5% fee per year to buy s&p500 with principle gaurantee

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
bigwave2
Posts: 5
Joined: Thu Jan 17, 2013 10:54 pm

5% fee per year to buy s&p500 with principle gaurantee

Post by bigwave2 » Mon Jul 24, 2017 10:18 pm

which is a better idea.....
Invest $100 in the s&p500 for up to 1 year with the $100 completely at risk
Or
Pay $5 to leverage $95 of the s&p500 for up to 1year, with the $95 guaranteed to be there at the end of a year even if the market crashes?

Both scenarios allow unlimited upside in the s&p500 (if the market has a gain at the time the s&p500 is sold)

Thanks for your opinions

MotoTrojan
Posts: 861
Joined: Wed Feb 01, 2017 8:39 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by MotoTrojan » Mon Jul 24, 2017 10:29 pm

Would be fairly straightforward to run this through history. I'd wager it may come out on top in the long run, since the average increase is over 5%, and this eliminates the left-tail.

sharukh
Posts: 74
Joined: Mon Jun 20, 2016 10:19 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by sharukh » Mon Jul 24, 2017 10:30 pm

I guess you can implement this with buying call options.

But 5% is too expensive. Not worth the cost. may be at 2% I would say yes.

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Mon Jul 24, 2017 11:50 pm

The at-the-money Put on SPY for July 2018 sells a little above 13 and the underlying goes for almost 247. Dividends should be $5.

So, I'll take you deal, short SPY and write those puts.

MathWizard
Posts: 2651
Joined: Tue Jul 26, 2011 1:35 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by MathWizard » Tue Jul 25, 2017 12:02 am

I'm not sure leverage is he correct term here.

You are really just insuring against a drop.

5% seems way too high.

The SP500 is not going to drop to zero. (If so, any guarantee you have is probably worthless too as the US has now become worthless.)

On a 25% drop, your get 25% for your 5% insurance premium, so in the case of $100 you are $20 ahead,
but most years you would pay 5% and get nothing for it. My guess is that we won't have 25% drops every 5 years.

Nate79
Posts: 1445
Joined: Thu Aug 11, 2016 6:24 pm
Location: Portland, OR

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Nate79 » Tue Jul 25, 2017 12:06 am

This kind of sounds like that horrible product called a fixed index annuity.

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Tue Jul 25, 2017 12:24 am

It is a simple put hedge. $5 is about the market price, depending on whether the OP gets the full index with dividends, or without.

User avatar
Phineas J. Whoopee
Posts: 6692
Joined: Sun Dec 18, 2011 6:18 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Phineas J. Whoopee » Tue Jul 25, 2017 4:29 pm

Nate79 wrote:This kind of sounds like that horrible product called a fixed index annuity.
I agree, that's what it sounds like.
PJW

bigwave2
Posts: 5
Joined: Thu Jan 17, 2013 10:54 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigwave2 » Tue Jul 25, 2017 7:22 pm

This would not be an annuity.
I was more interested in a comparison of spending some % of money to guarantee against loss of principle (avoid crashes) vs just buying and holding the s&p 500 over the long term as the market rallies and crashes. I believe bogleheads love index funds and hate fees that eat away at gains, but I was hoping some bogleheads may have considered if they paid a 5% fee every year to avoid any market crashes if that would be money well spent vs just buying and holding and riding the roller coaster up and down year after year.

Thoughts?

MotoTrojan
Posts: 861
Joined: Wed Feb 01, 2017 8:39 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by MotoTrojan » Tue Jul 25, 2017 7:31 pm

bigwave2 wrote:This would not be an annuity.
I was more interested in a comparison of spending some % of money to guarantee against loss of principle (avoid crashes) vs just buying and holding the s&p 500 over the long term as the market rallies and crashes. I believe bogleheads love index funds and hate fees that eat away at gains, but I was hoping some bogleheads may have considered if they paid a 5% fee every year to avoid any market crashes if that would be money well spent vs just buying and holding and riding the roller coaster up and down year after year.

Thoughts?
Again, why don't you run this through a calculation and find out what % payment would have been break-even, over the last XX years?

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Tue Jul 25, 2017 7:53 pm

Did the OP pull that $5 figure out of a hat ??
If so, by sheer lock it turned out to be almost exactly the premium on an at-the-money SPY put expring JUL18.

bigwave2
Posts: 5
Joined: Thu Jan 17, 2013 10:54 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigwave2 » Tue Jul 25, 2017 8:09 pm

@mototrojan. I have run the numbers. Was hoping to compare my numbers with someone who also ran the numbers...as you say this is easy to do... like reinventing the wheel.

@thesaints. Check your pm inbox.

MotoTrojan
Posts: 861
Joined: Wed Feb 01, 2017 8:39 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by MotoTrojan » Tue Jul 25, 2017 8:17 pm

bigwave2 wrote:@mototrojan. I have run the numbers. Was hoping to compare my numbers with someone who also ran the numbers...as you say this is easy to do... like reinventing the wheel.

@thesaints. Check your pm inbox.
Easy but tedious, and time is money.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Tue Jul 25, 2017 8:31 pm

Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
David Jay
Posts: 4084
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by David Jay » Tue Jul 25, 2017 8:50 pm

bigwave2 wrote:... if that would be money well spent vs just buying and holding and riding the roller coaster up and down year after year.
willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
There is your answer.

As to "why?", may I suggest that the market isn't a roller coaster, it is an "up" escalator, with an occasional rapid elevator ride back down a couple of floors. So carrying the load of "insurance" every year it too high a penalty to pay for the occasional down years.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

itstoomuch
Posts: 4825
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by itstoomuch » Tue Jul 25, 2017 9:12 pm

Not like FIa but closer to older GLWB VA
I pay about 1.15% contract fee for the GLWB with living benefit steps of 5% plus the loss of dividend of about 2%. Total approx 3.25%. Add in death benefit and annuity taxes and profit then we are looking at about 5%. .

Would I buy more or pay 5%- no, we have enough protection and wealth is now large enough to weather most problems.
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

alex_686
Posts: 2605
Joined: Mon Feb 09, 2015 2:39 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by alex_686 » Tue Jul 25, 2017 9:22 pm

willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
Historical back testing is one way to do it but back testing has its issues. I have seen more sophisticated approaches using the Fisher - Black Model. It came to the same broad conclusion you did. Except that you get basically the same result by increasing your AA to bonds. This is what I would recommend to the OP.

bigred77
Posts: 1934
Joined: Sat Jun 11, 2011 4:53 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigred77 » Tue Jul 25, 2017 9:23 pm

willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
I can't verify the specific numbers, but this is pretty much my thoughts as well.

You could MAYBE interest me in exploring this as a defense against large draw downs early in retirement but even then I doubt it would be appealing. A 4% withdrawal rate PLUS 5% in insurance costs is a 9% headwind in year 1. I'm not thinking it would work out.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Tue Jul 25, 2017 9:32 pm

bigred77 wrote:
willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
I can't verify the specific numbers, but this is pretty much my thoughts as well.

You could MAYBE interest me in exploring this as a defense against large draw downs early in retirement but even then I doubt it would be appealing. A 4% withdrawal rate PLUS 5% in insurance costs is a 9% headwind in year 1. I'm not thinking it would work out.
Based off historical returns, it would certainly smooth out the returns, but the 5% cost of the insurance is steep. Like all insurance, it comes with a price tag that, on average, makes it a bad idea. But like insurance, you don't buy it for the average situations; you buy it to protect against situations that would be truly detrimental. For someone using something like a 4% WR and a 'typical' AA like 60/40, they already have 'insurance' built in to their strategy.

I certainly wouldn't recommend this approach, even though it might be alright if someone doing this used something like an 80/20 or 90/10 AA instead of something like 60/40 to counter the lower returns and lower downside risk of the stocks. I suspect that the end result would likely be very similar.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

bigred77
Posts: 1934
Joined: Sat Jun 11, 2011 4:53 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigred77 » Tue Jul 25, 2017 9:45 pm

willthrill81 wrote:
bigred77 wrote:
willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
I can't verify the specific numbers, but this is pretty much my thoughts as well.

You could MAYBE interest me in exploring this as a defense against large draw downs early in retirement but even then I doubt it would be appealing. A 4% withdrawal rate PLUS 5% in insurance costs is a 9% headwind in year 1. I'm not thinking it would work out.
Based off historical returns, it would certainly smooth out the returns, but the 5% cost of the insurance is steep. Like all insurance, it comes with a price tag that, on average, makes it a bad idea. But like insurance, you don't buy it for the average situations; you buy it to protect against situations that would be truly detrimental. For someone using something like a 4% WR and a 'typical' AA like 60/40, they already have 'insurance' built in to their strategy.

I certainly wouldn't recommend this approach, even though it might be alright if someone doing this used something like an 80/20 or 90/10 AA instead of something like 60/40 to counter the lower returns and lower downside risk of the stocks. I suspect that the end result would likely be very similar.
I think the put option plan works best with 100% equities in retirement, because that way you've put a floor at a 5% loss and are hoping for volatile returns (since you only participate in the upside volatility.

I think what you actually would have done with this strategy is simply exchange the risk of extreme volatility early in retirement to instead taking on the risk volatility being "too low". If you only get a range of returns between let's say, -10 to +10 over the first decade, your going to be in trouble quick.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Tue Jul 25, 2017 9:53 pm

bigred77 wrote:I think the put option plan works best with 100% equities in retirement, because that way you've put a floor at a 5% loss and are hoping for volatile returns (since you only participate in the upside volatility.

I think what you actually would have done with this strategy is simply exchange the risk of extreme volatility early in retirement to instead taking on the risk volatility being "too low". If you only get a range of returns between let's say, -10 to +10 over the first decade, your going to be in trouble quick.
+1

Spot on. Since 1990, there have only been four years (2000-2002 and 2008) where this 'insurance' would have helped you at all. In every other year, it would have just cost you 5%. I think that makes it seem as expensive as it really is.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
David Jay
Posts: 4084
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by David Jay » Tue Jul 25, 2017 10:23 pm

On the general topic of insurance against stock risk, I think there is a "nisiprius" quote that applies:

"The stock market is risky. It is a form of greed to believe that there is some easy, effective way to get the risk premium without actually taking the risk. Many people go through a stage in which they engage in delusional thinking:
a) The stock market has had high returns. That's good, I'd like that.
b) The stock market has had high risk. I don't like that.
c) I can't accept "a" and "b" are a package deal.
d) The stock market is risky for everybody else, but not for me, because I can do something clever and get the return without the risk.
"
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

bigwave2
Posts: 5
Joined: Thu Jan 17, 2013 10:54 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigwave2 » Tue Jul 25, 2017 11:34 pm

Giving up some gains by insuring principle is the complete opposite of greed in my opinion.

All I am attempting to do here is get some gains with less risk. I'm not trying to invest in some clever way to get the "risky" gains without any risk. That would be greedy and delusional thinking.

Are you a delusional lawyer ?
:annoyed

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Wed Jul 26, 2017 12:04 am

bigwave2 wrote:Giving up some gains by insuring principle is the complete opposite of greed in my opinion.

All I am attempting to do here is get some gains with less risk. I'm not trying to invest in some clever way to get the "risky" gains without any risk. That would be greedy and delusional thinking.

Are you a delusional lawyer ?
:annoyed
I really don't think he was referring specifically to you, just the general notion of trying to find a way around market risk.

As an aside, when I ran the numbers again over the same period as before (1972 - now), your proposed method would have had a slightly lower return than a portfolio comprised of 50% S&P 500 and 50% intermediate term Treasuries, but with more volatility (higher std. dev., 12.1% vs. 8.33%). Further, you would have had a loss greater than 5% in only three of these nearly 45 years (1973, -5.85%; 1974, -10.61%; 2008, -11.85%) So over the last almost half century, this just would not have worked well.

And that's the real crux of the issue. If you want to get market returns, you must take market risk. If you want to lower the risk, you will lower the returns.

That being said, you may be interested in something called the Larry Portfolio. The basic idea of it is to put your equity holdings into the highest (historically) earning asset classes and then counter that risk with very secure fixed income, like intermediate term Treasuries. Just to give you an idea how this might look and how it has performed, since 1972, a portfolio comprised of 35% small cap value and 65% ITT has had virtually the same return as the S&P 500 but with approximately half the volatility and a far better 'worst year' (-5.53% vs. -37.02%). The future will likely be different in some unknowable way, but at least that may give you some ideas. You can read a lot about this type of portfolio and various iterations of it on the forum.
Last edited by willthrill81 on Wed Jul 26, 2017 12:15 am, edited 1 time in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Swelfie
Posts: 181
Joined: Mon Mar 14, 2016 12:54 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Swelfie » Wed Jul 26, 2017 12:14 am

bigwave2 wrote:Giving up some gains by insuring principle is the complete opposite of greed in my opinion.

All I am attempting to do here is get some gains with less risk. I'm not trying to invest in some clever way to get the "risky" gains without any risk. That would be greedy and delusional thinking.

Are you a delusional lawyer ?
:annoyed
And I think in the buying side of the options market you are going to pay a hefty price for the insurance. And I also believe there are (marginally) better ways to accomplish such a thing.

US Treasuries I think are amazingly efficient to give such a risk free rate of return that we often call it the risk free rate. TIPS/iBonds might even be better!

Put-write strategies are a twist on what your post is trying to do, but from a different angle. They take on the risk that you are attempting to insure against to an extent and earn a premium for it. I think that's a better strategy personally to buffer against left tail risk. But it doesn't cover ALL the risk as yours does, but there is inherent risk in that premium you pay because you sacrifice the good years and the sideways years for that insurance.

Diversification is your best option, being the only truly free lunch. You have total stocks and total bonds.... Then a huge debate as to whether you can get.more free lunch or not. So there is that.

But from the research I've seen, insuring against loss like you are implying is a losing game overall. The insurer always wins by diversifying across individual cases. On the other hand, there is a level of insurance that protects you from destitution that is worth the premium, even if it's a losing game.

Because the goal isn't always to to the best... It's really to not do so bad that you can't live with the consequences.

User avatar
ThePrune
Posts: 894
Joined: Wed Nov 10, 2010 9:38 am
Location: Midland, MI

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by ThePrune » Wed Jul 26, 2017 5:07 am

Phineas J. Whoopee wrote:
Nate79 wrote:This kind of sounds like that horrible product called a fixed index annuity.
I agree, that's what it sounds like.
PJW
It's similar to a traditional FIA, but not exactly so.

Strictly speaking, it's a Floor-Design Hybrid ("FIA-like") Variable Annuity that has a 5% annual fee, a Floor (loss limit) of 0.0% and no cap on the upside gain. This can be quantitatively modeled with the Monte Carlo FIA Modeler using the settings for FIA-Like Hybrid Annuities.

I ran your problem using the FIA Modeler, using historical monthly returns data starting from 1927 (Prof. Shiller's dataset). There are 1083 one year periods starting on any month of the year. Here are the summary statistics:

Image
Edited: New results table! Previous table used incorrect S&P index in the calculations :oops:

The first column is your "$5 leverage". As expected, the minimum value of the original $100 investment after 1 year is $95. The median value is $107.24. The maximum was $227.82. This investment would have lost money (returned less than $100) 34.2% of the time.

The second column is 100% S&P 500 + 0% bonds. (The modeler always expects this combination). The minimum value of the original $100 investment after 1 year is $37.68. The median value is $112.77. The maximum was $239.57. This investment would have lost money (returned less than $100) 25.9% of the time.

The last column represents, for every one of the 1083 years tested, the value of the 100% Stocks investment minus the "$5 Leverage" investment. The median performance advantage for the 100% stocks investments was $5.53. Investing in 100% stocks (relative to the "$5 Leverage") would have been the losing choice 19.1% of the time.

(Note to those of you who already have this Excel Program: to run this example I went to the "Hidden Area" and reduced the minimum investment from $10,000 to $100 and reduced the minimum surrender period from 3 years to 1 year.)

Art "ThePrune"
Last edited by ThePrune on Tue Aug 01, 2017 6:05 am, edited 2 times in total.
Investment skill is often just luck in sheep's clothing.

User avatar
David Jay
Posts: 4084
Joined: Mon Mar 30, 2015 5:54 am
Location: Michigan

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by David Jay » Wed Jul 26, 2017 9:06 am

bigwave2 wrote:Giving up some gains by insuring principle is the complete opposite of greed in my opinion.

All I am attempting to do here is get some gains with less risk. I'm not trying to invest in some clever way to get the "risky" gains without any risk. That would be greedy and delusional thinking.

Are you a delusional lawyer ?
:annoyed
First, this was a verbatim quote of a respected forum member, so the total quote was not specifically about you. In particular, I highlighted "d" because I thought that best applied. The "greed' comment at the top is part of the complete quote and brings context, I am not saying that it applies in your case.

The highlighted passage does, however apply to something we see here a lot at BH - I want stock market gains (or near-stock-market gains) but without the volatility. Posters are regularly looking for some way to do this. They are coming BH to in essence say: "I think I found the way..." and if you re-read your original post I think it could come across that way to some people. To me, this approach does not display humility because if their solution worked then they have found something that 6 generations of Wall Street types have never discovered and applied.

And to paraphrase nisiprius (because I am not in a place to look up verbatim quote): "If it worked then the stock market would not be risky and the risk premium for stocks would disappear." So please don't discover anything that destroys the risk premium of the stock market. :(

[edit] oh, and I am an engineer...
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 9:48 am

It seems to me that many posters on this thread haven't fully understood what the OP proposes to do.
Long calls, or protective puts (if one already owns the underlying security), are absolutely standard techniques.
Will he beat the market ? Likely not, due to extra transaction costs and, more importantly, worse tax efficiency.
Is it a flawed strategy ? Absolutely not, especially considering that interest rates and VIX are at historical lows (which incidentally means the "annual fee" is not going to stay this low).

Yes, it would have only helped in a small subset of years in the past 3 decades, but my liability insurance hasn't helped at all in the same time span and yet I gladly renew it each year.
Last edited by Thesaints on Wed Jul 26, 2017 9:55 am, edited 1 time in total.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Wed Jul 26, 2017 9:54 am

Thesaints wrote:It seems to me that many posters on this thread haven't fully understood what the OP proposes to do.
Long calls, or protective puts (if one already owns the underlying security), are absolutely standard techniques.
Will he beat the market ? Likely not, due to extra transaction costs and, more importantly, worse tax efficiency.
Is it a flawed strategy ? Absolutely not, especially considering that interest rates and VIX are at historical lows.

Yes, it would have only helped in a small subset of years in the past 3 decades, but my liability insurance hasn't helped at all in the same time span and yet I gladly renew it each year.
In a post above, I showed that over the last 45 years, he could have achieved a better net return with a 50% TSM / 50% ITT portfolio but without the hassle of the proposed strategy. Had he used a Larry Portfolio, he could have outperformed this strategy with just 35% SCV / 65% ITT, and with even lower volatility to boot.

While it may not be inherently a terrible strategy, it seems far from optimal and even beyond what I would personally call reasonable.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

itstoomuch
Posts: 4825
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by itstoomuch » Wed Jul 26, 2017 9:58 am

^ DavidJay
"Engineers," over engineer to prevent against failure.
I am was too greedy having a BH 60/40 portfolio and no human capital in 2007-2009
I am now too conservative in having deferred, all equity, VA and FIA.
We have LTCi which now we don't need financially but now could need because of an health issue of mine.
If you are in retirement, you have performance drag somewhere :oops:
YMMV
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 9:59 am

willthrill81 wrote:
Thesaints wrote:It seems to me that many posters on this thread haven't fully understood what the OP proposes to do.
Long calls, or protective puts (if one already owns the underlying security), are absolutely standard techniques.
Will he beat the market ? Likely not, due to extra transaction costs and, more importantly, worse tax efficiency.
Is it a flawed strategy ? Absolutely not, especially considering that interest rates and VIX are at historical lows.

Yes, it would have only helped in a small subset of years in the past 3 decades, but my liability insurance hasn't helped at all in the same time span and yet I gladly renew it each year.
In a post above, I showed that over the last 45 years, he could have achieved a better net return with a 50% TSM / 50% ITT portfolio but without the hassle of the proposed strategy. Had he used a Larry Portfolio, he could have outperformed this strategy with just 35% SCV / 65% ITT, and with even lower volatility to boot.

While it may not be inherently a terrible strategy, it seems far from optimal and even beyond what I would personally call reasonable.
Why don't you compare to 50% ITT + 50% TSM with the 5% floor ?
It is apples and oranges, otherwise
Plus, it is a backtest and according to backtests I should drop all my insurances.

bigred77
Posts: 1934
Joined: Sat Jun 11, 2011 4:53 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigred77 » Wed Jul 26, 2017 10:03 am

Thesaints wrote:It seems to me that many posters on this thread haven't fully understood what the OP proposes to do.
Long calls, or protective puts (if one already owns the underlying security), are absolutely standard techniques.
Will he beat the market ? Likely not, due to extra transaction costs and, more importantly, worse tax efficiency.
Is it a flawed strategy ? Absolutely not, especially considering that interest rates and VIX are at historical lows (which incidentally means the "annual fee" is not going to stay this low).

Yes, it would have only helped in a small subset of years in the past 3 decades, but my liability insurance hasn't helped at all in the same time span and yet I gladly renew it each year.
"Standard Techniques" is a subjective term. This practice is certainly not standard around Bogleheads. It's certainly not standard among retail investors. I suppose I would classify it as "relatively easy to understand and implement for experienced investors" at best.

One would have been far better off increasing exposure to fixed income rather than buying protective puts if the goal was to reduce volatility or max drawdown, etc.

If one can not handle a drop below a predetermined level of assets in any given year, then those funds need to be in risk free assets and the remainder of the portfolio can be invested in risky assets. I suspect you'd be far more efficient putting 95% of the portfolio in CD's or 1 year treasuries and then using 5% to buy long calls on super volatile assets (basically leverage the risky assets since you are only participating in the upside anyway).

psteinx
Posts: 2659
Joined: Tue Mar 13, 2007 2:24 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by psteinx » Wed Jul 26, 2017 10:10 am

If you're truly trying to backtest an options strategy, then you need to know not only the returns of the S&P 500 (or whatever vehicle you're contemplating), but also, past prices of options. In a volatile market (say, 2008-9), options are generally much more pricey than in a calm market (say, 2017).

More generally, the use of options can be, among other things, a way to try to push on the boundaries of the efficient market curve. i.e. To get more return per unit of risk. i.e. A conventional way to take less than full market risk is to go to, say, 60/40 equities/bonds. It's generally acknowledged that 60/40 has less risk, but also less expected return (over the long haul) than 100% equities. One can devise various options strategies that also give up some expected return in exchange for lower risk. The question is, are such strategies better than the more conventional approach of adding bonds, or cash, or whatever? Note that the use of options will generally require more time, and probably higher transaction costs, versus just lowering one's equity allocation...

(And of course, in either case one should be contemplating more diversification generally - i.e. more than just the S&P 500 for stocks, various lower risk investments like bonds, cash, etc.)

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 10:13 am

bigred77 wrote:"Standard Techniques" is a subjective term. This practice is certainly not standard around Bogleheads. It's certainly not standard among retail investors. I suppose I would classify it as "relatively easy to understand and implement for experienced investors" at best.
Hate having to break it to you, but Bogleheads are not the most sophisticated class of investors and the standard retail investor has less than 250k.

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 10:14 am

psteinx wrote:If you're truly trying to backtest an options strategy, then you need to know not only the returns of the S&P 500 (or whatever vehicle you're contemplating), but also, past prices of options. In a volatile market (say, 2008-9), options are generally much more pricey than in a calm market (say, 2017).

More generally, the use of options can be, among other things, a way to try to push on the boundaries of the efficient market curve. i.e. To get more return per unit of risk. i.e. A conventional way to take less than full market risk is to go to, say, 60/40 equities/bonds. It's generally acknowledged that 60/40 has less risk, but also less expected return (over the long haul) than 100% equities. One can devise various options strategies that also give up some expected return in exchange for lower risk. The question is, are such strategies better than the more conventional approach of adding bonds, or cash, or whatever? Note that the use of options will generally require more time, and probably higher transaction costs, versus just lowering one's equity allocation...

(And of course, in either case one should be contemplating more diversification generally - i.e. more than just the S&P 500 for stocks, various lower risk investments like bonds, cash, etc.)

Certainly. But what about adding protection to the stocks component ?

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Wed Jul 26, 2017 10:15 am

Thesaints wrote:
willthrill81 wrote:
Thesaints wrote:It seems to me that many posters on this thread haven't fully understood what the OP proposes to do.
Long calls, or protective puts (if one already owns the underlying security), are absolutely standard techniques.
Will he beat the market ? Likely not, due to extra transaction costs and, more importantly, worse tax efficiency.
Is it a flawed strategy ? Absolutely not, especially considering that interest rates and VIX are at historical lows.

Yes, it would have only helped in a small subset of years in the past 3 decades, but my liability insurance hasn't helped at all in the same time span and yet I gladly renew it each year.
In a post above, I showed that over the last 45 years, he could have achieved a better net return with a 50% TSM / 50% ITT portfolio but without the hassle of the proposed strategy. Had he used a Larry Portfolio, he could have outperformed this strategy with just 35% SCV / 65% ITT, and with even lower volatility to boot.

While it may not be inherently a terrible strategy, it seems far from optimal and even beyond what I would personally call reasonable.
Why don't you compare to 50% ITT + 50% TSM with the 5% floor ?
It is apples and oranges, otherwise
Plus, it is a backtest and according to backtests I should drop all my insurances.
I've already demonstrated that the proposed strategy has resulted in substantially lower CAGR over time.

My point is that there are simpler, more effective ways to reduce risk and volatility than the OP's proposed strategy. Bonds are one of them.
bigred77 wrote:One would have been far better off increasing exposure to fixed income rather than buying protective puts if the goal was to reduce volatility or max drawdown, etc.
Precisely.
Thesaints wrote:
psteinx wrote:If you're truly trying to backtest an options strategy, then you need to know not only the returns of the S&P 500 (or whatever vehicle you're contemplating), but also, past prices of options. In a volatile market (say, 2008-9), options are generally much more pricey than in a calm market (say, 2017).

More generally, the use of options can be, among other things, a way to try to push on the boundaries of the efficient market curve. i.e. To get more return per unit of risk. i.e. A conventional way to take less than full market risk is to go to, say, 60/40 equities/bonds. It's generally acknowledged that 60/40 has less risk, but also less expected return (over the long haul) than 100% equities. One can devise various options strategies that also give up some expected return in exchange for lower risk. The question is, are such strategies better than the more conventional approach of adding bonds, or cash, or whatever? Note that the use of options will generally require more time, and probably higher transaction costs, versus just lowering one's equity allocation...

(And of course, in either case one should be contemplating more diversification generally - i.e. more than just the S&P 500 for stocks, various lower risk investments like bonds, cash, etc.)

Certainly. But what about adding protection to the stocks component ?
Because in the end, it's been demonstrated that you were actually worse off than just choosing a more conservative AA.
Last edited by willthrill81 on Wed Jul 26, 2017 10:16 am, edited 1 time in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 10:26 am

Then we are doomed not to understand each other and I'd advise checking out the "90% treasuries + 10% LEAP" thread.

psteinx
Posts: 2659
Joined: Tue Mar 13, 2007 2:24 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by psteinx » Wed Jul 26, 2017 10:39 am

willthrill81 wrote:
Thesaints wrote:Certainly. But what about adding protection to the stocks component ?
Because in the end, it's been demonstrated that you were actually worse off than just choosing a more conservative AA.
Basically, what will says. Is it more cost effective, in terms of how much expected return you give up, to lower risk by:

1) Lowering equity allocation (i.e. going from 100/0 to 60/40 or whatever)

or

2) Employing an options strategy
?

While I wouldn't go as far as will is suggesting and say that there it's been categorically "demonstrated that [conservative AA beats options protection]" I will say that it is hard to find free lunches, within the options space.

i.e. There are a plethora of possible options strategies that one could have employed, or could employ for the future. Very likely, with the right data sets and sufficient data mining, one could find options strategies that backtest favorably compared to, say, a 60/40 portfolio. But favorable (likely data-mined) backtests may not work so well going forward. The *known* issues with options strategies are:

1) Complexity
2) Hassle to implement
3) Transaction costs, commissions, etc.
4) Possibly unfavorable tax consequences, compared to more passive asset allocations

So yeah, maybe you can find an options strategy that looks better than 60/40 (or whatever risk level you'd otherwise target), and if you try the options strategy, you might even come out a winner (relative to your baseline). But I would guess that your odds aren't especially favorable, especially for the average reader/poster on this forum, who is likely far less sophisticated than the Wall Street technicians who, I think, are a major part of the options markets.

User avatar
randomizer
Posts: 714
Joined: Sun Jul 06, 2014 3:46 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by randomizer » Wed Jul 26, 2017 10:45 am

Thesaints wrote:The at-the-money Put on SPY for July 2018 sells a little above 13 and the underlying goes for almost 247. Dividends should be $5.

So, I'll take you deal, short SPY and write those puts.
Does anybody have any tricks for remembering what "puts", "calls", "options", "futures", "shorts" etc all mean. I feel like every time somebody mentions this, I have to go and look it up. (Thank god that I can make a decent return by just buying-and-holding a simple index fund. I'd be lost otherwise.)

User avatar
Portfolio7
Posts: 270
Joined: Tue Aug 02, 2016 3:53 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Portfolio7 » Wed Jul 26, 2017 10:46 am

Just some noob questions & thoughts...

I believe that one has to start with the concept of insurance, which is to protect against significant risk (not to protect against all risk.)

Rather than insuring the principle via options, wouldn't it make a lot more sense (and be a lot less expensive) to only insure against significant drops, such as those that exceed 20%, or 25%? I mean the real concern is when stocks drop 50% or more.

I know little about options, but I would think that level of insurance much cheaper?

Even then - I haven't read of anyone suggesting this kind of approach to Sequence of Returns Risk, which is where I would think it's most applicable, since you'd only need to employ it for perhaps a decade?
An investment in knowledge pays the best interest.

User avatar
willthrill81
Posts: 2364
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by willthrill81 » Wed Jul 26, 2017 10:53 am

Portfolio7 wrote:Just some noob questions & thoughts...

I believe that one has to start with the concept of insurance, which is to protect against significant risk (not to protect against all risk.)

Rather than insuring the principle via options, wouldn't it make a lot more sense (and be a lot less expensive) to only insure against significant drops, such as those that exceed 20%, or 25%? I mean the real concern is when stocks drop 50% or more.

I know little about options, but I would think that level of insurance much cheaper?

Even then - I haven't read of anyone suggesting this kind of approach to Sequence of Returns Risk, which is where I would think it's most applicable, since you'd only need to employ it for perhaps a decade?
The 'problem' is that in the last 45 years, there have only been three years with TSM losses greater than 20%. Even a 1% continuous added cost in the form of insurance on a portfolio is a big drag over the long-term. During the first decade of retirement, the bigger risk is that there will be flat returns rather than a year or two of big losses followed by a fairly quick recovery as we saw after 2000-2002 and 2008. Insuring against a decade of flat returns in a profitable way is going to be very difficult, likely impossible.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

rgs92
Posts: 1466
Joined: Mon Mar 02, 2009 8:00 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by rgs92 » Wed Jul 26, 2017 10:59 am

I concentrate more on investing principles than principal.

bigred77
Posts: 1934
Joined: Sat Jun 11, 2011 4:53 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by bigred77 » Wed Jul 26, 2017 11:02 am

Thesaints wrote:
bigred77 wrote:"Standard Techniques" is a subjective term. This practice is certainly not standard around Bogleheads. It's certainly not standard among retail investors. I suppose I would classify it as "relatively easy to understand and implement for experienced investors" at best.
Hate having to break it to you, but Bogleheads are not the most sophisticated class of investors and the standard retail investor has less than 250k.
I'm not claiming that bogleheads are the most sophisticated investors around, but if you could point me in the direction of a strategy that provides better risk adjusted returns than a boglehead strategy with academic research supporting it, I certainly like to review it.



Options, futures, derivatives of all kinds have a purpose and a place. 99% of retail investors don't need them (and 99% of us here on bogleheads are retail investors). In the OP the question was simply "what is a better idea" without qualifying what the goal was. The assumption made by many was the goal is probably "which strategy do I end up with more money in the end". The answer is pretty clearly the strategy without the put option insurance.

Grt2bOutdoors
Posts: 17253
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Grt2bOutdoors » Wed Jul 26, 2017 11:18 am

Thesaints wrote:
bigred77 wrote:"Standard Techniques" is a subjective term. This practice is certainly not standard around Bogleheads. It's certainly not standard among retail investors. I suppose I would classify it as "relatively easy to understand and implement for experienced investors" at best.
Hate having to break it to you, but Bogleheads are not the most sophisticated class of investors and the standard retail investor has less than 250k.
The most sophisticated class of investors - like folks who invest with Madoff or other hedge funds who quote the salad days but then wind up eating the salad? :oops: Or, perhaps institutional investors playing in the energy space who have lost their proverbial shirts or perhaps those sophisticated investors who pay the 2 and 20 game with PE and VC only to find out the alpha they thought they would get failed to materialize?

Sophisticated - there are those who think they are and then those who really are. Far and few between. Having large sums of money available to play with does not make one a sophisticated investor. Those who are sophisticated will pay when results are delivered not before. I would put the Yale endowment folks in the class of sophisticated and Swenson is not a big fan of paying fees either but the returns he does deliver. Those who are not, will fork over 5% of their capital in return for hocus-pocus. The last sophisticated investor I read about in the WSJ yesterday orchestrated a series of puts and calls against the VIX just a few days ago with settlement in October guaranteeing themselves a maximum loss of $60 million, a potential gain of $268 million and earned $5 million in premiums writing the calls. Is that what you were referring to in terms of a sophisticated investor?

Nothing wrong with being average - hitting singles all day long will get you across the plate more consistently than the investor who is still waiting for the fat pitch while high expenses erode their capital base. It's all about on base percentage with the least amount of swings and low costs.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

roflwaffle
Posts: 363
Joined: Mon Mar 02, 2015 10:08 pm

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by roflwaffle » Wed Jul 26, 2017 11:24 am

David Jay wrote:
bigwave2 wrote:... if that would be money well spent vs just buying and holding and riding the roller coaster up and down year after year.
willthrill81 wrote:Here are the numbers.

From Jan., 1972, to June, 2017, the S&P 500 would have taken $10,000 to $823,904. Using the OP's approach, the final balance would be $509,272. Both of these are in nominal dollars.

Where such an approach might still be worthwhile is in retirement, when years of negative returns can ran really throw you into a poor sequence of returns.
There is your answer.

As to "why?", may I suggest that the market isn't a roller coaster, it is an "up" escalator, with an occasional rapid elevator ride back down a couple of floors. So carrying the load of "insurance" every year it too high a penalty to pay for the occasional down years.
At some point in time the greater earnings more than offset even the higher magnitude/relatively infrequent drops, so it really only prevents the absolute drops for the first however many years.

Grt2bOutdoors
Posts: 17253
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Grt2bOutdoors » Wed Jul 26, 2017 11:28 am

randomizer wrote:
Thesaints wrote:The at-the-money Put on SPY for July 2018 sells a little above 13 and the underlying goes for almost 247. Dividends should be $5.

So, I'll take you deal, short SPY and write those puts.
Does anybody have any tricks for remembering what "puts", "calls", "options", "futures", "shorts" etc all mean. I feel like every time somebody mentions this, I have to go and look it up. (Thank god that I can make a decent return by just buying-and-holding a simple index fund. I'd be lost otherwise.)
Put - the right to "put" your security to a purchaser at a set time in the future at a set price per share less an upfront premium per share to induce purchaser to buy the shares from you when no rational person would. (think October 1929)
Call - the right to "call away or purchase" a security from a holder of that security at a set time in the future for the cost of security at strike price (price per share) and a premium per share at time of call purchase

Short - borrowing a security you don't own, selling it on the open market in the hopes that its price will decline further in price before you buy the shares back to return to the lender. The difference between sale price and buy price is your net loss (if buy price is higher) or net gain (if sale price was higher than subsequent buy) less the amount of margin interest you pay the broker/lender who gave you "shares" to sell short in first instance.

Futures - an option to buy a security at a set price far into the future, You pay a premium for the right to buy. You can make a profit if the option strike price is lower than true future price. If the strike price is higher, you don't exercise the option to buy and you simply lose the value of premium you paid upfront for that option.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

itstoomuch
Posts: 4825
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by itstoomuch » Wed Jul 26, 2017 2:51 pm

Another thread made me think of this:
Vanguard's GLWB VA. You won't get the VTI, but balanced portfolios. Total fee is ~2.5% of which ~1% is the put option (GLWB option) bu the unseen drag is the balanced portfolio yield against VTI or SP500.
Since ~2012, GLWB VAs are balanced portfolios. Vanguard and Fidelity introduced GLWB late in the game and only in a balanced portfolio model. IIRC.
Earlier portfolios allowed you to go all equity to all bonds, for which a few Insurance/Annuity cos became TBTF entities.
YMMV
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 7:41 pm

Let's say "sophisticated" as in "able to not confuse a long call for an annuity".

User avatar
market timer
Posts: 5809
Joined: Tue Aug 21, 2007 1:42 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by market timer » Wed Jul 26, 2017 7:54 pm

What you are proposing is exactly the same as buying an at-the-money call option. It should be easy to verify which is a better deal by comparing the cost of the call option vs. 5% fee.

Historical comparisons are not so meaningful because volatility is not constant over time. Currently, volatility is extraordinarily low, so options are cheap.

Thesaints
Posts: 1015
Joined: Tue Jun 20, 2017 12:25 am

Re: 5% fee per year to buy s&p500 with principle gaurantee

Post by Thesaints » Wed Jul 26, 2017 7:58 pm

market timer wrote:What you are proposing is exactly the same as buying an at-the-money call option. It should be easy to verify which is a better deal by comparing the cost of the call option vs. 5% fee.

Historical comparisons are not so meaningful because volatility is not constant over time. Currently, volatility is extraordinarily low, so options are cheap.
Two days ago the cost was almost exactly $5 for $100. I think that's what the OP was referring to.

Post Reply