Lifecycle Investing - Leveraging when young

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rascott
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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Thu Jul 04, 2019 5:49 pm

So there are now micro e-minis that have come on the market since this thread was started. These are 1/10th the size of the traditional e-mini. I understand they are targeted more to the retail investor, rather than e-minis which are so big they are really for institutional.

Wouldn't this be an ideal product for someone using this strategy?

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privatefarmer
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Re: Lifecycle Investing - Leveraging when young

Post by privatefarmer » Thu Jul 04, 2019 7:08 pm

rascott wrote:
Thu Jul 04, 2019 5:49 pm
So there are now micro e-minis that have come on the market since this thread was started. These are 1/10th the size of the traditional e-mini. I understand they are targeted more to the retail investor, rather than e-minis which are so big they are really for institutional.

Wouldn't this be an ideal product for someone using this strategy?
Could you explain in detail how to buy these? For the life of me I cannot figure out how to go about buying LEAPS or futures. It’s above my head. I’ve just been using leveraged ETFs and a margin loan but am sure there’s a better way

rascott
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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Thu Jul 04, 2019 8:17 pm

privatefarmer wrote:
Thu Jul 04, 2019 7:08 pm
rascott wrote:
Thu Jul 04, 2019 5:49 pm
So there are now micro e-minis that have come on the market since this thread was started. These are 1/10th the size of the traditional e-mini. I understand they are targeted more to the retail investor, rather than e-minis which are so big they are really for institutional.

Wouldn't this be an ideal product for someone using this strategy?
Could you explain in detail how to buy these? For the life of me I cannot figure out how to go about buying LEAPS or futures. It’s above my head. I’ve just been using leveraged ETFs and a margin loan but am sure there’s a better way
LEAPS are just very long dated options. You can buy them via any broker.

I've never bought a future.... to this point they've been too large a position to make sense for me. I would just use options. But this new offering is very interesting

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Thu Jul 04, 2019 8:49 pm

rascott wrote:
Thu Jul 04, 2019 8:17 pm
privatefarmer wrote:
Thu Jul 04, 2019 7:08 pm
rascott wrote:
Thu Jul 04, 2019 5:49 pm
So there are now micro e-minis that have come on the market since this thread was started. These are 1/10th the size of the traditional e-mini. I understand they are targeted more to the retail investor, rather than e-minis which are so big they are really for institutional.

Wouldn't this be an ideal product for someone using this strategy?
Could you explain in detail how to buy these? For the life of me I cannot figure out how to go about buying LEAPS or futures. It’s above my head. I’ve just been using leveraged ETFs and a margin loan but am sure there’s a better way
LEAPS are just very long dated options. You can buy them via any broker.

I've never bought a future.... to this point they've been too large a position to make sense for me. I would just use options. But this new offering is very interesting
Yes I agree. These positions are very interesting. I will have to look into them more.

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Ben Mathew
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Fri Jul 05, 2019 9:21 am

305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
The implication is that if I wanted to use this strategy, I should pick a strike price that has plenty of options traded in order to minimize the spread cost.
Yes, you'd want to go with the strike price that's most thickly traded (smallest bid ask spread), which is generally at strike around current price. The further you go away from the current price, the more thinly traded the options tend to be.
305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
Also I just realized that by choosing higher strike prices, I would get even more leverage no? I could also pick a strike price where the put directly offsets the call and then I'd need "zero down" on the strategy. Any strike prices above that, and I'd actually get money back initially, increasing leverage further. Is this all correct? Is the additional money that I can borrow by choosing higher strike prices also effectively borrowing at the same rate that I determined earlier through math?
Yes, the leverage is coming from the fact that you are NOT holding the bonds you would need to create the synthetic stock position. If strike is $100, then you have to hold bonds that pay out $100 at expiry to create the synthetick stock. If you choose not to hold it, then you have effectively borrowed $100 discounted to the present--say $97. If strike is $120, then you have to hold bonds that pay out $120 at expiry to create the synthetic stock. By not holding it, you have effectively borrowed $120 discounted to the present--say $116.

You can increase your leverage by buying more options at strike=current price (at the money options), or by going with fewer options with higher strikes (out of the money options). Since at the money options tend to be more thickly traded, it would probably be best get your desired leverage through those.
305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
Thanks man, you're immensely helpful.
My pleasure. Stay safe!

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Jul 05, 2019 3:16 pm

Ben Mathew wrote:
Fri Jul 05, 2019 9:21 am
305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
The implication is that if I wanted to use this strategy, I should pick a strike price that has plenty of options traded in order to minimize the spread cost.
Yes, you'd want to go with the strike price that's most thickly traded (smallest bid ask spread), which is generally at strike around current price. The further you go away from the current price, the more thinly traded the options tend to be.
305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
Also I just realized that by choosing higher strike prices, I would get even more leverage no? I could also pick a strike price where the put directly offsets the call and then I'd need "zero down" on the strategy. Any strike prices above that, and I'd actually get money back initially, increasing leverage further. Is this all correct? Is the additional money that I can borrow by choosing higher strike prices also effectively borrowing at the same rate that I determined earlier through math?
Yes, the leverage is coming from the fact that you are NOT holding the bonds you would need to create the synthetic stock position. If strike is $100, then you have to hold bonds that pay out $100 at expiry to create the synthetick stock. If you choose not to hold it, then you have effectively borrowed $100 discounted to the present--say $97. If strike is $120, then you have to hold bonds that pay out $120 at expiry to create the synthetic stock. By not holding it, you have effectively borrowed $120 discounted to the present--say $116.

You can increase your leverage by buying more options at strike=current price (at the money options), or by going with fewer options with higher strikes (out of the money options). Since at the money options tend to be more thickly traded, it would probably be best get your desired leverage through those.
305pelusa wrote:
Thu Jul 04, 2019 2:55 pm
Thanks man, you're immensely helpful.
My pleasure. Stay safe!
@Ben:
When I choose LEAPS options for the SPY with strike price being market value (297), I get an implied borrowing rate of 1.61%.
When I choose the highest strike price (410), the implied rate is more like 1.47%. This is the opposite of what I expected since I imagined the additional money I spend to buy the thinly trade call (and the money I don't get for selling the thinly traded put) would come out as a higher borrowing cost.

So:
1) Is there something else going on with choosing a higher strike price? I'm thinking in terms of how much time value they have, which might be playing a role in the above?
2) Is this as simply as going through the various strike price options and choosing whichever has the smallest implied borrowing rate?

Just trying to figure out if there are any second-order effects that play a role above (ex: choosing strike prices well away from the market price makes the time value decay much faster, forcing me to liquidate the position and set another straddle much more often, which would increase my transaction costs).

Thanks once again.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Fri Jul 05, 2019 3:39 pm

Are you using current bid/ask quotes for the calculations (not last price, which will be stale)? If so, can you post the bid/ask quotes you got?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Jul 05, 2019 7:43 pm

Ben Mathew wrote:
Fri Jul 05, 2019 3:39 pm
Are you using current bid/ask quotes for the calculations (not last price, which will be stale)? If so, can you post the bid/ask quotes you got?
I think so. Here's where I got them from (LEAPS, Dec 17, 2021):
https://finance.yahoo.com/quote/SPY/opt ... 1639699200

The 410 call would cost me 1.55 while I could get 110.47 for selling the put at the 410 strike price. The 300 call would cost me 29.06 while I would get 29.02 for selling the put.

Right then and there you can tell the problem I think. The former position is identical to the latter except that the former lets me borrow 108.92 today and it only costs me 110 more at expiration 2 years from today to "exercise". So some of the leverage is like 0%.

Either way, I'll state my other assumptions. I'm assuming 6 dividends of 1.3% would get paid out. I assume they get reinvested at 2.35% (this doesn't really change things much). I'm assuming 30 dollars for transaction costs for both. I don't think these matter much because they're common to both positions.

I get that the former has an implied borrowing rate of 1.45% while the latter has 1.76%. They're slightly off from my previous post (not super sure why, maybe I was looking at another data). Either way, it's a little surprising no?

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Fri Jul 05, 2019 7:54 pm

Ben Mathew wrote:
Fri Jul 05, 2019 3:39 pm
Are you using current bid/ask quotes for the calculations (not last price, which will be stale)? If so, can you post the bid/ask quotes you got?
I think so. Here's where I got them from (LEAPS, Dec 17, 2021):
https://finance.yahoo.com/quote/SPY/opt ... 1639699200

The 410 call would cost me 1.55 while I could get 110.47 for selling the put at the 410 strike price. The 300 call would cost me 29.06 while I would get 29.02 for selling the put.

Right then and there you can tell the problem I think. The former position is identical to the latter except that the former lets me borrow 108.92 today and it only costs me 110 more at expiration 2 years from today to "exercise". So the additional leverage obtained by moving the strike price up is at like ~0.5%.

Either way, I'll state my other assumptions. I'm assuming 6 dividends of 1.3% would get paid out. I assume they get reinvested at 2.35% (this doesn't really change things much). I'm assuming 30 dollars for transaction costs for both. I don't think these matter much because they're common to both positions.

I get that the former has an implied borrowing rate of 1.45% while the latter has 1.76%. They're slightly off from my previous post (not super sure why, maybe I was looking at another data). Either way, it's a little surprising no?

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Re: Lifecycle Investing - Leveraging when young

Post by White Oak » Sun Jul 07, 2019 9:28 pm

305pelusa wrote:
Fri Mar 01, 2019 12:11 am
Hello,
I recently came across the research from Prof. Ayres and Nalebuff about lifecycle investing and time diversification.
Thanks 305pelusa for this thread. I read this book this spring and have been thinking about implementing this myself. I am in my mid 30s with no debt, so I think it could be an option for me.

If I do implement it, I'd probably use leveraged ETFs for the convenience, accepting the higher cost. Options or futures sound like a bit of hassle. I am still undecided whether I would use all stocks, or mix in bonds similar to Hedgefundie's 3x 40/60 approach. I realize that including bonds is contrary to Ayres and Nalebuff's advice, but I'm tempted by the efficiency of the mixed portfolio. The PIMCO StocksPLUS funds look like a particularly simple option in this regard.

Question for you: In chapter 7 of Lifecycle Investing, the authors modify the Samuelson share using the current PE10 and VIX. The spreadsheet on their website includes these factors in the calculation. When I enter the current values (PE10 = 30 and VIX = 13%) in the spreadsheet, the Samuelson share is 0%. I haven't seen you mention anything about the PE10 or VIX. Are you factoring these in to your Samuelson share, or are you just ignoring these adjustments?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sun Jul 07, 2019 10:35 pm

White Oak wrote:
Sun Jul 07, 2019 9:28 pm
305pelusa wrote:
Fri Mar 01, 2019 12:11 am
Hello,
I recently came across the research from Prof. Ayres and Nalebuff about lifecycle investing and time diversification.
Thanks 305pelusa for this thread. I read this book this spring and have been thinking about implementing this myself. I am in my mid 30s with no debt, so I think it could be an option for me.

If I do implement it, I'd probably use leveraged ETFs for the convenience, accepting the higher cost. Options or futures sound like a bit of hassle. I am still undecided whether I would use all stocks, or mix in bonds similar to Hedgefundie's 3x 40/60 approach. I realize that including bonds is contrary to Ayres and Nalebuff's advice, but I'm tempted by the efficiency of the mixed portfolio. The PIMCO StocksPLUS funds look like a particularly simple option in this regard.

Question for you: In chapter 7 of Lifecycle Investing, the authors modify the Samuelson share using the current PE10 and VIX. The spreadsheet on their website includes these factors in the calculation. When I enter the current values (PE10 = 30 and VIX = 13%) in the spreadsheet, the Samuelson share is 0%. I haven't seen you mention anything about the PE10 or VIX. Are you factoring these in to your Samuelson share, or are you just ignoring these adjustments?
I got u fam. This is what Ian Ayres emailed me back when I asked him this exact question:

"Thanks for reading the book and for emailing. Barry and I are not certified financial advisors and so can’t give you financial advice. Reasonable academics have some disagreement on whether or not any market timing (include PE10 timing ala Shiller) is worthwhile or not. If one chooses not to make a PE10 adjustment, one way of proceeding is to just make the expected equity premium based on some historically based measure or upon some measure of what economist survey suggest future equity premium will be. I leave it to you to consult the literature on this question. Sorry not to be more directive."

And here's what Barry Nalebuff added:
"If you do not think there is any premium to equities over bonds then there is no reason to take on the extra risk. One might note that the CAPE is about to get smaller due to the financial crisis period dripping out of the equation; see WSJ article below.

Article Start
In his annual letter to shareholders, published on Saturday, the chief executive of Berkshire Hathaway said his quest for a large acquisition has continued to come up short. “Prices are sky-high for businesses possessing decent long-term prospects,” he complained.

Mr. Buffett is hamstrung in part because he has more than $100 billion in cash to put to work. Unable to find what he called an elephant-sized acquisition, he said Berkshire would likely be expanding its portfolio of stocks instead. Considering where valuations are, even that hunt for smaller game could be trying.

Start with how stocks stack up against expected earnings. A year ago, the S&P 500 traded at 17.1 times what analysts thought its underlying companies would earn over the next 12 months, according to FactSet. Now, that forward price/earnings ratio is about 16.2. That is right around the average of 16 for the 23 years for which FactSet has data.

But 23 years doesn’t count as a lot of history. And since it is for is a period that includes both the nose-bleed valuations of the dot-com bubble and the deep discounts that came after the financial crisis, it is hard to say what the right forward P/E should be.

Warren Buffett’s Berkshire Hathaway is hamstrung in part because it has more than $100 billion in cash to put to work.
Warren Buffett’s Berkshire Hathaway is hamstrung in part because it has more than $100 billion in cash to put to work. PHOTO: RICK WILKING/REUTERS
Investors also can look backwards using trailing P/Es—what stocks fetch relative to earnings already in the books rather than what analysts were projecting. One popular way of doing that is the “cyclically adjusted price-earnings,” or CAPE ratio, that economists Robert Shiller and John Campbell came up with in the late 1990s. This looks at stock prices versus the past 10 years of earnings, smoothing out the effects of economic booms and busts and adjusting for inflation.
Article End

Today the CAPE is at around 30, which compares to with an average of about 20 over the past half century—in other words, quite expensive. But the CAPE may overstate how pricey stocks are. First, it still reflects (but soon won’t) large write-downs from the financial crisis a decade ago. Second, it reflects a different tax regime. Through the first three quarters of last year, the corporate tax cut boosted the earnings measure the CAPE relies on by about 11%, according to Zion Research Group. If last year’s tax cut had prevailed over the past decade, the CAPE would be about three points lower.

To avoid the impact of the tax cut, and also the question of whether tax laws will be changed again, investors could look at a valuation measure Mr. Buffett has pointed to: The market capitalization of U.S. stocks as a percentage of gross national product. Right now, that measure stands at about 159% which isn’t far from the 171% it hit during the dot-com bubble.

Of course no single measure can really capture how under or overvalued the stock market might be—there are too many moving parts. But looking across a variety of them suggests the market is hardly a bargain. Some individual stocks almost certainly are, but for both Mr. Buffett and regular investors, identifying them is no easy task."

Mildly helpful advice but not much there so.

What I personally did is that I opened a thread to hear some thoughts:
viewtopic.php?t=274224


After a lot of thought, I figured any reasonable estimate is about as good as any so I just settled for the equity and volatility estimates of Vanguard and called it a day:
https://pressroom.vanguard.com/nonindex ... 120618.pdf

Hope that helps :)

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Ben Mathew
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Jul 08, 2019 11:24 am

305pelusa wrote:
Fri Jul 05, 2019 7:54 pm
Ben Mathew wrote:
Fri Jul 05, 2019 3:39 pm
Are you using current bid/ask quotes for the calculations (not last price, which will be stale)? If so, can you post the bid/ask quotes you got?
I think so. Here's where I got them from (LEAPS, Dec 17, 2021):
https://finance.yahoo.com/quote/SPY/opt ... 1639699200

The 410 call would cost me 1.55 while I could get 110.47 for selling the put at the 410 strike price. The 300 call would cost me 29.06 while I would get 29.02 for selling the put.

Right then and there you can tell the problem I think. The former position is identical to the latter except that the former lets me borrow 108.92 today and it only costs me 110 more at expiration 2 years from today to "exercise". So the additional leverage obtained by moving the strike price up is at like ~0.5%.

Either way, I'll state my other assumptions. I'm assuming 6 dividends of 1.3% would get paid out. I assume they get reinvested at 2.35% (this doesn't really change things much). I'm assuming 30 dollars for transaction costs for both. I don't think these matter much because they're common to both positions.

I get that the former has an implied borrowing rate of 1.45% while the latter has 1.76%. They're slightly off from my previous post (not super sure why, maybe I was looking at another data). Either way, it's a little surprising no?

I checked prices today when markets were open, and I'm getting

Price of SPY= 296.65

@Strike 300
Call ask = 27.93
put bid = 29.99

@ strike 410
call ask = 1.51
put bid = 111.61

If dividends=$0, I'm getting implied interest of .43% @ strike 300 and .80% @ strike 410
But if dividends=$8, I'm getting implied interest of 3.11% @ strike 300 and 2.77% @ strike 410

It seems pretty senstive to dividend assumptions. But you're right that it's odd to get a better implied interest on strike 410 than on strike 300 assuming normal dividends. Not sure why that is.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 11:56 am

Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am
305pelusa wrote:
Fri Jul 05, 2019 7:54 pm
Ben Mathew wrote:
Fri Jul 05, 2019 3:39 pm
Are you using current bid/ask quotes for the calculations (not last price, which will be stale)? If so, can you post the bid/ask quotes you got?
I think so. Here's where I got them from (LEAPS, Dec 17, 2021):
https://finance.yahoo.com/quote/SPY/opt ... 1639699200

The 410 call would cost me 1.55 while I could get 110.47 for selling the put at the 410 strike price. The 300 call would cost me 29.06 while I would get 29.02 for selling the put.

Right then and there you can tell the problem I think. The former position is identical to the latter except that the former lets me borrow 108.92 today and it only costs me 110 more at expiration 2 years from today to "exercise". So the additional leverage obtained by moving the strike price up is at like ~0.5%.

Either way, I'll state my other assumptions. I'm assuming 6 dividends of 1.3% would get paid out. I assume they get reinvested at 2.35% (this doesn't really change things much). I'm assuming 30 dollars for transaction costs for both. I don't think these matter much because they're common to both positions.

I get that the former has an implied borrowing rate of 1.45% while the latter has 1.76%. They're slightly off from my previous post (not super sure why, maybe I was looking at another data). Either way, it's a little surprising no?

I checked prices today when markets were open, and I'm getting

Price of SPY= 296.65

@Strike 300
Call ask = 27.93
put bid = 29.99

@ strike 410
call ask = 1.51
put bid = 111.61

If dividends=$0, I'm getting implied interest of .43% @ strike 300 and .80% @ strike 410
But if dividends=$8, I'm getting implied interest of 3.11% @ strike 300 and 2.77% @ strike 410

It seems pretty senstive to dividend assumptions. But you're right that it's odd to get a better implied interest on strike 410 than on strike 300 assuming normal dividends. Not sure why that is.
I will plug these numbers in later today to see if I'm getting the same numbers.

Either way, it's somewhat consistent in that the lower the strike price I choose, the greater the rate. I chose ~35 as a strike price last week and got a rate of ~6%.

Is there anything else that occurs to you that might explain why the rate would go down as strike price goes up given a reasonable dividend? Maybe something to do with how likely the option would get assigned earlier or something? Perhaps if it's very thinly traded, it would be too difficult to liquidate the position before assignment?

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Jul 08, 2019 12:25 pm

305pelusa wrote:
Mon Jul 08, 2019 11:56 am
Is there anything else that occurs to you that might explain why the rate would go down as strike price goes up given a reasonable dividend? Maybe something to do with how likely the option would get assigned earlier or something? Perhaps if it's very thinly traded, it would be too difficult to liquidate the position before assignment?
Nothing I can think of, but I'm not an options expert. This is not a strategy I've personally followed, so there are probably details/aspects to this I'm not aware of.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 4:37 pm

@Ben, I plugged things into my spreadsheet and I'm getting different numbers. Hopefully, we could check my math here real quick?
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am
Price of SPY= 296.65

@Strike 300
Call ask = 27.93
put bid = 29.99
...
If dividends=$0, I'm getting implied interest of .43% @ strike 300
This would imply you invest (296.65-27.93+29.99) 298.71 in a bond that pays out 300 in Dec 17, 2021. There are 893 days until then. So the rate is :
(300/298.71)^(365/893) - 1 = 0.18%

How did you get 0.43%? I'm afraid I'm doing something wrong.
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am

Price of SPY= 296.65

.
.

@ strike 410
call ask = 1.51
put bid = 111.61

If dividends=$0, ... .80% @ strike 410
I'm getting 0.33% when using my spreadsheet here. As follows:

You invest (296.65-1.51+111.61) 406.75 today in a bond that must pay 410 by Dec 17, 2021. That came out to 0.33%. I agree it comes out larger than the scenario before but I'm getting some wildly different rates here.

Thoughts?

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Re: Lifecycle Investing - Leveraging when young

Post by White Oak » Mon Jul 08, 2019 7:21 pm

305pelusa wrote:
Sun Jul 07, 2019 10:35 pm
After a lot of thought, I figured any reasonable estimate is about as good as any so I just settled for the equity and volatility estimates of Vanguard and called it a day:
https://pressroom.vanguard.com/nonindex ... 120618.pdf
Thank you for your reply.

I'm impressed that the authors took the time to answer your email.

As you say, the answer they gave doesn't seem very intellectually satisfying. Given that limitation, it sounds like your use of the Vanguard estimate is a reasonable strategy.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 7:54 pm

White Oak wrote:
Mon Jul 08, 2019 7:21 pm
305pelusa wrote:
Sun Jul 07, 2019 10:35 pm
After a lot of thought, I figured any reasonable estimate is about as good as any so I just settled for the equity and volatility estimates of Vanguard and called it a day:
https://pressroom.vanguard.com/nonindex ... 120618.pdf
Thank you for your reply.

I'm impressed that the authors took the time to answer your email.

As you say, the answer they gave doesn't seem very intellectually satisfying. Given that limitation, it sounds like your use of the Vanguard estimate is a reasonable strategy.
Yeah they've been great. I've asked them questions ranging from the calculations of the Samuelson share to constant vs variable leverage.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Jul 08, 2019 8:30 pm

305pelusa wrote:
Mon Jul 08, 2019 4:37 pm
@Ben, I plugged things into my spreadsheet and I'm getting different numbers. Hopefully, we could check my math here real quick?
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am
Price of SPY= 296.65

@Strike 300
Call ask = 27.93
put bid = 29.99
...
If dividends=$0, I'm getting implied interest of .43% @ strike 300
This would imply you invest (296.65-27.93+29.99) 298.71 in a bond that pays out 300 in Dec 17, 2021. There are 893 days until then. So the rate is :
(300/298.71)^(365/893) - 1 = 0.18%

How did you get 0.43%? I'm afraid I'm doing something wrong.
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am

Price of SPY= 296.65

.
.

@ strike 410
call ask = 1.51
put bid = 111.61

If dividends=$0, ... .80% @ strike 410
I'm getting 0.33% when using my spreadsheet here. As follows:

You invest (296.65-1.51+111.61) 406.75 today in a bond that must pay 410 by Dec 17, 2021. That came out to 0.33%. I agree it comes out larger than the scenario before but I'm getting some wildly different rates here.

Thoughts?
Sorry, that was the total interest till expiry. Annualizing gives

if dividends=$0
.18% for strike 300
.33% for strike 410

So same as yours.

And if dividends = $8
1.26% for strike 300
1.12% for strike 410

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 8:49 pm

Ben Mathew wrote:
Mon Jul 08, 2019 8:30 pm
305pelusa wrote:
Mon Jul 08, 2019 4:37 pm
@Ben, I plugged things into my spreadsheet and I'm getting different numbers. Hopefully, we could check my math here real quick?
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am
Price of SPY= 296.65

@Strike 300
Call ask = 27.93
put bid = 29.99
...
If dividends=$0, I'm getting implied interest of .43% @ strike 300
This would imply you invest (296.65-27.93+29.99) 298.71 in a bond that pays out 300 in Dec 17, 2021. There are 893 days until then. So the rate is :
(300/298.71)^(365/893) - 1 = 0.18%

How did you get 0.43%? I'm afraid I'm doing something wrong.
Ben Mathew wrote:
Mon Jul 08, 2019 11:24 am

Price of SPY= 296.65

.
.

@ strike 410
call ask = 1.51
put bid = 111.61

If dividends=$0, ... .80% @ strike 410
I'm getting 0.33% when using my spreadsheet here. As follows:

You invest (296.65-1.51+111.61) 406.75 today in a bond that must pay 410 by Dec 17, 2021. That came out to 0.33%. I agree it comes out larger than the scenario before but I'm getting some wildly different rates here.

Thoughts?
Sorry, that was the total interest till expiry. Annualizing gives

if dividends=$0
.18% for strike 300
.33% for strike 410

So same as yours.

And if dividends = $8
1.26% for strike 300
1.12% for strike 410
Plugged those in and I got the same numbers, great.

I think 8 dollars total of dividends would be quite a low estimate no? There are 9 dividends until Dec17, 2021. Each quarterly dividend has been ~1.3 to 1.4 dollars (for an annual dividend yield of ~1.9%). That's about 13 dollars worth of dividends. My spreadsheet reinvests them so they get to about 14.5 bucks by the end. I get then:

1.76% for strike 410
2.12% for strike 300
7.83% for strike 80

I can't help but think there's something else here. I'm considering linking to the options chain data and creating some graphs to look at some of these patterns. Meh, some day perhaps.

Thanks for the help once again!

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Re: Lifecycle Investing - Leveraging when young

Post by privatefarmer » Mon Jul 08, 2019 9:18 pm

I cannot seem to wrap my head around LEAPS... but if you buy a LEAP contract you do not receive dividends, correct? So if I wanted to borrow 100k of sp500 I would miss out on the dividends and pay the implied interest using a LEAP?

Interactive brokers is charging me ~3.5% to borrow via margin, after the tax deduction it comes to 2.7%. Would LEAPS really be any cheaper considering that I do get dividends when borrowing on margin?

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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Mon Jul 08, 2019 9:54 pm

I'm going to ask this question again.....why would anyone use LEAPS or margin loan when you can now buy micro-e-mini futures...where one contract has a notional value of roughly $15k ($5x the SP500 index)...?

Need less than 5% down in the trade. Yeah, you'd need to roll them every quarter....but what else am I missing here?

https://www.cmegroup.com/trading/equity ... tures.html

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 10:20 pm

privatefarmer wrote:
Mon Jul 08, 2019 9:18 pm
I cannot seem to wrap my head around LEAPS... but if you buy a LEAP contract you do not receive dividends, correct? So if I wanted to borrow 100k of sp500 I would miss out on the dividends and pay the implied interest using a LEAP?
This is all correct. There's nothing special about LEAPs; it's just an option with a longer expiration. I'm considering them because it would minimize the number of transactions I would have to do (I would only have to re-set the position every couple of years instead of every quarter, for instance).
privatefarmer wrote:
Mon Jul 08, 2019 9:18 pm
Interactive brokers is charging me ~3.5% to borrow via margin, after the tax deduction it comes to 2.7%. Would LEAPS really be any cheaper considering that I do get dividends when borrowing on margin?
Think of it this way:

Margin
You get the price appreciation and dividends. You pay 2.7% of the money you borrow

Options
You only get the price appreciation. That rate comes out to be really small (sometimes even negative). In order to get an apples-to-apples comparison to margin, you must make a reasonable dividend prediction to understand what you miss out. The rates calculated earlier in the thread (like 1.7%) are the money you need to pay yourself to make up these dividends so then it's like you actually do get both the price appreciation and the dividends. Then it can be directly compared to a margin loan.

Does that kinda make sense?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 10:26 pm

rascott wrote:
Mon Jul 08, 2019 9:54 pm
I'm going to ask this question again.....why would anyone use LEAPS or margin loan when you can now buy micro-e-mini futures...where one contract has a notional value of roughly $15k ($5x the SP500 index)...?
If LEAPs or a margin loan offered a better rate, then it would make sense I think.

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Re: Lifecycle Investing - Leveraging when young

Post by rascott » Mon Jul 08, 2019 10:42 pm

305pelusa wrote:
Mon Jul 08, 2019 10:26 pm
rascott wrote:
Mon Jul 08, 2019 9:54 pm
I'm going to ask this question again.....why would anyone use LEAPS or margin loan when you can now buy micro-e-mini futures...where one contract has a notional value of roughly $15k ($5x the SP500 index)...?
If LEAPs or a margin loan offered a better rate, then it would make sense I think.

How would one calculate the implied rate on a futures contract? I thought it was basically the risk free rate? And the leverage is much higher, no?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Jul 08, 2019 10:55 pm

rascott wrote:
Mon Jul 08, 2019 10:42 pm
305pelusa wrote:
Mon Jul 08, 2019 10:26 pm
rascott wrote:
Mon Jul 08, 2019 9:54 pm
I'm going to ask this question again.....why would anyone use LEAPS or margin loan when you can now buy micro-e-mini futures...where one contract has a notional value of roughly $15k ($5x the SP500 index)...?
If LEAPs or a margin loan offered a better rate, then it would make sense I think.

How would one calculate the implied rate on a futures contract? I thought it was basically the risk free rate? And the leverage is much higher, no?
I added a section for futures contracts on my spreadsheet and I'm getting a rate of 1.67% for the upcoming September contract. That's certainly better than the LEAPs @ strike price of 300 (2.12%) but basically rounding error from the higher strike-price LEAPs (1.76%).

I can't comment on the leverage; I haven't thought about it much. I'm not looking for ridiculous leverage any ways. 1.5 leverage is about right for me. So it'll come down to whichever product is easier to work with and has the cheaper rate. For the time being, it looks like that might be the futures contracts. Especially because I trust the rates I get there more than what I'm calculating (which sound too good to be true honestly).

But I'm just keeping an open mind and trying to work through the numbers and math, that's all. Doesn't mean I'll actually fire up the LEAPs.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Tue Jul 09, 2019 12:32 am

305pelusa wrote:
Mon Jul 08, 2019 8:49 pm
I think 8 dollars total of dividends would be quite a low estimate no? There are 9 dividends until Dec17, 2021. Each quarterly dividend has been ~1.3 to 1.4 dollars (for an annual dividend yield of ~1.9%). That's about 13 dollars worth of dividends. My spreadsheet reinvests them so they get to about 14.5 bucks by the end.
Agree. I used 1.5 instead of 2.5 years worth of dividends.
305pelusa wrote:
Mon Jul 08, 2019 8:49 pm

I get then:

1.76% for strike 410
2.12% for strike 300
7.83% for strike 80

I can't help but think there's something else here.
Probably. Hopefully someone who knows more about options will come along and clarify why the 410 strike is cheaper than the 300 strike.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Jul 09, 2019 6:51 pm

Ben Mathew wrote:
Tue Jul 09, 2019 12:32 am
305pelusa wrote:
Mon Jul 08, 2019 8:49 pm
I think 8 dollars total of dividends would be quite a low estimate no? There are 9 dividends until Dec17, 2021. Each quarterly dividend has been ~1.3 to 1.4 dollars (for an annual dividend yield of ~1.9%). That's about 13 dollars worth of dividends. My spreadsheet reinvests them so they get to about 14.5 bucks by the end.
Agree. I used 1.5 instead of 2.5 years worth of dividends.
305pelusa wrote:
Mon Jul 08, 2019 8:49 pm

I get then:

1.76% for strike 410
2.12% for strike 300
7.83% for strike 80

I can't help but think there's something else here.
Probably. Hopefully someone who knows more about options will come along and clarify why the 410 strike is cheaper than the 300 strike.
Mkay so here's my theory.

The put-call parity equations we've been using only apply truly to European options. So the better rate we calculate for the strike price assumes the put does not get assigned until around expiration. If it gets assigned before, then you've spent the same amount of dollars for the position but over a shorter amount of time, making for a higher annualized borrowing rate. So what I keep calculating could be thought of as the best-case rate. The higher the strike price, the lower the likelihood of that best case occurring.

Assignment is less likely with lower volatility. So that's when I realized that higher strike prices do make a position on volatility as well. I looked through the options and the higher strike price position would not be Vega neutral at all. That's to say: my deep ITM short put is hurt far more by volatility than my deep OTM call benefits from it.

So the strike price chosen needs to be balanced. It can't be too high otherwise volatility hurts the position. It can't be too low, otherwise the position benefits from volatility. Turns out the strike prices that achieve Vega neutrality are somewhat close to the market price.

A Vega-neutral position, in theory, is one where the risk of my put assignment is somewhat offset by the benefits that I could assign my call I think.

The Vega-neutral position also happened to have a Delta = 1.0. For some reason, higher strike price positions had Deltas lower than 1.0 (not sure why), so even more reason to stay away from them.

I also noticed the position should ideally be Theta-neutral (the time value I lose on my calls should be offset equally by the time value I gain from the short put). However, not a single strike price would lead to Theta-neutrality. I think that means SPY has a form of volatility skew. Specifically, the magnitude of theta for the calls were about twice as much as for the puts. This means I lose more value on my calls than I "gain" on my short put.

I don't really know if that's a good thing or a bad thing. It's hard to figure out the implication of that finding.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Jul 09, 2019 7:59 pm

For those who like graphs, here are the Greeks for the January 17, 2020 expirations.

http://tinypic.com/view.php?pic=2wf8nls ... SU4VZNKi-s

At around a strike price of 300, Delta becomes 1 and Vega becomes zero. I think that strike price would best simulate stock ownership. It has an interest rate of 2.58%. Note that Theta is not zero, but it would be ideal if it was. Gamma is also not zero although it isn't as bad I don't think.

If we go to another maturity (Dec 18, 2020), we reach Vega-neutrality (and Delta of 1) at strike price of 303. It has an implied borrowing rate of 2.3%.

Overall, futures seem to offer lower rates. And because they're daily settled, that should give neutrality in the rest of the Greeks. Overall, futures are probably the ideal to implement leverage I think.

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Re: Lifecycle Investing - Leveraging when young

Post by FIProfessor » Sat Jul 20, 2019 2:13 pm

305pelusa wrote:
Mon Jul 08, 2019 10:26 pm
rascott wrote:
Mon Jul 08, 2019 9:54 pm
I'm going to ask this question again.....why would anyone use LEAPS or margin loan when you can now buy micro-e-mini futures...where one contract has a notional value of roughly $15k ($5x the SP500 index)...?
If LEAPs or a margin loan offered a better rate, then it would make sense I think.
If you just buy LEAP calls (i.e., the book's strategy, not the matched put-calls that Ben and 305pelusa have been discussing) then, to me, the main benefit over both margin loan and buying futures is that there is no risk of margin calls. It seems like you might pay quite a premium in implied borrowing rates for this protection, so I can't tell if it's worth it. The exchange mandated maintenance margin rates for futures are very low compared to the Reg T requirements for margin loans, especially if you're only trying to achieve 2x leverage, so the risk may be minimal. But I believe your broker can always require larger rates, and they're free to impose such a requirement at almost any time. This makes me nervous in a tax advantaged account, where you may not even be able to deposit more.

In a taxable account, another possible advantage of LEAP calls over futures is that if you hold them over a year, they're taxed as long term capital gains, whereas futures are taxed at a 60/40 split between long and short term capital gains. (But conversely, compared to margin loans, they both have a disadvantage in that their implied borrowing costs are not deductible.)

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 8:49 am

Another 3 months have gone by:
Stock Exposure = 251k
Debt = 101k
Equity in the exposure = 150k
Leverage = 1.68

I will update the OP to quickly see the quarterly progress.

My debt grew by around 9k while my equity increased by 7k. Hence, my stock exposure increased by ~15k. Debt is still mostly non-callable (94k) although the rest is on 0% credit cards. Once those expire, I will just pay them off.

I accepted a higher paying job while moving in with SO (slashing rent expenses). These two have a rather large effect in my estimated savings ability for the future, which abruptly increased the present value of my future contributions.
Hence, I am back on Phase 1 until I can hit my Samuelson number.

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sat Aug 03, 2019 10:27 am

This thread is getting long, but anyhow, I really, really recommend reading this paper:

https://riskcenter.berkeley.edu/wp-cont ... r1_000.pdf

I see a lot of confusion in this thread and others about how leverage affects volatility decay. The key thing to realize is that holding the arithmetic return of a series of returns constant, your geometric return will be less as a function of the variance of your returns. Specifically, you subtract the variance divided by 2, per period, to adjust the arithmetic return for variance drag and approximate the geometric return. A consequence of this mathematical relationship between variance and geometric return is that variance drag is quadratic, not linear, with respect to leverage, since variance squares deviations from the arithmetic mean.

Daily rebalancing is actually very helpful in a down market. There is a persistent relationship between market declines and future volatility. Daily rebalancing will decrease your effective total leverage after a sharp decline in order to keep the leverage ratio fixed - exactly what you want. It's sort of the inverse of martingale betting, which leads to ruin.

All this to say - I do think leverage can make sense if you really now what you're doing. Both Buffet and the best PE funds apply leverage to assets with a margin of safety, and it works. But you really do need to understand leverage deeply first to avoid making serious mistakes with managing risk.

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sat Aug 03, 2019 10:38 am

I would also add - it is odd that people will advise against any form of portfolio leverage, and then pile into equities where the companies' management use huge amounts of leverage. After a sharp decline in share prices, companies that had high debt to equity ratios will have VERY high debt to equity ratios, since their debt remains largely fixed yet shareholders equity has declined. These equities will then be very volatile, and act almost like a levered fund; this has been termed the "leverage effect". A modestly levered portfolio of low beta value stocks with low debt, along with treasuries, could very well be safer than an unlevered growth stock ETF.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 1:19 pm

no simpler wrote:
Sat Aug 03, 2019 10:27 am
This thread is getting long, but anyhow, I really, really recommend reading this paper:

https://riskcenter.berkeley.edu/wp-cont ... r1_000.pdf
Thanks for the link although I don't think anyone is confused about this and I'm not sure how it applies to this strategy.
no simpler wrote:
Sat Aug 03, 2019 10:27 am
Daily rebalancing will decrease your effective total leverage after a sharp decline in order to keep the leverage ratio fixed - exactly what you want.
That's the opposite of what I want. I don't want strategies that systematically encourage selling when the market drops and buying when it rises. If the market drops, if anything, I want to be further invested.

I can always bite the bullet and sell during a downmarket if my leverage begins to increase too much. But the market will have to drop significantly before I ever entertain the motion of selling during Bear markets.

This makes me immune to volatility decay (which people with daily leverage resets do have). It does expose me to trend losses (which, as you describe, are lower for those who reset their leverage). So I guess it's a "pick your poison" kinda deal. I pick the former.

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sat Aug 03, 2019 4:03 pm

305pelusa wrote:
Sat Aug 03, 2019 1:19 pm
no simpler wrote:
Sat Aug 03, 2019 10:27 am
This thread is getting long, but anyhow, I really, really recommend reading this paper:

https://riskcenter.berkeley.edu/wp-cont ... r1_000.pdf
Thanks for the link although I don't think anyone is confused about this and I'm not sure how it applies to this strategy.
no simpler wrote:
Sat Aug 03, 2019 10:27 am
Daily rebalancing will decrease your effective total leverage after a sharp decline in order to keep the leverage ratio fixed - exactly what you want.
That's the opposite of what I want. I don't want strategies that systematically encourage selling when the market drops and buying when it rises. If the market drops, if anything, I want to be further invested.

I can always bite the bullet and sell during a downmarket if my leverage begins to increase too much. But the market will have to drop significantly before I ever entertain the motion of selling during Bear markets.

This makes me immune to volatility decay (which people with daily leverage resets do have). It does expose me to trend losses (which, as you describe, are lower for those who reset their leverage). So I guess it's a "pick your poison" kinda deal. I pick the former.
I'm 100% sure this is wrong. Check out the old market timer threads. You def do not want to be more levered following a decline. I'm not talking about selling and getting out of the market, I'm talking about the amount of leverage. If you want to try a martingale betting strategy where you increase buying after losses, go for it. You will quickly learn the hard way.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 5:15 pm

no simpler wrote:
Sat Aug 03, 2019 4:03 pm
305pelusa wrote:
Sat Aug 03, 2019 1:19 pm
no simpler wrote:
Sat Aug 03, 2019 10:27 am
This thread is getting long, but anyhow, I really, really recommend reading this paper:

https://riskcenter.berkeley.edu/wp-cont ... r1_000.pdf
Thanks for the link although I don't think anyone is confused about this and I'm not sure how it applies to this strategy.
no simpler wrote:
Sat Aug 03, 2019 10:27 am
Daily rebalancing will decrease your effective total leverage after a sharp decline in order to keep the leverage ratio fixed - exactly what you want.
That's the opposite of what I want. I don't want strategies that systematically encourage selling when the market drops and buying when it rises. If the market drops, if anything, I want to be further invested.

I can always bite the bullet and sell during a downmarket if my leverage begins to increase too much. But the market will have to drop significantly before I ever entertain the motion of selling during Bear markets.

This makes me immune to volatility decay (which people with daily leverage resets do have). It does expose me to trend losses (which, as you describe, are lower for those who reset their leverage). So I guess it's a "pick your poison" kinda deal. I pick the former.
I'm 100% sure this is wrong. Check out the old market timer threads. You def do not want to be more levered following a decline. I'm not talking about selling and getting out of the market, I'm talking about the amount of leverage. If you want to try a martingale betting strategy where you increase buying after losses, go for it. You will quickly learn the hard way.
The problem with MT's strategy was the usage of callable debt:
Market declines would produce an increase in leverage. That's not bad in itself. The bad part is that once leverage was high enough (10-20), he was forced to sell his contracts due to insufficient collateral. His brokerage would then effectively force him to sell his contracts to maintain appropriate collateral (i.e. ensure leverage did not keep rising). Notice how MT's problems begin once he is forced to do precisely what you recommend; to sell once the market declines to maintain constant leverage (dictated by the contracts' collateral).

So over the course of a week, the market would tank, he'd be sold out of his contracts. Then the market would go back to the previous level but he wouldn't get to participate on the upswing. That's known as "volatility decay".

You can take whatever lesson you want from that. It's tempting to use hindsight and recommend capping the leverage at X number; it would've helped because the market kept declining. Of course, we only know that in hindsight.

The lesson I take is the one MT himself gives:
market timer wrote:
Mon Oct 27, 2008 12:40 pm
To all MTs (past, present, and future): I've been following this thread for over a year. Thanks for this mess. Please take my advice. Never use callable debt.
A lesson many others share, such as White Coat Investor:
White Coat Investor wrote:
Mon Oct 27, 2008 1:57 pm
market timer wrote: Never use callable debt.
That's really the bottom line, isn't it. The strategy would likely have been fine with non-callable, low-interest debt. It would have been a horrible year, but no worse than those of us with a big mortgage. If you could service the debt with your income you would have been fine. It was the margin calls that killed you (as long as the income you're using to service the debt stayed okay.)

So let's put it this way:
Reducing exposure (selling after market declines) is a way to work with callable debt; it's simply necessary. If you don't do it, it will be done for you.

Those who have non-callable debt (mortgages, car loans, HELOC, borrowed money from family members) simply don't have to do this. I would not recommend someone with a mortgage to sell stocks during a Bear market to prepay the mortgage. Would you?

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sat Aug 03, 2019 7:29 pm

305pelusa wrote:
Sat Aug 03, 2019 5:15 pm
no simpler wrote:
Sat Aug 03, 2019 4:03 pm
305pelusa wrote:
Sat Aug 03, 2019 1:19 pm
no simpler wrote:
Sat Aug 03, 2019 10:27 am
This thread is getting long, but anyhow, I really, really recommend reading this paper:

https://riskcenter.berkeley.edu/wp-cont ... r1_000.pdf
Thanks for the link although I don't think anyone is confused about this and I'm not sure how it applies to this strategy.
no simpler wrote:
Sat Aug 03, 2019 10:27 am
Daily rebalancing will decrease your effective total leverage after a sharp decline in order to keep the leverage ratio fixed - exactly what you want.
That's the opposite of what I want. I don't want strategies that systematically encourage selling when the market drops and buying when it rises. If the market drops, if anything, I want to be further invested.

I can always bite the bullet and sell during a downmarket if my leverage begins to increase too much. But the market will have to drop significantly before I ever entertain the motion of selling during Bear markets.

This makes me immune to volatility decay (which people with daily leverage resets do have). It does expose me to trend losses (which, as you describe, are lower for those who reset their leverage). So I guess it's a "pick your poison" kinda deal. I pick the former.
I'm 100% sure this is wrong. Check out the old market timer threads. You def do not want to be more levered following a decline. I'm not talking about selling and getting out of the market, I'm talking about the amount of leverage. If you want to try a martingale betting strategy where you increase buying after losses, go for it. You will quickly learn the hard way.
The problem with MT's strategy was the usage of callable debt:
Market declines would produce an increase in leverage. That's not bad in itself. The bad part is that once leverage was high enough (10-20), he was forced to sell his contracts due to insufficient collateral. His brokerage would then effectively force him to sell his contracts to maintain appropriate collateral (i.e. ensure leverage did not keep rising). Notice how MT's problems begin once he is forced to do precisely what you recommend; to sell once the market declines to maintain constant leverage (dictated by the contracts' collateral).

So over the course of a week, the market would tank, he'd be sold out of his contracts. Then the market would go back to the previous level but he wouldn't get to participate on the upswing. That's known as "volatility decay".

You can take whatever lesson you want from that. It's tempting to use hindsight and recommend capping the leverage at X number; it would've helped because the market kept declining. Of course, we only know that in hindsight.

The lesson I take is the one MT himself gives:
market timer wrote:
Mon Oct 27, 2008 12:40 pm
To all MTs (past, present, and future): I've been following this thread for over a year. Thanks for this mess. Please take my advice. Never use callable debt.
A lesson many others share, such as White Coat Investor:
White Coat Investor wrote:
Mon Oct 27, 2008 1:57 pm
market timer wrote: Never use callable debt.
That's really the bottom line, isn't it. The strategy would likely have been fine with non-callable, low-interest debt. It would have been a horrible year, but no worse than those of us with a big mortgage. If you could service the debt with your income you would have been fine. It was the margin calls that killed you (as long as the income you're using to service the debt stayed okay.)

So let's put it this way:
Reducing exposure (selling after market declines) is a way to work with callable debt; it's simply necessary. If you don't do it, it will be done for you.

Those who have non-callable debt (mortgages, car loans, HELOC, borrowed money from family members) simply don't have to do this. I would not recommend someone with a mortgage to sell stocks during a Bear market to prepay the mortgage. Would you?
I mean, you can ultimately do whatever you want. I'm just trying to help folks avoid needless pain.

I think the misunderstanding that you have is that you think by buying more when the market dips, you're being a value investor of sorts. That's not how value investing works, though - value investing operates on a MUCH longer time scale. Hence the famous Keynes quote: "the market can stay irrational longer than you can stay solvent."

The leverage effect is a real phenomenon. When the market drops significantly, you don't just become more leveraged if you don't rebalance - the market also becomes more leveraged, and consequently, more volatile. So you're now amplifying risk from two sources. To keep risk constant, you would need less leverage, not just in total terms but in relation to equity. And when I say risk, I mean both volatility and max drawdown - things that are no longer mere academic constructs when you apply leverage, as failing to manage them will wipe out your account.

Do whatever you want though.

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sat Aug 03, 2019 8:18 pm

https://www.portfoliovisualizer.com/bac ... 0&total3=0

3:1 leverage with annual rebalancing...

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Sat Aug 03, 2019 8:33 pm

no simpler wrote:
Sat Aug 03, 2019 8:18 pm
https://www.portfoliovisualizer.com/bac ... 0&total3=0

3:1 leverage with annual rebalancing...
“Max Drawdown: N/A”

I think you just broke PV 😁

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 8:38 pm

no simpler wrote:
Sat Aug 03, 2019 7:29 pm

I think the misunderstanding that you have is that you think by buying more when the market dips, you're being a value investor of sorts. That's not how value investing works, though - value investing operates on a MUCH longer time scale. Hence the famous Keynes quote: "the market can stay irrational longer than you can stay solvent."
Call it whatever you want but I'm like every BH in this respect. If the market drops, my IPS tells me to buy more stocks to get back to my desired allocation. It really is as simple as that.
no simpler wrote:
Sat Aug 03, 2019 8:18 pm
https://www.portfoliovisualizer.com/bac ... 0&total3=0

3:1 leverage with annual rebalancing...
What you've shown there is a strategy that rebalances the leverage back to 3:1 every year. Note how it "blows up"; at some point you owe more than you have invested so the simulation ends. It ends because when it goes to rebalance, it cannot achieve 3:1 leverage again. EDIT: It looks like it just ends because PV just doesn't allow a >100% drawdown.

My strategy is fundamentally different. I never rebalance the leverage. I don't have to in fact because it is non-callable.
If you want to backtest it, here are the two portfolios to pit:
1) 10000 into SPY from 1994 to 2019. The 10k grows to 102k.
2) 30000 into SPY (initial leverage of 3:1) with the same dates. The 30k grows into 307k. Now I pay back my debt. Let's say the debt grew at a 3% interest rate for the 25 years (now it's 41k). I pay it back and end up with 266k.


Where Lifecycle Investing gets in trouble is when you start selling during downmarkets. And callable debt will force that on you. That was MT's demise. And that's what your backtest shows.
Last edited by 305pelusa on Sat Aug 03, 2019 9:05 pm, edited 1 time in total.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 8:46 pm

no simpler wrote:
Sat Aug 03, 2019 8:18 pm
https://www.portfoliovisualizer.com/bac ... 0&total3=0

3:1 leverage with annual rebalancing...
Also, that was some sneaky cherry-picking. You didn't show 2:1 leverage because it actually survives and beats the unlevered portfolio. I was wondering where you were getting 3:1 since my leverage is 1.68 at the moment. You were just looking for something that blows up.

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Re: Lifecycle Investing - Leveraging when young

Post by MoneyMarathon » Sat Aug 03, 2019 9:35 pm

Great thoughts! The rate I'm seeing at Interactive Brokers is 3.4%, which I think is pretty reasonable. As for margin calls and equity, the strategy recommends selling if needed to maintain the leverage at 2:1. Ideally, my savings rate can make up any market drops to maintain the correct leverage without having to sell.
Where Lifecycle Investing gets in trouble is when you start selling during downmarkets. And callable debt will force that on you.
I don't understand what your plan is here. Please explain again: how are you trying to run this? What is the source of the loan? How are you trying to avoid ruin?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sat Aug 03, 2019 9:54 pm

MoneyMarathon wrote:
Sat Aug 03, 2019 9:35 pm
Great thoughts! The rate I'm seeing at Interactive Brokers is 3.4%, which I think is pretty reasonable. As for margin calls and equity, the strategy recommends selling if needed to maintain the leverage at 2:1. Ideally, my savings rate can make up any market drops to maintain the correct leverage without having to sell.
Where Lifecycle Investing gets in trouble is when you start selling during downmarkets. And callable debt will force that on you.
I don't understand what your plan is here. Please explain again: how are you trying to run this? What is the source of the loan? How are you trying to avoid ruin?
First, just to touch on your quote of the other poster:
Phase 1 from the book recommends constant leverage at 2:1 until you hit your target dollar exposure. They recommend leverage via call options, which gets extremely expensive with leverage past that. If you're going to implement this with call options, I also think you shouldn't allow your leverage to go past 2:1. I imagine they also don't want to go on record recommending excessive amounts of leverage to readers in a book.
If you use margin, it's not up to you. 2:1 is the legal maximum.

As far as that poster is concerned, 2:1 is about the best you can do. If you have access to non-callable debt at reasonable rates however, I see no issue with going further in leverage to hit your target dollar exposure sooner. And in fact, if the market tanks, my leverage will increase well past 2:1. No matter, I just won't sell. It's not any more expensive to me and it's not callable any ways.

As to your questions:
1) I run this as follows: I create a spreadsheet estimating my post tax yearly income, subtract expenses (to come to my yearly savings) and then discount that over the next 20-30 years. That number represents the present value of my future savings contributions. This dollar amount is like a bond (steady stream of income). I add to that "human capital bond" my present savings to arrive at my present lifetime wealth. I want to invest 20% in stocks at the moment (yes, I'm fairly conservative). 20% of my present lifetime wealth is higher than my present savings (because so much of my wealth is still to be earned) so I need to borrow money to hit that exposure.

2) The source of my loans are a family member who I pay interest to and will repay the entire capital in the next 5-10 years.

3) What do you mean by "ruin" exactly? If you can describe a situation that you would consider "ruin" I can give you a better answer.

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Re: Lifecycle Investing - Leveraging when young

Post by MoneyMarathon » Sat Aug 03, 2019 10:05 pm

305pelusa wrote:
Sat Aug 03, 2019 9:54 pm
The source of my loans are a family member who I pay interest to and will repay the entire capital in the next 5-10 years.
Right, I forgot that part. Thanks.

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Re: Lifecycle Investing - Leveraging when young

Post by tadamsmar » Sun Aug 04, 2019 5:53 am

bobcat2 wrote:
Sat Mar 02, 2019 9:09 am
From April 2010 - The ideas that I have been criticizing do not shrivel up and die. They always come back.

bobcat2 wrote:
Sat Apr 17, 2010 9:08 am
I notice at the Amazon preview of their book, Lifecycle Investing, Ayres and Nalebuff dedicate the book "to their teacher Paul Samuelson" and claim their book is a straightforward application of research done by Samuelson.

In October of 2008 Paul Samuelson attended an economics conference on lifecycle investing. I believe it was the last economics conference Samuelson attended. Here is what Paul Samuelson said about the investing strategy of Ayres and Nalebuff at that conference.
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.

Now, when I read such things, my eyebrows arch upwards. I think I have written 27 articles rebutting this idea—with at least one article completely in one syllable words, except for the word “syllable” itself. 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.

The ideas that I have been criticizing do not shrivel up and die. They always come back... Recently I received an abstract for a paper in which a Yale economist and a Yale law school professor advise the world that when you are young and you have many years ahead of you, you should borrow heavily, invest in stocks on margin, and make a lot of money. I want to remind them, with a well-chosen counterexample: I always quote from Warren Buffett (that wise, wise man from Nebraska) that in order to succeed, you must first survive. People who leverage heavily when they are very young do not realize that the sky is the limit of what they could lose and from that point on, they would be knocked out of the game.

So once Samuelson dies a year later Ayres and Nalebuff dedicate a book to Samuelson on an investment strategy Samuelson and his research had roundly rejected, while he was alive and able to defend his rejection of their strategy.

Shame on them. Shame.

BobK

PS - Link to conference proceedings that includes Samuelson quote.
http://www.cfainstitute.org/memresource ... cle_4.html

Link to original thread - viewtopic.php?t=53714

BobK
Here's Kahneman's rebuttal of Samuelson's 27 rebuttals:

https://books.google.com/books?id=P5GsR ... ue&f=false

You can also find a version in Thinking Fast and Slow

Samuelson's logic is sound, but it involves atomizing a set of joint decisions, it's a misapplication of utility.

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Re: Lifecycle Investing - Leveraging when young

Post by White Oak » Sun Aug 04, 2019 7:41 am

Here's another question for those who have read the book.

The authors base their recommendations on the present value of total lifetime savings. They give a method to estimate your total lifetime earnings. I guess this is looking at the supply side of savings.

The other way would be to look at your retirement/FI savings goal. This would be the demand side, how much savings so I need or want?

I guess the two could be equivalent if you stop working when you've met your goal. In my mind though, it makes sense to base my calculations on a FI number rather than total lifetime savings.

What do you all think about this?

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sun Aug 04, 2019 7:53 am

White Oak wrote:
Sun Aug 04, 2019 7:41 am
Here's another question for those who have read the book.

The authors base their recommendations on the present value of total lifetime savings. They give a method to estimate your total lifetime earnings. I guess this is looking at the supply side of savings.

The other way would be to look at your retirement/FI savings goal. This would be the demand side, how much savings so I need or want?

I guess the two could be equivalent if you stop working when you've met your goal. In my mind though, it makes sense to base my calculations on a FI number rather than total lifetime savings.

What do you all think about this?
I figured it out as follows:
- I determined my retirement/FI savings goal. I'd need X dollars by Y age to fully retire comfortably and leave a bequest.
- From that, I know I need to save Z% of my income for W upcoming years to hit the above.
- From that, I can determine the present value of my future savings contributions. I use a much more rigorous process to calculate it than what they give in the book. The method they use makes assumptions on the interest rate, savings rate, etc. So I have personalized it in a spreadsheet where I can toggle numbers.

If you're someone who is very confident you will save/work far past your FI/savings goal (simply because you know you like to work), then you could just ignore the first bullet point completely. If not, I would use it to dictate the "demand side" and go from there as detailed above.

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Re: Lifecycle Investing - Leveraging when young

Post by White Oak » Sun Aug 04, 2019 8:41 am

305pelusa wrote:
Sun Aug 04, 2019 7:53 am
I figured it out as follows:
- I determined my retirement/FI savings goal. I'd need X dollars by Y age to fully retire comfortably and leave a bequest.
- From that, I know I need to save Z% of my income for W upcoming years to hit the above.
- From that, I can determine the present value of my future savings contributions. I use a much more rigorous process to calculate it than what they give in the book. The method they use makes assumptions on the interest rate, savings rate, etc. So I have personalized it in a spreadsheet where I can toggle numbers.

If you're someone who is very confident you will save/work far past your FI/savings goal (simply because you know you like to work), then you could just ignore the first bullet point completely. If not, I would use it to dictate the "demand side" and go from there as detailed above.
Okay, that's helpful.

If you calculate your necessary savings fraction based on your retirement goal, then you have constrained the lifetime savings amount. In that case, is the lifetime savings method different than using the present value of your retirement goal at your retirement age?

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Re: Lifecycle Investing - Leveraging when young

Post by White Oak » Sun Aug 04, 2019 8:54 am

305pelusa wrote:
Sun Aug 04, 2019 7:53 am
If you're someone who is very confident you will save/work far past your FI/savings goal (simply because you know you like to work), then you could just ignore the first bullet point completely. If not, I would use it to dictate the "demand side" and go from there as detailed above.
I guess this depends on your risk tolerance. If I was confident that I was going to blow past my retirement goal, then I would still base these lifecycle calculations on my retirement goal rather than my total savings. I'd rather not be applying leverage after I had met my goal.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Sun Aug 04, 2019 9:17 am

White Oak wrote:
Sun Aug 04, 2019 8:41 am
305pelusa wrote:
Sun Aug 04, 2019 7:53 am
I figured it out as follows:
- I determined my retirement/FI savings goal. I'd need X dollars by Y age to fully retire comfortably and leave a bequest.
- From that, I know I need to save Z% of my income for W upcoming years to hit the above.
- From that, I can determine the present value of my future savings contributions. I use a much more rigorous process to calculate it than what they give in the book. The method they use makes assumptions on the interest rate, savings rate, etc. So I have personalized it in a spreadsheet where I can toggle numbers.

If you're someone who is very confident you will save/work far past your FI/savings goal (simply because you know you like to work), then you could just ignore the first bullet point completely. If not, I would use it to dictate the "demand side" and go from there as detailed above.
Okay, that's helpful.

If you calculate your necessary savings fraction based on your retirement goal, then you have constrained the lifetime savings amount. In that case, is the lifetime savings method different than using the present value of your retirement goal at your retirement age?
This is a very sharp and intelligent question; you're certainly understanding this strategy very well.

The answer is yes! If you will only generate/save enough wealth throughout your career to hit a specific retirement/FI number in a given number of years, then discounting that final wealth to the present will give you the same value as discounting every annual savings contribution to the present.

As someone who is fairly confident they can hit their FI/savings goal (because I calculated it and it looks like I'm well on track), I have now shifted to using the "demand side" as you mentioned. I discount however much I predict I will save over the next however many years and use that.
White Oak wrote:
Sun Aug 04, 2019 8:54 am
305pelusa wrote:
Sun Aug 04, 2019 7:53 am
If you're someone who is very confident you will save/work far past your FI/savings goal (simply because you know you like to work), then you could just ignore the first bullet point completely. If not, I would use it to dictate the "demand side" and go from there as detailed above.
I guess this depends on your risk tolerance. If I was confident that I was going to blow past my retirement goal, then I would still base these lifecycle calculations on my retirement goal rather than my total savings. I'd rather not be applying leverage after I had met my goal.
If you do so, you will almost surely under-invest in equities at first and over-invest with them when you have that "additional past retirement" money in the future. You would use that additional money for your retirement if you needed it right? So temporally diversify it too!

It is a difficult strategy to wrap your head around at first. There's no "conservative" or "aggressive". There's only "under invest now" or "over invest now" (and the opposite for the future) and they are both temporally undiversified.

I have found the easiest and most logical way to implement this is to be as truthful and honest as I can about what my future savings contributions are, and then temporally diversify all of it.

If you want to be conservative, you would decrease your Samuelson share instead of playing around with mental accounting barriers as you describe. This would keep you less invested in equities throughout your life. That will force you to invest less in equities now (same thing that you are doing by not discounting all of your future wealth), but also less in the future. I believe this is the correct way of making the strategy conservative because everything is still properly temporally diversified.

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Re: Lifecycle Investing - Leveraging when young

Post by no simpler » Sun Aug 04, 2019 9:58 am

tadamsmar wrote:
Sun Aug 04, 2019 5:53 am
bobcat2 wrote:
Sat Mar 02, 2019 9:09 am
From April 2010 - The ideas that I have been criticizing do not shrivel up and die. They always come back.

bobcat2 wrote:
Sat Apr 17, 2010 9:08 am
I notice at the Amazon preview of their book, Lifecycle Investing, Ayres and Nalebuff dedicate the book "to their teacher Paul Samuelson" and claim their book is a straightforward application of research done by Samuelson.

In October of 2008 Paul Samuelson attended an economics conference on lifecycle investing. I believe it was the last economics conference Samuelson attended. Here is what Paul Samuelson said about the investing strategy of Ayres and Nalebuff at that conference.
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.

Now, when I read such things, my eyebrows arch upwards. I think I have written 27 articles rebutting this idea—with at least one article completely in one syllable words, except for the word “syllable” itself. 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.

The ideas that I have been criticizing do not shrivel up and die. They always come back... Recently I received an abstract for a paper in which a Yale economist and a Yale law school professor advise the world that when you are young and you have many years ahead of you, you should borrow heavily, invest in stocks on margin, and make a lot of money. I want to remind them, with a well-chosen counterexample: I always quote from Warren Buffett (that wise, wise man from Nebraska) that in order to succeed, you must first survive. People who leverage heavily when they are very young do not realize that the sky is the limit of what they could lose and from that point on, they would be knocked out of the game.

So once Samuelson dies a year later Ayres and Nalebuff dedicate a book to Samuelson on an investment strategy Samuelson and his research had roundly rejected, while he was alive and able to defend his rejection of their strategy.

Shame on them. Shame.

BobK

PS - Link to conference proceedings that includes Samuelson quote.
http://www.cfainstitute.org/memresource ... cle_4.html

Link to original thread - viewtopic.php?t=53714

BobK
Here's Kahneman's rebuttal of Samuelson's 27 rebuttals:

https://books.google.com/books?id=P5GsR ... ue&f=false

You can also find a version in Thinking Fast and Slow

Samuelson's logic is sound, but it involves atomizing a set of joint decisions, it's a misapplication of utility.
agree - I think Samuelson is reifying an irrational bias (loss aversion) as a standard utility function. It makes more sense to me to simply train ourselves against loss aversion. This is sort of an appeal to nature fallacy.

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