stopping gets you more at age 65 than investing from 35 to 65.) By borrowing money, their bond allocation can go from -200% to 65% from age 25 to age 65.
But going "negative" bond is leveraging your stock investments. Unless you pay 100% cash for your home, you borrow money during your investing life. So the question shouldn't be if you should borrow, it is what type of borrowing. What is the best way to borrow so you can invest in stocks while young?
a) credit cards balance
b) home mortgage
I think arguments can be made that borrowing against your house is better than using margin, but since a majority of people do borrow at some time in some form during the time they are saving for retirement, you can't really say that no one should borrow ever. Or perhaps you can, but I haven't seen that argument.
Note that the authors did not suggest 2x leverage for 20 years, but declining leverage as you age. When you take a mortgage so you can afford to have that house and save for retirement at the same time, you also have a declining balance as you pay the mortgage off (I am referring here to sane people who don't commit heloc abuse with serial refinancings at higher and higher balances).
So borrow when you are young to invest in stocks and reduce your borrowing as you age and simultaneously increase your bond allocation. Is that really such bad advice? Many people do it and retire comfortably.
1) How is this different from using a home mortgage and contributing to a 401k?
2) If someone believes in staying the course with their AA, does anything change when using leverage? For example, does an 80/20 non-leveraged AA turn into 60/40 when leveraged 2x?
3) What stays the same? TLH?
4) If the annualized return of the balanced fund is 8% nominal, what does leveraged 2x nominal return look like? Real return?
5) If the annualized return of the balanced fund is -8% nominal, what does leveraged 2x nominal return look like? Real return?
-=-=-=-=-=-=-=-=- Update -=-=-=-=-=-=-=-=-
After several hundred comments and lively discussion, I decided to try this concept. The current experiment is tracked in this spreadsheet:
https://docs.google.com/spreadsheets/d/ ... sp=sharing