Lifecycle Investing - Leveraging when young

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bobcat2
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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Thu Mar 07, 2019 11:13 am

market timer wrote:
Thu Mar 07, 2019 10:18 am
Lifecycle Investing is about trying to maintain constant risk over time.
I agree with you. People investing for retirement should invest heavily in stocks earlier in their careers, because so much of their total capital is not financial capital, but instead retirement relevant human capital, i.e. future retirement savings including pension savings and SS savings. OTOH as they approach retirement, say within 15 years of their retirement date, they should sharply reduce the stock proportion of their portfolio on account of their rapidly dwindling relevant human capital.

Where we may be more likely to disagree is how many young people can go so far as leveraging their stock portfolio. I would put the percentage of young Americans who can reasonably leverage at less than 1%.

As Ayres and Nalebuff note on page 9 of their book no one should leverage who has credit card or student loan debt or, for that matter, pay day loans or similar consumer debt. The investor also needs to be more risk tolerant than most people, but hold a very secure job. The investor needs to be very knowledgeable about investing, but have employment not connected or correlated with the capital markets. I personally don't know any young people like this, although I am certain such rare beasts exist.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: Lifecycle Investing - Leveraging when young

Post by acegolfer » Thu Mar 07, 2019 11:25 am

pezblanco wrote:
Thu Mar 07, 2019 10:10 am
Maybe you could explain as if to a small child, why maximizing the geometric mean is a bad idea??? I'm not an economist, so maybe it's just my basic ignorance of the code words here.

.... As for maximizing a utility function, I think that would be a splendid idea if we could agree on what utility function I (or anyone else) wants to maximize.
Sorry if I'm out of context (didn't read the entire thread). I'll try to answer your q's as simple as possible.

1. A popular utility function used in portfolio analysis is CARA, which involves risk aversion factor. (https://ocw.mit.edu/courses/economics/1 ... _Chap3.pdf page 21).

2. A nice feature of this function is a simple certainty equivalent, which has 3 inputs: mean, variance and risk aversion coefficient.

3. Higher the mean increases expected utility. But if it involves a higher variance, then the net effect can be negative.

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Re: Lifecycle Investing - Leveraging when young

Post by pezblanco » Thu Mar 07, 2019 11:42 am

market timer wrote:
Thu Mar 07, 2019 10:19 am
pezblanco wrote:
Thu Mar 07, 2019 10:10 am
Maybe you could explain as if to a small child, why maximizing the geometric mean is a bad idea??? I'm not an economist, so maybe it's just my basic ignorance of the code words here.
This is what Samuelson would say to a small child: http://www.nccr-finrisk.uzh.ch/media/pd ... BF1979.pdf
Wow .... what a terrible writing style. Did you read what you sent me? He makes a lot of statements that he provides no explanation for. It seems that there is some subtext here. Maybe what I wanted was an explanation for a small child that can follow some simple math. He obviously truly believes in utility functions .... maximizing the geometric mean is just another utility function (according to the author) so why not choose another one, seems to be the principal argument. I don't see why their performance has to come (with probabiity one) close to each other as N gets large, as he claims.

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Re: Lifecycle Investing - Leveraging when young

Post by pezblanco » Thu Mar 07, 2019 11:46 am

acegolfer wrote:
Thu Mar 07, 2019 11:25 am
pezblanco wrote:
Thu Mar 07, 2019 10:10 am
Maybe you could explain as if to a small child, why maximizing the geometric mean is a bad idea??? I'm not an economist, so maybe it's just my basic ignorance of the code words here.

.... As for maximizing a utility function, I think that would be a splendid idea if we could agree on what utility function I (or anyone else) wants to maximize.
Sorry if I'm out of context (didn't read the entire thread). I'll try to answer your q's as simple as possible.

1. A popular utility function used in portfolio analysis is CARA, which involves risk aversion factor. (https://ocw.mit.edu/courses/economics/1 ... _Chap3.pdf page 21).

2. A nice feature of this function is a simple certainty equivalent, which has 3 inputs: mean, variance and risk aversion coefficient.

3. Higher the mean increases expected utility. But if it involves a higher variance, then the net effect can be negative.
Thanks, I just saw this after I posted my last statement. I still think that the choice of any utility function is arbitrary .... I think maximizing wealth or growth rate of wealth or the asymptotic growth rate of wealth has something fundamental about it in terms of investment, gambling, etc etc that an arbitrary utility function doesn't have.

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Re: Lifecycle Investing - Leveraging when young

Post by CULater » Thu Mar 07, 2019 11:49 am

And by the way, maintaining a constant dollar amount (lump sum) in stocks in retirement will eliminate equity sequence of return risk also, which is why the "rising equity glide path" approach touted by Kitces and Pfau works better than the "age in bonds" or other falling equity glide path approaches. When you spend down your fixed-return assets first, the percent of equity will of course increase if you aren't drawing down equities; ergo, there rising equity glide path. Sequence of Return explains a lot of things more simply than the convoluted explanations I see all around.
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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Thu Mar 07, 2019 11:57 am

bobcat2 wrote:
Thu Mar 07, 2019 11:13 am
Where we may be more likely to disagree is how many young people can go so far as leveraging their stock portfolio. I would put the percentage of young Americans who can reasonably leverage at less than 1%.
No disagreement from me there.

However, as I've noted previously, the advice in this book has a greater impact on the nearing-middle age crowd than the 20-somethings. Judging by 305pelusa's writing style and MIT avatar, I doubt his decision to borrow and invest $30K from a relative is going to make much of a difference in his lifetime consumption or wealth acquisition. It's just not much money as a fraction of lifetime wealth.

As the "nearing-middle age" example, I'm approaching 40 now with a pretty sizable portfolio that is conservatively invested 40% in stocks. If I were to follow the idea of maximizing expected wealth for a given level of risk, perhaps I'd pick something closer to 100% stocks. However, now that I have reached a reasonable FI level, my goal is not to maximize expected wealth given a risk constraint. Instead, I prefer to imagine my income could dry up tomorrow, and I like to keep my investments and fixed expenses consistent with an immediate retirement. It is difficult and painful to adjust lifestyle and expectations lower, but easy to ratchet up year after year. Solving the dynamic problem with psychic adjustment costs and uncertain income might be a good sequel to Lifecycle Investing.

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Re: Lifecycle Investing - Leveraging when young

Post by acegolfer » Thu Mar 07, 2019 11:59 am

pezblanco wrote:
Thu Mar 07, 2019 11:46 am
Thanks, I just saw this after I posted my last statement. I still think that the choice of any utility function is arbitrary .... I think maximizing wealth or growth rate of wealth or the asymptotic growth rate of wealth has something fundamental about it in terms of investment, gambling, etc etc that an arbitrary utility function doesn't have.
That's because in traditional Economics (not in finance), the utility is derived from consuming goods. In their view, utility doesn't come from wealth itself. OTOH, CARA function (which you may claim arbitrary) is used in finance because it provides a direct link between consumption and wealth within the same framework. Without CARA, today's theoretical finance would be different because we couldn't use many economics models.

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market timer
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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Thu Mar 07, 2019 12:18 pm

pezblanco wrote:
Thu Mar 07, 2019 11:42 am
market timer wrote:
Thu Mar 07, 2019 10:19 am
pezblanco wrote:
Thu Mar 07, 2019 10:10 am
Maybe you could explain as if to a small child, why maximizing the geometric mean is a bad idea??? I'm not an economist, so maybe it's just my basic ignorance of the code words here.
This is what Samuelson would say to a small child: http://www.nccr-finrisk.uzh.ch/media/pd ... BF1979.pdf
Wow .... what a terrible writing style. Did you read what you sent me? He makes a lot of statements that he provides no explanation for. It seems that there is some subtext here. Maybe what I wanted was an explanation for a small child that can follow some simple math. He obviously truly believes in utility functions .... maximizing the geometric mean is just another utility function (according to the author) so why not choose another one, seems to be the principal argument. I don't see why their performance has to come (with probabiity one) close to each other as N gets large, as he claims.
This is a relatively well-known paper because the style is so odd--using only one-syllable words. I believe it was even cited in Fortune's Formula.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Mar 07, 2019 12:26 pm

bobcat2 wrote:
Thu Mar 07, 2019 11:13 am
I would put the percentage of young Americans who can reasonably leverage at less than 1%.
You've said that figure twice. Could you tell me how you're coming up with that estimate? Thank you

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Thu Mar 07, 2019 12:50 pm

bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
Ben Mathew wrote:
Tue Mar 05, 2019 10:37 pm
I can understand the reasoning behind what Samuelson wrote in 1969. I cannot understand the reasoning behind what he said in 2008.
I think the reasoning of what he said in 2008 is straightforward. Here is the kernel of what Samuelson said in 2008.

Many analysts argue that when you average over many investment periods, so favorable are the long-run returns of stocks that while you are still young, you should borrow substantially to hold large positions in stocks and you should do so because some kind of “stochastic dominance” is supposed to justify it.

I think I have written 27 articles rebutting this idea. It smacks of what I call the “Milton Friedman fallacy.” When that sage was a TIAA trustee before me, he believed that investing for a large number of future periods did, by some law of large numbers, mandate becoming more risk tolerant. The Milton Friedman fallacy is a simple one. Also called the Kelly criterion, it leads to the conclusion that, in contrast to utility theory, one should always maximize the geometric mean. It is the same as the 1738 Daniel Bernoulli conjecture that if you have a duel with your brother-in-law and you are faced with a stationary probability process—stationary through time—going to the geometric mean is the way to win. Being second in investing, unlike being second in dueling, is good, however, and very few attain it.


What is it about the above you have trouble understanding?

BobK
Paul Samuelson seems to be under the impression that Ayres and Nalebuff are falling victim to the fallacy of time diversification, a subject that Paul Samuelson has written about--apparently 27 times! But Ayres and Nalebuff are not making that error.

The fallacy of time diversification is the idea that if you hold stocks for a longer period of time, the ups and downs cancel each other and you end up with low risk in the long run. This is not correct. The longer you hold stocks, the more bets you are taking. So there's a higher chance of very good and very bad outcomes--i.e. more risk. Think of every year in the stock market as an independent bet with a positive expected return--say a coin toss where if it's heads, you get $10, and if it's tails, you lose $5. The more bets you make, the more your expected payout, but the more widely distributed your payouts will be. The bets don't cancel out. It is true that the average payout per bet is subject to the law of large numbers and becomes more and more tightly distributed around the expected payout of .5*($10)+.2*(-5)=$2.50. But the payout that you are going to be walking away in the end is not the average payout. It's the total payout. And since you are adding more and more bets over time, your actual payout, which is the total payout, is getting more and more widely distributed--i.e. more and more risky. In the same way, with a portfolio invested in the stock market, the longer you stay in the market, the less variance there will be in your average log return. But you are not eating your average log return. You are eating the actual dollars in your portfolio. And the actual dollars in your portfolio will be getting more and more widely distributed the longer you stay in the market. So you are increasing both your expected return and your risk by staying longer in the market.

But Ayres and Nalebuff do not make this fallacious argument for time diversification. Their version of time diversification is entirely correct. In terms of the coin toss analogy, what they are saying is not that you should just take more coin tosses. What they are saying is that you should spread your bets over as many coin tosses as you can, taking a smaller bet on each coin toss. It's a subtle but crucial difference. They are saying that instead of betting $1 on 10 coin tosses, bet $.50 on 20 coin tosses. This is real diversification. Both betting strategies will yield an expected payout of $2.50 * 10 = .5 * $2.50 * 20 = $25. But the $.50 bet spread across 20 bets will yield a payout that is more tightly distributed around the expected payout of $25 than the $1 bets concentrated on 10 coin tosses. The law of large numbers does apply in this case. It is possible to diversify across time by spreading your bets across time instead of concentrating it all on a few years. Time diversification works when done properly--smaller bets over a longer period of time instead of bigger bets over a shorter period of time.

This error of not recognizing the possibility of time diversification by reducing the bet and spreading it out over time deserves a name. I'd like to call it the "fallacy of the fallacy of time diversification."
Last edited by Ben Mathew on Thu Mar 07, 2019 1:02 pm, edited 1 time in total.

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 12:59 pm

CULater wrote:
Thu Mar 07, 2019 11:11 am
Bernstein agrees with the theory and discusses the leverage strategy in depth and concludes that it is impractical for several reasons. He suggests an alternative that might be easier, cheaper, and more reasonable is for young investors to tilt heavily toward small cap value stocks.

I'd recommend studying Bernstein's detailed discussion in "Ages of the Investor". You'll better understand the issue and perhaps be able to develop a more practical and sustainable approach.
Much has changed in the investment universe since Bernstein wrote "Ages of the Investor", so what was impractical then might not be so impractical now.

Using a combination of easily traded ETFs, an investor could in minutes construct a well-diversified four fund portfolio that has 150% equity exposure with an expense ratio of around 47 bps. Using futures they might be able to do it even more cheaply, though probably not as quickly or easily.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Lifecycle Investing - Leveraging when young

Post by CULater » Thu Mar 07, 2019 2:02 pm

Ben Mathew wrote:
Thu Mar 07, 2019 12:50 pm
bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
Ben Mathew wrote:
Tue Mar 05, 2019 10:37 pm
I can understand the reasoning behind what Samuelson wrote in 1969. I cannot understand the reasoning behind what he said in 2008.
I think the reasoning of what he said in 2008 is straightforward. Here is the kernel of what Samuelson said in 2008.

Many analysts argue that when you average over many investment periods, so favorable are the long-run returns of stocks that while you are still young, you should borrow substantially to hold large positions in stocks and you should do so because some kind of “stochastic dominance” is supposed to justify it.

I think I have written 27 articles rebutting this idea. It smacks of what I call the “Milton Friedman fallacy.” When that sage was a TIAA trustee before me, he believed that investing for a large number of future periods did, by some law of large numbers, mandate becoming more risk tolerant. The Milton Friedman fallacy is a simple one. Also called the Kelly criterion, it leads to the conclusion that, in contrast to utility theory, one should always maximize the geometric mean. It is the same as the 1738 Daniel Bernoulli conjecture that if you have a duel with your brother-in-law and you are faced with a stationary probability process—stationary through time—going to the geometric mean is the way to win. Being second in investing, unlike being second in dueling, is good, however, and very few attain it.


What is it about the above you have trouble understanding?

BobK
Paul Samuelson seems to be under the impression that Ayres and Nalebuff are falling victim to the fallacy of time diversification, a subject that Paul Samuelson has written about--apparently 27 times! But Ayres and Nalebuff are not making that error.

The fallacy of time diversification is the idea that if you hold stocks for a longer period of time, the ups and downs cancel each other and you end up with low risk in the long run. This is not correct. The longer you hold stocks, the more bets you are taking. So there's a higher chance of very good and very bad outcomes--i.e. more risk. Think of every year in the stock market as an independent bet with a positive expected return--say a coin toss where if it's heads, you get $10, and if it's tails, you lose $5. The more bets you make, the more your expected payout, but the more widely distributed your payouts will be. The bets don't cancel out. It is true that the average payout per bet is subject to the law of large numbers and becomes more and more tightly distributed around the expected payout of .5*($10)+.2*(-5)=$2.50. But the payout that you are going to be walking away in the end is not the average payout. It's the total payout. And since you are adding more and more bets over time, your actual payout, which is the total payout, is getting more and more widely distributed--i.e. more and more risky. In the same way, with a portfolio invested in the stock market, the longer you stay in the market, the less variance there will be in your average log return. But you are not eating your average log return. You are eating the actual dollars in your portfolio. And the actual dollars in your portfolio will be getting more and more widely distributed the longer you stay in the market. So you are increasing both your expected return and your risk by staying longer in the market.

But Ayres and Nalebuff do not make this fallacious argument for time diversification. Their version of time diversification is entirely correct. In terms of the coin toss analogy, what they are saying is not that you should just take more coin tosses. What they are saying is that you should spread your bets over as many coin tosses as you can, taking a smaller bet on each coin toss. It's a subtle but crucial difference. They are saying that instead of betting $1 on 10 coin tosses, bet $.50 on 20 coin tosses. This is real diversification. Both betting strategies will yield an expected payout of $2.50 * 10 = .5 * $2.50 * 20 = $25. But the $.50 bet spread across 20 bets will yield a payout that is more tightly distributed around the expected payout of $25 than the $1 bets concentrated on 10 coin tosses. The law of large numbers does apply in this case. It is possible to diversify across time by spreading your bets across time instead of concentrating it all on a few years. Time diversification works when done properly--smaller bets over a longer period of time instead of bigger bets over a shorter period of time.

This error of not recognizing the possibility of time diversification by reducing the bet and spreading it out over time deserves a name. I'd like to call it the "fallacy of the fallacy of time diversification."
I really think it's just the simple fact that a constant dollar amount invested over time has no sequence of return risk. Ayres and Nalebuff simply showed that when you take out sequence risk over a large number of investment time periods, you end up with a larger average terminal value. It ain't complicated and it has nothing to do with time diversification.
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Re: Lifecycle Investing - Leveraging when young

Post by MotoTrojan » Thu Mar 07, 2019 2:55 pm

vineviz wrote:
Thu Mar 07, 2019 12:59 pm

Using a combination of easily traded ETFs, an investor could in minutes construct a well-diversified four fund portfolio that has 150% equity exposure with an expense ratio of around 47 bps. Using futures they might be able to do it even more cheaply, though probably not as quickly or easily.
What funds would that be???

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 3:20 pm

MotoTrojan wrote:
Thu Mar 07, 2019 2:55 pm
vineviz wrote:
Thu Mar 07, 2019 12:59 pm

Using a combination of easily traded ETFs, an investor could in minutes construct a well-diversified four fund portfolio that has 150% equity exposure with an expense ratio of around 47 bps. Using futures they might be able to do it even more cheaply, though probably not as quickly or easily.
What funds would that be???
There are multiple options, but the one I was referencing was:

30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)


If you didn't want the emerging markets exposure you could do it somewhat cheaper (35bps) with:

33.33% ProShares UltraPro S&P500 ETF (UPRO)
50.00% Vanguard Small-Cap Value ETF (VBR)
16.67% Vanguard Extended Duration Trs ETF (EDV)
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Lifecycle Investing - Leveraging when young

Post by MotoTrojan » Thu Mar 07, 2019 4:06 pm

vineviz wrote:
Thu Mar 07, 2019 3:20 pm
MotoTrojan wrote:
Thu Mar 07, 2019 2:55 pm
vineviz wrote:
Thu Mar 07, 2019 12:59 pm

Using a combination of easily traded ETFs, an investor could in minutes construct a well-diversified four fund portfolio that has 150% equity exposure with an expense ratio of around 47 bps. Using futures they might be able to do it even more cheaply, though probably not as quickly or easily.
What funds would that be???
There are multiple options, but the one I was referencing was:

30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)


If you didn't want the emerging markets exposure you could do it somewhat cheaper (35bps) with:

33.33% ProShares UltraPro S&P500 ETF (UPRO)
50.00% Vanguard Small-Cap Value ETF (VBR)
16.67% Vanguard Extended Duration Trs ETF (EDV)
Interesting, I would think the volatility decay of the 2x and 3x funds would kill you without leveraged (or at-least much higher allocation) long-term treasuries, such as EDV (which behaves much like a 2x 20 year fund).

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Re: Lifecycle Investing - Leveraging when young

Post by inbox788 » Thu Mar 07, 2019 5:44 pm

vineviz wrote:
Thu Mar 07, 2019 3:20 pm
30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)
Interesting backtesting, though limited by short UPRO history. Mostly achieves the objective of 150% return, but down years 2015 and 2018 are a little concerning. I'm surprised Sharpe Ratio and Sortino Ratio don't seem to be impacted. I don't understand them, and because it's a ratio, the leverage may cancel out. ( https://quant.stackexchange.com/questio ... d-leverage )
Portfolio Returns
Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio US Mkt Correlation
Portfolio 1 $10,000 $44,248 17.61% 18.05% 44.15% -15.82% -22.23% 0.97 1.60 0.95
Portfolio 2 $10,000 $29,975 12.72% 12.94% 33.35% -5.26% -17.74% 0.96 1.58 1.00
https://www.portfoliovisualizer.com/bac ... ion5_2=100
[Note: The time period was automatically adjusted based on the available data (Jul 2009 - Feb 2019) for the selected asset: ProShares UltraPro S&P500 (UPRO)]

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 5:55 pm

MotoTrojan wrote:
Thu Mar 07, 2019 4:06 pm
vineviz wrote:
Thu Mar 07, 2019 3:20 pm
There are multiple options, but the one I was referencing was:

30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)


If you didn't want the emerging markets exposure you could do it somewhat cheaper (35bps) with:

33.33% ProShares UltraPro S&P500 ETF (UPRO)
50.00% Vanguard Small-Cap Value ETF (VBR)
16.67% Vanguard Extended Duration Trs ETF (EDV)
Interesting, I would think the volatility decay of the 2x and 3x funds would kill you without leveraged (or at-least much higher allocation) long-term treasuries, such as EDV (which behaves much like a 2x 20 year fund).
For sure you could build a more efficient portfolio using leveraged bonds (like TMF), but for moderate amounts of leverage they aren't crucial and funds like ZROZ or EDV have MUCH lower expense ratios and introduce no volatility drag of their own.

Also, IMHO the best use case for a 150% equity portfolio is someone who is in the first half of their accumulation phase. Their weekly or monthly contributions (which can be thought of as the interest payments from their human capital "bond") would generally provide enough ballast to keep the leverage ratio intact.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 6:09 pm

inbox788 wrote:
Thu Mar 07, 2019 5:44 pm
vineviz wrote:
Thu Mar 07, 2019 3:20 pm
30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)
Interesting backtesting, though limited by short UPRO history. Mostly achieves the objective of 150% return, but down years 2015 and 2018 are a little concerning. I'm surprised Sharpe Ratio and Sortino Ratio don't seem to be impacted. I don't understand them, and because it's a ratio, the leverage may cancel out. ( https://quant.stackexchange.com/questio ... d-leverage )
You can estimate the performance over a slightly longer period by using SSO instead of UPRO at a 3:2 ratio (to account for the leverage difference) and using TLT instead of EDV at a 1.6:1 ratio to account for differences in duration. You'd have to use VWO instead of SPEM also. Use a negative cash position to get the total portfolio back to 100% in PV.

Image

https://www.portfoliovisualizer.com/bac ... ion5_1=-30

Also note that a simpler 150% strategy without the diversification (e.g. 50% SSO and 50% IVV) is much less advantageous. Volatility drag is a much bigger problem with this kind of approach than using the leverage as we've discussed (i.e. using it intelligently on something closer to a maximum diversification or mean-variance optimal portfolio).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Lifecycle Investing - Leveraging when young

Post by MotoTrojan » Thu Mar 07, 2019 8:00 pm

vineviz wrote:
Thu Mar 07, 2019 6:09 pm
inbox788 wrote:
Thu Mar 07, 2019 5:44 pm
vineviz wrote:
Thu Mar 07, 2019 3:20 pm
30.00% ProShares UltraPro S&P500 ETF (UPRO)
15.00% ProShares Ultra SmallCap600 ETF (SAA)
30.00% SPDR Portfolio Emerging Markets ETF (SPEM)
25.00% Vanguard Extended Duration Trs ETF (EDV)
Interesting backtesting, though limited by short UPRO history. Mostly achieves the objective of 150% return, but down years 2015 and 2018 are a little concerning. I'm surprised Sharpe Ratio and Sortino Ratio don't seem to be impacted. I don't understand them, and because it's a ratio, the leverage may cancel out. ( https://quant.stackexchange.com/questio ... d-leverage )
You can estimate the performance over a slightly longer period by using SSO instead of UPRO at a 3:2 ratio (to account for the leverage difference) and using TLT instead of EDV at a 1.6:1 ratio to account for differences in duration. You'd have to use VWO instead of SPEM also. Use a negative cash position to get the total portfolio back to 100% in PV.

Image

https://www.portfoliovisualizer.com/bac ... ion5_1=-30

Also note that a simpler 150% strategy without the diversification (e.g. 50% SSO and 50% IVV) is much less advantageous. Volatility drag is a much bigger problem with this kind of approach than using the leverage as we've discussed (i.e. using it intelligently on something closer to a maximum diversification or mean-variance optimal portfolio).
You need to check out hedgefundie’s thread where there is simulated UPRO and TMF data back to 1986.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Mar 07, 2019 11:34 pm

It appears to me that someone who opts for risk parity to obtain maximum risk-adjusted returns, and then leverages that portfolio is one looking to maximize geometric returns. The strategy gets applied irrespective of current or future wealth. The nature of the savings contributions (salary) are not taken into account (as far as I'm aware at least). Backtesting/analysis is simply used to determine the best risk parity and then leveraged up for returns.

While lifecycle investing does leverage as well, it feels like the fundamental difference is that it only aims to diversify stock exposure across time. That means leverage when younger and no leverage when older. It means that if your future savings (salary) are highly correlated with the market, you don't leverage at all. Individual risk aversion is also taken into account.

In a way, it feels to me like lifecycle investing is just regular traditional investing, except that you also take future contributions (and their nature) into account when you think of your "portfolio". In that light, it's not radically different and it doesn't need many assumptions to work (i.e. to lower risk).

But the risk parity strategies seem more involved. They do rely on certain assumptions of correlation (or lack thereof) and the optimal bet size seems to get repeated over and over again (while lifecycle investing's bet size decreases with time). These strategies seem more in line with Kelly bets and what Samuelson might disagree with than lifecycle investing.

I find this fascinating because I've had posters ask me about leveraging bonds. I've had posters tell me the strategy is inconsistent with Samuelson's ideas. And other posters who said this thread is similar enough to other leverage threads in that perhaps we're at the peak of a bubble and holding cash would be good. Presumably, I'm getting these comments because the strategy is very similar to the risk-parity ones. But to me, the difference between leveraged risk-parity/balanced strategies and lifecycle investing is MUCH larger than between lifecycle investing and traditional "age in bonds".

Would this be a fair assessment? I'd like to hear some thoughts on this.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Fri Mar 08, 2019 2:46 pm

CULater wrote:
Thu Mar 07, 2019 2:02 pm
I really think it's just the simple fact that a constant dollar amount invested over time has no sequence of return risk.
A constant dollar amount invested over time will have no sequence of return risk only if the investment is not allowed to compound (i.e. your discount rate is 0%). Since our investments grow over time, $1 early on will be equivalent to more than $1 later on. So $1 at risk early on will have more impact than $1 at risk later. That means that keeping a constant dollar amount at risk will cause the portfolio to be overweighted early on, and underweighted later. It's the discounted dollar value at risk that would need to be held constant in order to avoid sequence of return risk. A simple way to achieve that is to invest a lump sum and let it grow without further contributions or withdrawals. I discussed this in more detail upthread.
CULater wrote:
Thu Mar 07, 2019 2:02 pm
Ayres and Nalebuff simply showed that when you take out sequence risk over a large number of investment time periods, you end up with a larger average terminal value. It ain't complicated and it has nothing to do with time diversification.
Avoiding sequence of return risk is equivalent to spreading risk evenly over time--i.e. diversifying over time. Ayres and Nalebuff's strategy is best understood as diversifying over time, and that's how they think of it as well.

From Lifecycle Investing (pg 2-3):
Our plan takes diversification a step further. Just as Swensen helped Yale achieve better diversification across asset classes, we aim to help you do a better job diversifying your investments across time.

Diversifying Time
In its simplest form, diversification across time is an intuitive idea that's a lot like asset diversification. Just as it would be a mistake to invest all your savings in a single stock, it would be reckless to concentrate all your exposure to the stock market into a single year. If you did that and the market happened to nosedive just then, you'd be toast. You're much safer spreading your stock investments across decades.

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Re: Lifecycle Investing - Leveraging when young

Post by pezblanco » Fri Mar 08, 2019 6:50 pm

I just got the book and have been skimming it. The philosophy seems reasonable to me although I don't still understand all the rationale. I still don't understand Ben's statements about the discount rate should be that of stocks ... why not inflation? But anyway, I must work on this. By the way, they mention Market Timer quite a bit in the book. I think that it is interesting that MT had the basic ideas of this philosophy figured out quite a bit before the authors. I think all of us know that MT is a pretty smart guy ...

What I'm concerned about is the nuts and bolts of the strategy. I'll just come back to one of my favorite ways to think about investing strategies and leverage ... and that is the long term growth rate. If you look at the last 51 years of real stock and long term bond and short term bond returns and use those as an empirical distribution assuming that that future returns will be independent samples from this collection of 51 samples (each sample is three numbers ... real stock return, real long term bond return, 1-month T-bill return). Then you can compute the long term return of leveraging (in the graph below I assumed cost of borrowing was 1.5% +T-bill ... using 1 + T-bill doesn't change things very much):

Image

The leverage goes from 0 to 2 (zero means 100% bonds ... 1 means 100% stocks .... 2 means 200% stocks). There is an inflexion point on the graph at leverage of 1 with a long term return over the last 51 years of about 6% real for stocks. As the graph indicates, a leverage of 2 is too much .... you could get the same long term return of a leverage of 2 with a leverage of 1.2 ... about 1.5 seems to be optimal. This matches up and makes sense with other work done by Kelly and Thorpe (they used different assumptions about the distribution of returns and so their numbers vary a bit). Virtually no one comes up with leverages of greater than 1.5 or so ....

The authors in their book just sort of say, more than 2 is too much ... 2 is about right .... ummmm I think I disagree .... 2 is too much.

So, after posting this, I began thinking that their idea is that a young person is going to be adding to the allocation by a certain (growing amount) every year ... that should help making the optimal values of leverage higher, shouldn't it? I'll have to see if I can quantify that from their framework.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Mar 08, 2019 8:36 pm

pezblanco wrote:
Fri Mar 08, 2019 6:50 pm
So, after posting this, I began thinking that their idea is that a young person is going to be adding to the allocation by a certain (growing amount) every year ... that should help making the optimal values of leverage higher, shouldn't it? I'll have to see if I can quantify that from their framework.
Yes that's precisely the idea. If the money was all fully fronted (like the scenarios Samuelson entertains), they would not leverage it. The Kelly criterion you keep calculating assumes you do have a fronted bankroll and recommends leverage (all the way to 1.5+). So lifecycle investing will be much, much more conservative overall.

Another way to look at it is that your simulation recommends leveraging 1.5 of your bankroll or wealth. The point of lifecycle investing is that your wealth isn't just your current savings; it's also your future contributions, your social security, etc. If you think of THAT as your wealth, you're not really leveraging at all. And I'd argue you should think of it because in your simulation, losing X% a year is losing X% of your bankroll. It will determine the next year's bet to be smaller by that amount.

With lifecycle investing, a loss of X% does not translate to a smaller bet the next year necessarily. Your salary might more than make it up so your bankroll is intact the year after. Any way you slice it, if you are constantly adding money to the Kelly bankroll, you should be able to make far more aggressive bets than otherwise..

How aggressive? Here's a quick back-of-the-envelope calculation (which might be totally wrong but seems to make some sense, at least to first-order) I made to convince myself that 2:1 is not quite the Kelly Criterion for someone still saving:

Let's say the ideal historical Kelly leverage is 1.5, like you said. From a couple of sources, I'm seeing the ideal Kelly bet is as follows:
(1) F* = (u - r)/s^2 = 1.5 Where u is the mean return, r the risk free rate and s the standard deviation.

But an unaccounted for savings contribution yearly of 10% of your bankroll (and this part is very individual) would make the new mean 0.1 higher. How much does that change the Kelly bet?

Solve for (1) in terms of u and plug it into here:
(2) F*_1 = (u_1 - r_1)/s_1^2 If u_1 = u + 0.1, r_1 = r and s_1 = s (meaning, historical results continue but you now add savings), you get that the new, more aggressive Kelly bet is

F*_1 = F* + 0.1/s^2
The new, optimal Kelly bet is the savings rate as a percent of your current portfolio, divided by the volatility, plus the previous historical Kelly bet without savings contributions. If you use 1.5 for F*, a very modest saving of 10% of the portfolio (someone with 100k saves 10k that year) and the historical volatility of ~25% st. dev, you get that the ideal Kelly bet is 3.1:1 leverage. Just a rough estimate but helps put some numbers.

I will say what you've presented is very important because it tells me that 2:1 isn't just sunshine if you don't you aggressively save. If you barely make a contribution dent but stick to 2:1 leverage that year, you might very well overbet that year. This is a perspective I hadn't considered until I read MT's recommended book and is certainly very relevant. I appreciate that you've brought up this point about historical Kelly bet sizes.

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Fri Mar 08, 2019 10:25 pm

Ben Mathew wrote:
Thu Mar 07, 2019 12:50 pm
They (A&N) are saying that instead of betting $1 on 10 coin tosses, bet $.50 on 20 coin tosses. This is real diversification. Both betting strategies will yield an expected payout of $2.50 * 10 = .5 * $2.50 * 20 = $25. But the $.50 bet spread across 20 bets will yield a payout that is more tightly distributed around the expected payout of $25 than the $1 bets concentrated on 10 coin tosses.
So in the case of the stock market, if I want to make all my big investments over just 10 years from age 25 to age 35 how would I do this? Would I leverage even greater than A & N do?

Certainly what you write about diversification is true in that you must both pool and subdivide risk, but I fail to see how leverage would reduce the bets from $1 to 50 cents as in your coin flip example, and I also don't see how leverage lowers the individual annual (bets) in the stock market. Leverage in the early appears to increase - not decrease the bet.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Mar 08, 2019 11:00 pm

bobcat2 wrote:
Fri Mar 08, 2019 10:25 pm
I fail to see how leverage would reduce the bets from $1 to 50 cents as in your coin flip example
A traditional investor (say age in bonds) would have very little money in stocks years 25-35 and much more in stocks years 55-65. That's like betting $0.01 on 10 coins and $1 on another 10 coins. The first 10 coins are so lightly weighted vs the other 10 coins, it's almost like they're not even there. It's similar to simply betting $1 on 10 coins.

The lifecycle investing message is to use leverage to bet more on the earlier coins and correspondingly less on the later ones. The whole message is that young people are too unexposed to stocks while older people are way too exposed to stocks. So you leverage while younger, shift more of it to those first 10 coins and invest less in stocks while older. Now it's not $1 in 10 coins. It's more like $0.5 in all the 20 coins.

A traditional investor might start at 90% in stocks and ramp down to 50% by retirement. The same investor using lifecycle investing might start at 200% stocks and ramp down to 30-40% in stocks by retirement.
bobcat2 wrote:
Fri Mar 08, 2019 10:25 pm
I also don't see how leverage lowers the individual annual (bets) in the stock market. Leverage in the early appears to increase - not decrease the bet.
It increases the annual bets on the underweight coins (younger years) and decreases the annual bet on the already-overweight coins (later years) so that roughly the same amount of lifetime stock exposure (what authors call stock years in the book) is achieved but more evenly distributed throughout your life.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 12:50 am

bobcat2 wrote:
Fri Mar 08, 2019 10:25 pm
Ben Mathew wrote:
Thu Mar 07, 2019 12:50 pm
They (A&N) are saying that instead of betting $1 on 10 coin tosses, bet $.50 on 20 coin tosses. This is real diversification. Both betting strategies will yield an expected payout of $2.50 * 10 = .5 * $2.50 * 20 = $25. But the $.50 bet spread across 20 bets will yield a payout that is more tightly distributed around the expected payout of $25 than the $1 bets concentrated on 10 coin tosses.


So in the case of the stock market, if I want to make all my big investments over just 10 years from age 25 to age 35 how would I do this? Would I leverage even greater than A & N do?
If you want to concentrate the bet on only ages 25 to 35, you would borrow money and invest it in stocks at age 25, let it ride till age 35, then sell all your stocks and own only bonds from age 35 onwards. Just to be clear, this is not what Ayres and Nalebuff are recommending. They want you to spread your stock exposure as evenly as possible throughout your working years.

bobcat2 wrote:
Fri Mar 08, 2019 10:25 pm
Certainly what you write about diversification is true in that you must both pool and subdivide risk, but I fail to see how leverage would reduce the bets from $1 to 50 cents as in your coin flip example, and I also don't see how leverage lowers the individual annual (bets) in the stock market. Leverage in the early appears to increase - not decrease the bet.

BobK
Yes, you are increasing the bet in the early years using leverage. But that enables you to reduce your bets in the later years, leading to a lower lifetime portfolio risk.

Without leverage, you are betting only $.10 in your 20s and 30s (because you haven't saved up much money yet) and $.90 in your 40s and 50s (after most of your contributions have come in). Leverage allows you to increase your bet from $.10 to $.50 in your 20s and 30s. And that, in turn, allows you to reduce your bets from $.90 to $.50 in your 40s and 50s. Same expected return, but lower risk because you've spread your bets more evenly across time.

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Re: Lifecycle Investing - Leveraging when young

Post by Park » Sat Mar 09, 2019 1:04 am

https://awealthofcommonsense.com/2019/0 ... are-messy/

The following is from Ben Carlson, and he uses S&P real return and 5 year Treasury real returns from 1926-2018.

Image

About time diversification, the argument is that with time, stock return dispersion increases. Dispersion may increase, but it would appear that there is also some reversion to the mean.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 1:06 am

pezblanco wrote:
Fri Mar 08, 2019 6:50 pm
I just got the book and have been skimming it. The philosophy seems reasonable to me although I don't still understand all the rationale. I still don't understand Ben's statements about the discount rate should be that of stocks ... why not inflation?
The discount rate you use should be equal to the rate of return of whatever you are investing your stock "winnings" into. The simplest case is where you reinvest the gains back into stocks. Then the discount rate would be the rate of return of stocks. But if you are investing your stock "winnings" in some other investment, say bonds that return 3%, then the discount rate should be 3%.

The inflation rate would not be the appropriate discount rate. Discounting to get present or future values comes from the fact that $X today can be exchanged for $Y tomorrow. It's the rate of return that determines how much $Y you can get tomorrow if you give up $X today, not the inflation rate.
Last edited by Ben Mathew on Sat Mar 09, 2019 10:11 am, edited 2 times in total.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 1:14 am

Park wrote:
Sat Mar 09, 2019 1:04 am
About time diversification, the argument is that with time, stock return dispersion increases. Dispersion may increase, but it would appear that there is also some reversion to the mean.
It's true that stock dispersion increases with time. But lifecycle investing strategy is not claiming that if you hold stock for longer, your risk will go down. It's saying that if you spread your risk better across time (increase stock exposure in the underexposed years, and reduce it in the overexposed years), your risk will go down. There's a big difference.

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Re: Lifecycle Investing - Leveraging when young

Post by typical.investor » Sat Mar 09, 2019 3:34 am

305pelusa wrote:
Fri Mar 08, 2019 11:00 pm
A traditional investor (say age in bonds) would have very little money in stocks years 25-35 and much more in stocks years 55-65. That's like betting $0.01 on 10 coins and $1 on another 10 coins. The first 10 coins are so lightly weighted vs the other 10 coins, it's almost like they're not even there. It's similar to simply betting $1 on 10 coins.

The lifecycle investing message is to use leverage to bet more on the earlier coins and correspondingly less on the later ones. The whole message is that young people are too unexposed to stocks while older people are way too exposed to stocks. So you leverage while younger, shift more of it to those first 10 coins and invest less in stocks while older. Now it's not $1 in 10 coins. It's more like $0.5 in all the 20 coins.
I don't accept investing is a coin flip.

I don't think MarketTimer ran into a poor series of flips.

While precise timing is not known, it seems rather that valuations have something to say about your odds.

I wish there were more discussion about the bucket approach research and how it's failings were seemingly due to not taking advantage of low asset prices. Spending from cash didn't let you rebalance when using the bucket approach in some cases.
Ben Mathew wrote:
Sat Mar 09, 2019 1:14 am
Park wrote:
Sat Mar 09, 2019 1:04 am
About time diversification, the argument is that with time, stock return dispersion increases. Dispersion may increase, but it would appear that there is also some reversion to the mean.
It's true that stock dispersion increases with time. But lifecycle investing strategy is not claiming that if you hold stock for longer, your risk will go down. It's saying that if you spread your risk better across time (increase stock exposure in the underexposed years, and reduce it in the overexposed years), your risk will go down. There's a big difference.
Perhaps that will be the affect of lifecycle investing. I am not sure that leveraging into a market top will necessarily do that though.

In any case, I think it's a distortion to present stocks as a 50%/50% bet (ignoring valuation) while simultaneously describing the amount you are wagering as increasing as you accumulate assets. Sure you are wagering more as you are wealthier, but so too do have have more in reserves to take advantage of when stocks are at lower valuations and higher returns are more likely.

For young people who would leverage in US stocks now at their current valuations, I don't think the message should be that getting more in now will balance your exposure and reduce risk. I think the message should be that maintaining exposure is what will reduce your risk.

Obviously once you are spending, you don't have the same opportunity to rebalance, so we have to be careful about that. In that sense, investing when young has an advantage.

Sure we can claim and show that even leveraging into stocks at the high points is fine, but unless the effort is continued in drops and recoveries, then that's not really true.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Mar 09, 2019 8:17 am

typical.investor wrote:
Sat Mar 09, 2019 3:34 am
While precise timing is not known, it seems rather that valuations have something to say about your odds.
.
.
.
Perhaps that will be the affect of lifecycle investing. I am not sure that leveraging into a market top will necessarily do that though.
.
.
.
For young people who would leverage in US stocks now at their current valuations, I don't think the message should be that getting more in now will balance your exposure and reduce risk.
Well you got me here. If it's more probable that the market will crash than boom at this point in time, it's obviously more advantageous to remain as-is for now, wait for the market to crash/valuations to decrease, and then implement lifecycle investing. I would call this market timing btw.
typical.investor wrote:
Sat Mar 09, 2019 3:34 am
Sure we can claim and show that even leveraging into stocks at the high points is fine, but unless the effort is continued in drops and recoveries, then that's not really true.
That's a great point. The book goes into it and often enough, lifecycle investing starts way behind from the other traditional compared approaches (because the historical retiree began right before a crash). But eventually, he/she surpasses them every single time historically by retirement age.


I think my brain and heart are both convinced this is the right way to go. But they're debating on the timing of the strategy right now. And I can't quite convince myself either way on that.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 10:08 am

typical.investor wrote:
Sat Mar 09, 2019 3:34 am
Ben Mathew wrote:
Sat Mar 09, 2019 1:14 am
Park wrote:
Sat Mar 09, 2019 1:04 am
About time diversification, the argument is that with time, stock return dispersion increases. Dispersion may increase, but it would appear that there is also some reversion to the mean.
It's true that stock dispersion increases with time. But lifecycle investing strategy is not claiming that if you hold stock for longer, your risk will go down. It's saying that if you spread your risk better across time (increase stock exposure in the underexposed years, and reduce it in the overexposed years), your risk will go down. There's a big difference.
Perhaps that will be the affect of lifecycle investing. I am not sure that leveraging into a market top will necessarily do that though.

In any case, I think it's a distortion to present stocks as a 50%/50% bet (ignoring valuation) while simultaneously describing the amount you are wagering as increasing as you accumulate assets. Sure you are wagering more as you are wealthier, but so too do have have more in reserves to take advantage of when stocks are at lower valuations and higher returns are more likely.

For young people who would leverage in US stocks now at their current valuations, I don't think the message should be that getting more in now will balance your exposure and reduce risk. I think the message should be that maintaining exposure is what will reduce your risk.

Obviously once you are spending, you don't have the same opportunity to rebalance, so we have to be careful about that. In that sense, investing when young has an advantage.

Sure we can claim and show that even leveraging into stocks at the high points is fine, but unless the effort is continued in drops and recoveries, then that's not really true.
If you follow a traditional AA, you are heavily invested in stocks in your 50s and 60s. What if valuations are high during that time and you're buying into the top of the market? Lifecycle investing spreads your stock exposure from your 50s and 60s into your 20s and 30s. That way you get a better mix of valuations and returns across several decades. Of course it would be best if we can avoid buying into the top altogether. But short of that, buying a mix would be better than concentrating on a couple decades and hoping that those are not bad years. Lifecycle investing helps, not hurts, with this issue.

It's not true that you have more in reserves to handle market downturns when you are older. Yes, you have more dollars in your brokerage accounts. But you are also close to the end of your working life and there are no more contributions coming in. A drop in stocks when you are so concentrated in equities will do a lot of damage, no matter how savvy you are with rebalancing and buying stocks when it's down. It would be better to try to get a more even exposure to stocks.

I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach. I discussed this upthread:
Ben Mathew wrote:
Tue Mar 05, 2019 9:55 pm
The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. At some point, say 15 years in, you leave that stock account alone to do its thing--no further planned stock contributions. The remaining contributions over the rest of your working life goes into 100% bonds. Risk averse people will make the switch earlier--say, after just 7 years of stock contributions. Risk tolerant people will do the switch later--say, after 25 years of stock contributions.

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Sat Mar 09, 2019 1:03 pm

Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am
I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach.

The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. At some point, say 15 years in, you leave that stock account alone to do its thing--no further planned stock contributions. The remaining contributions over the rest of your working life goes into 100% bonds. Risk averse people will make the switch earlier--say, after just 7 years of stock contributions. Risk tolerant people will do the switch later--say, after 25 years of stock contributions.

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.
On this we have no disagreement. However, this is the standard life-cycle investing strategy that Paul Samuelson, Robert Merton, and others have been advising for decades before Ayres & Nalebuff (A&N) wrote their book. A&N are adding nothing to this part of life-cycle investing. Their only contribution is adding leverage.

But adding leverage is suitable for only a tiny subset of all young investors. Here are the contraindications against using the leverage strategy that A&N list in their book. They state that you should not try their strategy if ANY of these situations apply to you:

* You have credit card debt.
* You have student loan debt
* You have less than $4,000 to invest.
* Your employer matches contributions to a 401k plan.
* You need the money to pay for your kids' college education.
* Your salary is correlated with the stock market.
* You would worry too much about losing money. (You are not extremely risk tolerant.)

To the above contraindications A&N list I would add:
* You need to be very knowledgeable about investing.
* You need to have a very stable job. (Very low probability of being involuntarily laid off.)

How many young people do not have any of these red flags in their personal finance and economic situations? This leveraging strategy is life-cycle investing for kids from Ivy League schools who have wealthy parents. While there are such young people, they are relatively few in number, and this leveraging strategy is for them, and essentially them alone.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 1:18 pm

bobcat2 wrote:
Sat Mar 09, 2019 1:03 pm
Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am

I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach.

The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. At some point, say 15 years in, you leave that stock account alone to do its thing--no further planned stock contributions. The remaining contributions over the rest of your working life goes into 100% bonds. Risk averse people will make the switch earlier--say, after just 7 years of stock contributions. Risk tolerant people will do the switch later--say, after 25 years of stock contributions.

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.


On this we have no disagreement. However, this is the standard life-cycle investing strategy that Paul Samuelson, Robert Merton, and others have been advising for decades before Ayres & Nalebuff (A&N) wrote their book.
Is it? I did not know. Can you point me to where they have discussed this approach?

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Sat Mar 09, 2019 1:25 pm

bobcat2 wrote:
Sat Mar 09, 2019 1:03 pm
But adding leverage is suitable for only a tiny subset of all young investors. Here are the contraindications against using the leverage strategy that A&N list in their book. They state that you should not try their strategy if ANY of these situations apply to you:

* You have credit card debt.
* You have student loan debt
* You have less than $4,000 to invest.
* Your employer matches contributions to a 401k plan.
* You need the money to pay for your kids' college education.
* Your salary is correlated with the stock market.
* You would worry too much about losing money. (You are not extremely risk tolerant.)

To the above contraindications A&N list I would add:
* You need to be very knowledgeable about investing.
* You need to have a very stable job. (Very low probability of being involuntarily laid off.)
Some of those caveats are overly broad and most of the rest apply to ANY form of investing, leveraged or otherwise.

Furthermore, growth in ETF and fintech markets since they wrote their book has made it easier, cheaper, and safer to construct a modestly leveraged portfolio than it was just five years ago.

There certainly are simpler ways to invest, many of which might be more-than-good-enough, but that doesn't obviate the benefits of taking a lifecycle approach to investing.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Mar 09, 2019 2:04 pm

bobcat2 wrote:
Sat Mar 09, 2019 1:03 pm
Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am
I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach.

The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. At some point, say 15 years in, you leave that stock account alone to do its thing--no further planned stock contributions. The remaining contributions over the rest of your working life goes into 100% bonds. Risk averse people will make the switch earlier--say, after just 7 years of stock contributions. Risk tolerant people will do the switch later--say, after 25 years of stock contributions.

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.
On this we have no disagreement. However, this is the standard life-cycle investing strategy that Paul Samuelson, Robert Merton, and others have been advising for decades before Ayres & Nalebuff (A&N) wrote their book. A&N are adding nothing to this part of life-cycle investing. Their only contribution is adding leverage.

But adding leverage is suitable for only a tiny subset of all young investors. Here are the contraindications against using the leverage strategy that A&N list in their book. They state that you should not try their strategy if ANY of these situations apply to you:

* You have credit card debt.
* You have student loan debt
* You have less than $4,000 to invest.
* Your employer matches contributions to a 401k plan.
* You need the money to pay for your kids' college education.
* Your salary is correlated with the stock market.
* You would worry too much about losing money. (You are not extremely risk tolerant.)

To the above contraindications A&N list I would add:
* You need to be very knowledgeable about investing.
* You need to have a very stable job. (Very low probability of being involuntarily laid off.)

How many young people do not have any of these red flags in their personal finance and economic situations? This leveraging strategy is life-cycle investing for kids from Ivy League schools who have wealthy parents. While there are such young people, they are relatively few in number, and this leveraging strategy is for them, and essentially them alone.

BobK
BobK to be absolutely sincere and as respectful as I can:

You've brought this exact argument up thrice before and it's been addressed. All you gotta do is scroll up. I even asked you as to how you're estimating the figure you posted twice about this being 1%, to no answer.

You're repetitive, posting identical quotes multiple times as though we're not reading. It feels to me like you're the one not reading the posts. If you're not convinced at this point, that's perfectly acceptable. But that you keep bringing up the exact same points, seemingly not reading what posters answer gets frustrating.

I appreciate your contributions to this thread but you'll have to excuse me for deciding to just not address these comments any more. It does not feel like we're going anywhere with this topic you and I. I honestly cannot tell if I'm being trolled or not.

I do wish you much luck in your life. I truly mean that :happy

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Mar 09, 2019 2:08 pm

Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am
So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.
Just quoting a random comment so you get the notification.

Question, are you personally following the lifecycle investing model ? If so, I'd like to hear some thoughts as to how that's gone. If not, why not? Thanks

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Sat Mar 09, 2019 2:57 pm

Ben Mathew wrote:
Sat Mar 09, 2019 1:18 pm
bobcat2 wrote:
Sat Mar 09, 2019 1:03 pm
Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am

I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach.

The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. ...

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.


On this we have no disagreement. However, this is the standard life-cycle investing strategy that Paul Samuelson, Robert Merton, and others have been advising for decades before Ayres & Nalebuff (A&N) wrote their book.
Is it? I did not know. Can you point me to where they have discussed this approach?

This has been central to life-cycle investing probably since Samuelson's and Merton's companion papers on the topic in 1969. Certainly since the early 1990s life-cycle paper by Bodie, Merton, and Robert Samuelson (Paul's son).

I personally heard Robert Merton talk about this at a retirement conference in 2012. Below I provide a link to his slides. The slide where he talked about this at length is the slide on page 6 titled "Integrated Retirement Investment Approach and Asset Allocation Risk Measures". The slide without the accompanying verbal explanation requires some hard thinking on the part of the viewer.

Link - https://www.nber.org/programs/ag/rrc/rrc2012/ Scroll down the linked page to slides by guest speaker Robert Merton to see Merton's slides.

Last summer I gave a presentation at DC Bogleheads on this topic using Merton's slide slightly modified as the focal point of my presentation on some important aspects of life-cycle investing. In my example I kept the investor's percentage of stock in her combined financial portfolio and relevant human capital to 30% (or as close as she could get early on in her career) from her just starting out to when she retires. That meant 100% stock early in her career and only 30% in the year of her retirement. Of course, if she could meet her retirement income goals without 30% in stocks as she neared retirement, then in that case the percentage near retirement would be lower than 30%.

An important point I was trying to drive home is that young people should invest heavily in stocks early in their careers. But not because stocks are safe in the LR, but rather because young people have a lot of safe future contributions to SS,DB, and DC plans that is part of their total capital (financial and human) and that is why heavy stock investments are justified early in their careers. Late in their careers that relevant safe human capital is nearly depleted and the stock exposure in their financial portfolio needs to be decreased because of the near absence of human capital.

BobK

* The 100% stock early in career is that part of your financial assets dedicated to retirement. You will need other safe assets for your emergency portfolio to deal with job loss and/or a serious bad health state.
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 3:06 pm

305pelusa wrote:
Sat Mar 09, 2019 2:08 pm
Question, are you personally following the lifecycle investing model ? If so, I'd like to hear some thoughts as to how that's gone. If not, why not? Thanks
I'm 42 and my wife is 44. We started investing seriously around 2006 when I was about 30. Our plan from the start has always been to simply stay 100% stocks our whole lives. We've stuck with that plan so far. I was not aware of lifecycle investing considerations until very recently, so the unusual decision to go 100% stocks did not come from that. My reasons were:

- Small differences in returns (e.g., 1.5% real for bonds vs 5% real for stocks) compound to shockingly large differences in portfolio value over a lifetime.

- Over the course of our lives, it's very unlikely that stocks would perform worse than bonds.

- We save enough that it is very unlikely that we will run out of funds during retirement. We will almost certainly be leaving money to our kids and charities when we die. So the risk of stocks is actually being taken by our heirs, and not by us directly. Our kids are young and it's appropriate for them to take that risk. I posted about this here.

- I probably view stocks as less risky than most people do because I view stocks as a very well diversified business conglomerate. This "stocks as a real business" perspective, advocated by people like Benjamin Graham and Warren Buffett, keeps me more optimistic about the long term prospects of stocks than maybe most people. I posted about that here.

Now that I have become aware of the lifecycle investing strategy, there's not really much I can do to adjust because I am 100% stocks anyway. If I had known at 30 what I know now, I might have put in more effort to leverage a bit in my 30s. I had considered it a few times in the past, but I also don't like the hassle of managing a leveraged portfolio with call risk. 100% stocks is really easy compared to 110% stocks. Just set it and forget it. (Also, given that we are not paying off our mortgage as fast as possible, we have more in stocks than we would have if we paid down our mortgage faster. So in a sense we are leveraged using our mortgage loan.) Now that we are in our 40s, the imperative to leverage is going away anyway. We have plenty of stock exposure now. If I was not confident that retirement would be fully funded, I might consider switching new contributions to bonds for a few years at the end to get closer to the lifecycle model. But it won't make sense in our case since I believe that our retirement consumption will be well funded anyway, and so the risk is not falling on us, but on our heirs.

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Re: Lifecycle Investing - Leveraging when young

Post by inbox788 » Sat Mar 09, 2019 3:28 pm

Ben Mathew wrote:
Sat Mar 09, 2019 3:06 pm
(So in a sense we are leveraged using our mortgage loan.) Now that we are in our 40s, the imperative to leverage is going away anyway. We have plenty of stock exposure now. If I was not confident that retirement would be fully funded, I might consider switching new contributions to bonds for a few years at the end to get closer to the lifecycle model. But it won't make sense in our case since I believe that our retirement consumption will be well funded anyway, and so the risk is not falling on us, but on our heirs.
A home/mortgage is a wonderful leverage when you're young, deleverage as you age passive strategy. You typically begin with a 5:1 or 10:1 (10-20% down payment) and over a course of 15 or 30 years, delevage as you pay it off. I'm unaware of a similar passive strategy using equities. If someone crafted some sort of fund like target date funds, would there be sufficient interest?

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 6:17 pm

inbox788 wrote:
Sat Mar 09, 2019 3:28 pm
Ben Mathew wrote:
Sat Mar 09, 2019 3:06 pm
(So in a sense we are leveraged using our mortgage loan.) Now that we are in our 40s, the imperative to leverage is going away anyway. We have plenty of stock exposure now. If I was not confident that retirement would be fully funded, I might consider switching new contributions to bonds for a few years at the end to get closer to the lifecycle model. But it won't make sense in our case since I believe that our retirement consumption will be well funded anyway, and so the risk is not falling on us, but on our heirs.
A home/mortgage is a wonderful leverage when you're young, deleverage as you age passive strategy. You typically begin with a 5:1 or 10:1 (10-20% down payment) and over a course of 15 or 30 years, delevage as you pay it off. I'm unaware of a similar passive strategy using equities. If someone crafted some sort of fund like target date funds, would there be sufficient interest?
If I knew of a fund that leverages stocks long term with no call risk, I probably would have invested in it in my 30s. I think this could be structured as a pair of closed end funds, fund A and fund B, that together invests in, say, $100 million of total stock market for 30 years. At the end of 30 years, the B fund would pay $X to its owners, and the A fund owners would get the rest. So A is a leveraged investment in the stock market financed by B. X would be determined by the interest rate. Owners of the B fund are effectively loaning owners of the A fund money for 30 years at that interest rate. The interest rate would be higher than long term treasury bonds to compensate for the risk that stocks could underperform and owners of the B fund might not get all their money back.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 6:40 pm

bobcat2 wrote:
Sat Mar 09, 2019 2:57 pm
Ben Mathew wrote:
Sat Mar 09, 2019 1:18 pm
bobcat2 wrote:
Sat Mar 09, 2019 1:03 pm
Ben Mathew wrote:
Sat Mar 09, 2019 10:08 am

I actually think that you can get a lot of the benefits of lifecycle investing without leverage simply by adopting a "stocks first" approach.

The ideal risk-minimizing strategy of borrowing and investing $X in stock early in life, and then spending the rest of your life paying off the debt and purchasing bonds, is unattainable. But you can try to get close to this benchmark by directing all contributions towards 100% stock for the first several years of your working life. ...

I have played around with this on a spreadsheet, and it leads me to think that you can get a lot of the benefits using this "stocks first" approach, without having to take on leverage. The key is that because the stocks come in first and therefore get a very long horizon, you only need to allocate a few years' contributions towards stocks to achieve a relatively high stock allocation from a lifetime perspective. So you won't be spreading out your stock contributions over a very long period anyway, even without leverage. Your stocks can be pretty concentrated in the early part of your life with just a 100% stock AA.


On this we have no disagreement. However, this is the standard life-cycle investing strategy that Paul Samuelson, Robert Merton, and others have been advising for decades before Ayres & Nalebuff (A&N) wrote their book.
Is it? I did not know. Can you point me to where they have discussed this approach?

This has been central to life-cycle investing probably since Samuelson's and Merton's companion papers on the topic in 1969. Certainly since the early 1990s life-cycle paper by Bodie, Merton, and Robert Samuelson (Paul's son).

I personally heard Robert Merton talk about this at a retirement conference in 2012. Below I provide a link to his slides. The slide where he talked about this at length is the slide on page 6 titled "Integrated Retirement Investment Approach and Asset Allocation Risk Measures". The slide without the accompanying verbal explanation requires some hard thinking on the part of the viewer.

Link - https://www.nber.org/programs/ag/rrc/rrc2012/ Scroll down the linked page to slides by guest speaker Robert Merton to see Merton's slides.

Last summer I gave a presentation at DC Bogleheads on this topic using Merton's slide slightly modified as the focal point of my presentation on some important aspects of life-cycle investing. In my example I kept the investor's percentage of stock in her combined financial portfolio and relevant human capital to 30% (or as close as she could get early on in her career) from her just starting out to when she retires. That meant 100% stock early in her career and only 30% in the year of her retirement. Of course, if she could meet her retirement income goals without 30% in stocks as she neared retirement, then in that case the percentage near retirement would be lower than 30%.

An important point I was trying to drive home is that young people should invest heavily in stocks early in their careers. But not because stocks are safe in the LR, but rather because young people have a lot of safe future contributions to SS,DB, and DC plans that is part of their total capital (financial and human) and that is why heavy stock investments are justified early in their careers. Late in their careers that relevant safe human capital is nearly depleted and the stock exposure in their financial portfolio needs to be decreased because of the near absence of human capital.

BobK

* The 100% stock early in career is that part of your financial assets dedicated to retirement. You will need other safe assets for your emergency portfolio to deal with job loss and/or a serious bad health state.
Thanks for the link. From what I can make out from the slide you referred to, it seems that Merton is telling people to include the value of all their income streams in the total assets. Future wages (human capital), defined benefit pensions, and social security should count as bonds, and defined contribution savings counts as equity. That perspective will certainly help young people recognize that they are effectively holding a lot of bonds and so should probably have more exposure to equity. But I don't see an explicit discussion of time diversification and how getting stocks in first will help with that.

What you are saying makes sense--people should hold more stocks early and less late. But the "stocks first" approach is saying something more specific--that 100% of your contributions for a certain number of years go only into stocks. The remaining contributions after that cutoff year go only into bonds. Is that what you have in mind as well? I'm not sure I'm getting that from the slide.

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Sat Mar 09, 2019 7:29 pm

Ben Mathew wrote:
Sat Mar 09, 2019 6:40 pm
Thanks for the link. From what I can make out from the slide you referred to, it seems that Merton is telling people to include the value of all their income streams in the total assets. Future wages (human capital), defined benefit pensions, and social security should count as bonds, and defined contribution savings counts as equity.
Merton is not saying that. He is saying you should count the relevant portion of your human capital in total capital (financial portfolio plus relevant human capital). For retirement what is relevant human capital is the expected future contributions (FC on his table) being made to your defined contribution savings plan, your defined benefit pension plan, and Social Security. The preceding three saving streams should be counted in your retirement wealth as safe bond like capital. He is not telling retirement investors to include human capital that will be used for household expenditures between now and retirement. In other words, count the discounted present value of all your expected saving for retirement between now and retirement as part of your retirement capital. Keep counting these streams as safe retirement capital every year between now and retirement as they shrink towards zero at retirement.

When you approach retirement you don't simply make a mechanical cut off to bonds, instead you use a Liability Driven Investment (LDI) strategy to meet your retirement income goal with high probability. This typically involves duration matching with TIPS (bonds or funds) to your retirement income goal during the 15 years or so leading up to retirement. Thus, life-cycle investing is goal based investing that typically employs an LDI strategy and uses the funded ratio as a success metric.

Merton talks more about this here
Applying Life-Cycle Economics
https://www.nestpensions.org.uk/schemew ... cs,PDF.pdf

and here
The Crisis in Retirement Planning - HBR
https://hbr.org/2014/07/the-crisis-in-r ... t-planning

Wade Pfau discusses the DFA target date funds Merton developed in the following article. These target date funds attempt to at least follow the general outline of life-cycle investing, which is all but impossible to follow closely using a target date mutual fund framework. Pfau article at following link.
https://www.forbes.com/sites/wadepfau/2 ... etirement/

I discuss the funded ratio at Bogleheads here
viewtopic.php?f=10&t=219878


and in a short article here
https://finpage.blog/2017/01/15/monitor ... ded-ratio/Aside - When I finally get around to rewriting the article I will replace using discount rates with life annuity pricing.

BobK

PS - You might also want to peruse the articles and books linked to in the Bogleheads Wiki on life-cycle finance at the following link.
https://www.bogleheads.org/wiki/Life-cycle_finance
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sat Mar 09, 2019 7:58 pm

bobcat2 wrote:
Sat Mar 09, 2019 7:29 pm
Ben Mathew wrote:
Sat Mar 09, 2019 6:40 pm
Thanks for the link. From what I can make out from the slide you referred to, it seems that Merton is telling people to include the value of all their income streams in the total assets. Future wages (human capital), defined benefit pensions, and social security should count as bonds, and defined contribution savings counts as equity.
Merton is not saying that. He is saying you should count the relevant portion of your human capital in total capital (financial portfolio plus relevant human capital). For retirement what is relevant human capital is the expected future contributions (FC on his table) being made to your defined contribution savings plan, your defined benefit pension plan, and Social Security. The preceding three saving streams should be counted in your retirement wealth as safe bond like capital. He is not telling retirement investors to include human capital that will be used for household expenditures between now and retirement. In other words, count the discounted present value of all your expected saving for retirement between now and retirement as part of your retirement capital. Keep counting these streams as safe retirement capital every year between now and retirement as they shrink towards zero at retirement.

When you approach retirement you don't simply make a mechanical cut off to bonds, instead you use a Liability Driven Investment (LDI) strategy to meet your retirement income goal with high probability. This typically involves duration matching with TIPS (bonds or funds) to your retirement income goal during the 15 years or so leading up to retirement. Thus, life-cycle investing is goal based investing that typically employs an LDI strategy and uses the funded ratio as a success metric.

Merton talks more about this here
Applying Life-Cycle Economics
https://www.nestpensions.org.uk/schemew ... cs,PDF.pdf

and here
The Crisis in Retirement Planning - HBR
https://hbr.org/2014/07/the-crisis-in-r ... t-planning

Wade Pfau discusses the DFA target date funds Merton developed in the following article. These target date funds attempt to at least follow the general outline of life-cycle investing, which is all but impossible to follow closely using a target date mutual fund framework. Pfau article at following link.
https://www.forbes.com/sites/wadepfau/2 ... etirement/

I discuss the funded ratio at Bogleheads here
viewtopic.php?f=10&t=219878


and in a short article here
https://finpage.blog/2017/01/15/monitor ... ded-ratio/Aside - When I finally get around to rewriting the article I will replace using discount rates with life annuity pricing.

BobK

PS - You might also want to peruse the articles and books linked to in the Bogleheads Wiki on life-cycle finance at the following link.
https://www.bogleheads.org/wiki/Life-cycle_finance
Thanks for the links. I will go through them when I get a chance.

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Re: Lifecycle Investing - Leveraging when young

Post by CULater » Sun Mar 10, 2019 5:52 am

Back, now, to the subject of leverage-early. The strategy has a much larger problem than lack of proper implementation and underdiversification. No matter how theoretically and empirically appealing it is—and I’ll admit, it scores high on both points—there are no sentient beings in this quadrant of the galaxy capable of executing it. In the first place, leverage-early confines all of the investor’s risk within a derivatives wrapper, and there are few investment environments more psychologically toxic than an options account. Second, only the rare investor can tolerate a 1.0 beta, let alone a 2.0 beta. My experience is that young investors have lower tolerance for risk than older investors do. I’ll admit that the academic literature on risk tolerance and age is a tad ambiguous. But the data are crystal clear on one point: Risk tolerance increases with wealth. A 50% fall in the value of a 401(k) plan whose $25,000 balance represents the major liquid asset of a young saver will devastate her. She’ll likely be gun-shy about stocks in the future, her multimillion-dollar human capital notwithstanding.[7]
Bernstein, William J. The Ages of the Investor: A Critical Look at Life-cycle Investing (Investing for Adults) (Kindle Locations 211-212). Efficient Frontier Publications. Kindle Edition.
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Re: Lifecycle Investing - Leveraging when young

Post by dknightd » Sun Mar 10, 2019 8:34 am

305pelusa wrote:
Sat Mar 09, 2019 8:17 am
I think my brain and heart are both convinced this is the right way to go. But they're debating on the timing of the strategy right now. And I can't quite convince myself either way on that.
I think if you are going to do it you should start now, while you are young. You have to have the fortitude to stick with your plan if the markets do indeed drop. It is during these drops that your leveraged purchases will do you the most good. (or the most harm if you can not stick with your plan and sell)

If you are convinced you'd be comfortable with a 150% stock AA then go for it now and don't look back.
I would not do it, but I've always been way to conservative with my investments.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Sun Mar 10, 2019 10:06 am

Ben Mathew wrote:
Sat Mar 09, 2019 7:58 pm
bobcat2 wrote:
Sat Mar 09, 2019 7:29 pm
Ben Mathew wrote:
Sat Mar 09, 2019 6:40 pm
Thanks for the link. From what I can make out from the slide you referred to, it seems that Merton is telling people to include the value of all their income streams in the total assets. Future wages (human capital), defined benefit pensions, and social security should count as bonds, and defined contribution savings counts as equity.
Merton is not saying that. He is saying you should count the relevant portion of your human capital in total capital (financial portfolio plus relevant human capital). For retirement what is relevant human capital is the expected future contributions (FC on his table) being made to your defined contribution savings plan, your defined benefit pension plan, and Social Security. The preceding three saving streams should be counted in your retirement wealth as safe bond like capital. He is not telling retirement investors to include human capital that will be used for household expenditures between now and retirement. In other words, count the discounted present value of all your expected saving for retirement between now and retirement as part of your retirement capital. Keep counting these streams as safe retirement capital every year between now and retirement as they shrink towards zero at retirement.

When you approach retirement you don't simply make a mechanical cut off to bonds, instead you use a Liability Driven Investment (LDI) strategy to meet your retirement income goal with high probability. This typically involves duration matching with TIPS (bonds or funds) to your retirement income goal during the 15 years or so leading up to retirement. Thus, life-cycle investing is goal based investing that typically employs an LDI strategy and uses the funded ratio as a success metric.

Merton talks more about this here
Applying Life-Cycle Economics
https://www.nestpensions.org.uk/schemew ... cs,PDF.pdf

and here
The Crisis in Retirement Planning - HBR
https://hbr.org/2014/07/the-crisis-in-r ... t-planning

Wade Pfau discusses the DFA target date funds Merton developed in the following article. These target date funds attempt to at least follow the general outline of life-cycle investing, which is all but impossible to follow closely using a target date mutual fund framework. Pfau article at following link.
https://www.forbes.com/sites/wadepfau/2 ... etirement/

I discuss the funded ratio at Bogleheads here
viewtopic.php?f=10&t=219878


and in a short article here
https://finpage.blog/2017/01/15/monitor ... ded-ratio/Aside - When I finally get around to rewriting the article I will replace using discount rates with life annuity pricing.

BobK

PS - You might also want to peruse the articles and books linked to in the Bogleheads Wiki on life-cycle finance at the following link.
https://www.bogleheads.org/wiki/Life-cycle_finance
Thanks for the links. I will go through them when I get a chance.
I skimmed through all of these links, and while they are good articles about good ideas, I'm not understanding how they specifically relate to the idea of reducing portfolio risk by time diversification. Either I am missing some connection, or you are misunderstanding what Ayres and Nalebuff are trying to say.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sun Mar 10, 2019 10:15 am

CULater wrote:
Sun Mar 10, 2019 5:52 am
Back, now, to the subject of leverage-early. The strategy has a much larger problem than lack of proper implementation and underdiversification. No matter how theoretically and empirically appealing it is—and I’ll admit, it scores high on both points—there are no sentient beings in this quadrant of the galaxy capable of executing it. In the first place, leverage-early confines all of the investor’s risk within a derivatives wrapper, and there are few investment environments more psychologically toxic than an options account. Second, only the rare investor can tolerate a 1.0 beta, let alone a 2.0 beta. My experience is that young investors have lower tolerance for risk than older investors do. I’ll admit that the academic literature on risk tolerance and age is a tad ambiguous. But the data are crystal clear on one point: Risk tolerance increases with wealth. A 50% fall in the value of a 401(k) plan whose $25,000 balance represents the major liquid asset of a young saver will devastate her. She’ll likely be gun-shy about stocks in the future, her multimillion-dollar human capital notwithstanding.[7]
Bernstein, William J. The Ages of the Investor: A Critical Look at Life-cycle Investing (Investing for Adults) (Kindle Locations 211-212). Efficient Frontier Publications. Kindle Edition.
I have a hard time understanding these arguments. I am planning on taking a certain amount of risk in my life with stocks. Why not spread it out to lower that risk?

If you purely think of leverage as higher risk and higher returns, I get the argument. But I would be using leverage as a life-long, prudent strategy to lower risk via intertemporal time diversification.

Personally, I'm just about the opposite investor than his last statement. I'd feel far more comfortable with 100k plus another borrowed 100k in the market with 15+ working years left, than retiring with, say, 2M in a 50/50 portfolio. It feels to me like terrible things can happen in the first one (even lose it all completely, forever) and I could still manage. But a drop that stayed low for decades (like the Japanese market) would be exceedingly difficult in the latter.

Thank you for the quote! I enjoy Bernstein's commentaries.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sun Mar 10, 2019 10:22 am

dknightd wrote:
Sun Mar 10, 2019 8:34 am
305pelusa wrote:
Sat Mar 09, 2019 8:17 am
I think my brain and heart are both convinced this is the right way to go. But they're debating on the timing of the strategy right now. And I can't quite convince myself either way on that.
I think if you are going to do it you should start now, while you are young. You have to have the fortitude to stick with your plan if the markets do indeed drop. It is during these drops that your leveraged purchases will do you the most good. (or the most harm if you can not stick with your plan and sell)

If you are convinced you'd be comfortable with a 150% stock AA then go for it now and don't look back.
I would not do it, but I've always been way to conservative with my investments.
There is some possibility of moving in the near future, which adds some uncertainty to my income atm. I should know in 2-3 months exactly how that will play out. I will give myself until then to keep mulling this over since I don't think it wise to leverage 2:1 unless I have a clear view of my income for the upcoming 3+ years at least. We'd be talking of borrowing another 150k to truly follow the strategy so I want to make sure I do it right.

I will make the decision independent from market valuations but I am also not going to rush myself if I am not prepared. But based on the thoughts I've heard on this thread, there's a good chance I'll pull the trigger with the second, much bigger loan.

dknightd
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Re: Lifecycle Investing - Leveraging when young

Post by dknightd » Sun Mar 10, 2019 10:54 am

305pelusa wrote:
Sun Mar 10, 2019 10:22 am
dknightd wrote:
Sun Mar 10, 2019 8:34 am
305pelusa wrote:
Sat Mar 09, 2019 8:17 am
I think my brain and heart are both convinced this is the right way to go. But they're debating on the timing of the strategy right now. And I can't quite convince myself either way on that.
I think if you are going to do it you should start now, while you are young. You have to have the fortitude to stick with your plan if the markets do indeed drop. It is during these drops that your leveraged purchases will do you the most good. (or the most harm if you can not stick with your plan and sell)

If you are convinced you'd be comfortable with a 150% stock AA then go for it now and don't look back.
I would not do it, but I've always been way to conservative with my investments.
There is some possibility of moving in the near future, which adds some uncertainty to my income atm. I should know in 2-3 months exactly how that will play out. I will give myself until then to keep mulling this over since I don't think it wise to leverage 2:1 unless I have a clear view of my income for the upcoming 3+ years at least. We'd be talking of borrowing another 150k to truly follow the strategy so I want to make sure I do it right.

I will make the decision independent from market valuations but I am also not going to rush myself if I am not prepared. But based on the thoughts I've heard on this thread, there's a good chance I'll pull the trigger with the second, much bigger loan.
Good luck with whatever you decide. It sounds risky to me.
A few years ago I was talking with some older friends about retirement savings. Lets pretend it was 2009. I think it was about then.
One was all in the market. He said he was ready to retire, then the market crashed, and he did not have enough money yet.
The other took a very conservative approach, and he did not have enough to retire yet either. I'm about in the middle, but saved a little more than they did. 10 years later (at about their age) I think I can retire. Unfortunately both of those friends have died. Both of their widows are OK. The one invested in stocks has more money, at least for now.

It sounds like you have family money to support what I would call gambling. You are shooting for the moon. It could work out really well. Or not.

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