Lifecycle Investing - Leveraging when young

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rhe
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Re: Lifecycle Investing - Leveraging when young

Post by rhe » Mon Mar 04, 2019 12:25 am

HEDGEFUNDIE wrote:
Sun Mar 03, 2019 8:06 pm
rhe wrote:
Sun Mar 03, 2019 6:43 pm
It seems like the fundamental problem is that positions in a brokerage account (futures, options, leveraged etfs) do not accept your future income stream as collateral, and so will close you out if there are large losses, even if you could actually pay them off from your future income.
LETFs are not subject to margin call. You may lose a substantial amount of money, but you will never be "closed out".

As for futures, maintenance margin on a S&P e-mini contract is only $6k, which is 4.3% of the full contract value (as of Friday). If you were leveraged 3:1, you would have $47k put up as collateral, and the S&P would have to fall 29% for you to get a margin call.
Right, a leveraged ETF is keeping a constant leverage ratio. The problem is that this involves selling into losses as they occur. The fund does this internally for you, but it's the same as if you closed part of a futures position when it went against you.

As a simple example, suppose I have 200k right now, and I know that I'm going to save another 800k over the next sixteen years from a guaranteed salary. For simplicity suppose we're in a world with 0% risk free interest rates and no inflation. I want to invest my current savings as well as some of my future savings. Suppose I decide to buy 200k of a 2.5x leveraged ETF, which gives me a 500k position in the stock market. Now suppose the next day a 1987 style crash happens, and the market falls 20%. That's a loss of 100k, and my position size in the market is now only 250k, because we must maintain the constant leverage ratio for fear of future losses.

Suppose instead I had made a real estate investment. I put down 200k of cash, and take out a mortgage of 300k, and buy a 500k property (humour me and ignore transaction costs). The next day a real estate crisis happens and the value of my property drops by 20%. I've sustained the same 100k loss in this case, but the difference is that the leverage ratio rises naturally. I now have the same 300k of debt, but only 100k of equity, for a leverage ratio of 4x. This is what I want, remember, because my future income is unchanged, and I will pay off the debt out of my future income.

In the example with the stock market investment, we cannot allow the leverage ratio to rise, because at 4x leverage a 25% loss would wipe us out completely.

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Ben Mathew
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Mar 04, 2019 2:18 am

The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.

That aside, the main conclusion is correct and extremely important: people can reduce their lifetime risk if they spread their stock exposure more evenly over the course of their lives. That means increasing stock exposure beyond 100% in the early years when the portfolio is underweight and reducing it closer to retirement when the portfolio is overweight.

It's a fairly straightforward idea. I'm not sure why it's not more popular than it is. I suspect it's because of a deep-seated aversion towards leverage and debt. And I'm sure there is some wisdom behind that suspicion. Taking on leverage and dealing with it responsibly is very difficult, especially when you're young and inexperienced and have never gone through a bear market. But I think a lot more people can still benefit from this insight without resorting to leverage by going 100% stocks when young. Hold no bonds till you're closer to halfway to retirement. That's low hanging fruit with none of the costs and dangers of leverage. Once you fully appreciate the fact that 100% stocks when you're 30 is actually very little money at risk from a lifetime perspective, I think more young people can simply relax and take the ups and downs of 100% stock exposure with equanimity. The fact that you lost half of $100K in a bear market when you were 28 is really not that big a deal.

This is a strategy that can reduce your lifetime risk for a given expected return. But it has to be followed dispassionately--with a disciplined investor's mindset, not a hopeful gambler's.

Interestingly, the sequence of returns problem that is often discussed here is exactly the same mathematical problem applied to retirement years. The portfolio is overweight in early retirement and underweight in late retirement. The solution involves finding a way to shift risk out from the overweight early retirement years to the underweight late retirement years. Interestingly, these proposals don't seem to upset people quite as much as Ayres and Nalebuff advising people to shift risk from the middle into the early years. I'm guessing that's because it does not involve leverage. Yet shifting risk from the overweight middle years into late years is in many ways more challenging than shifting risk from the middle into the early years.

inbox788
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Re: Lifecycle Investing - Leveraging when young

Post by inbox788 » Mon Mar 04, 2019 4:15 am

Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
It's a fairly straightforward idea. I'm not sure why it's not more popular than it is. I suspect it's because of a deep-seated aversion towards leverage and debt. And I'm sure there is some wisdom behind that suspicion. Taking on leverage and dealing with it responsibly is very difficult, especially when you're young and inexperienced and have never gone through a bear market. But I think a lot more people can still benefit from this insight without resorting to leverage by going 100% stocks when young. Hold no bonds till you're closer to halfway to retirement. That's low hanging fruit with none of the costs and dangers of leverage. Once you fully appreciate the fact that 100% stocks when you're 30 is actually very little money at risk from a lifetime perspective, I think more young people can simply relax and take the ups and downs of 100% stock exposure with equanimity. The fact that you lost half of $100K in a bear market when you were 28 is really not that big a deal.
Early experience in the market, either too optimistic or to pessimistic can be detrimental to a young investor. Either can teach the wrong lesson about risk. Too much success may lead to too much risk taking later in life, while a traumatic failure may permanently deter the young investor from appropriately investing through a lifetime. Still, if a young investor does get wiped out, there is lots of time to prepare for a longer career to make up for the early loss. So it's the ideal time to take extra risk when the portfolio size is smaller and if things go wrong, a longer time to recover, even if it means postponing early retirement or planning to work a few extra years.

Now I recall where I got the 1.6 leverage figure. It was from a paper that tries to attribute most of Berkshire Hathaway success to using leverage: BUFFETT’S ALPHA by Frazzini, Kabiller and Pedersen.

https://www.gurufocus.com/news/614298/i ... -leverage-
https://www.nber.org/papers/w19681.pdf
http://docs.lhpedersen.com/BuffettsAlpha.pdf
305pelusa wrote:
Sun Mar 03, 2019 9:06 pm
It'll be 5 years of only interests and then 2-3 years to pay it off a la amortization way. As of now, the interest is fixed but we're both willing to change it as necessary so it's still a good deal for the both of us. Neither one is trying to take advantage of the other and we both fully trust each other. He's in retirement so this is basically a way for him to invest further in stocks through me. I keep all the risk and keep most of the premium.
I wish you luck. I don't think you're trying to take advantage of a relative, but it does seem you're getting a good deal. With 7 year CDs earning 3%+, lending it out to an individual for a tiny bit more interest or return doesn't seem like a good risk/reward. Also, I'm not seeing how the lender is participating in any equity upside.

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Re: Lifecycle Investing - Leveraging when young

Post by jbranx » Mon Mar 04, 2019 5:06 am

Now I recall where I got the 1.6 leverage figure. It was from a paper that tries to attribute most of Berkshire Hathaway success to using leverage: BUFFETT’S ALPHA by Frazzini, Kabiller and Pedersen.
One major difference with Buffet's leverage is that he has/is using the insurance "float" from his reinsurance business and has for most of his career had little or no leverage cost. In fact, in some years his interest costs have been negative. As well, he keeps a very hefty $20 billion, I think, in reserve at all times for catastrophic events. I have no doubt that the leverage has very much influenced his returns, and articles to that effect have been published many times. The first I recall was by Jim Grant in his Interest Rate Observer maybe 15 years ago. Others have pegged the leverage ratio as a constant 1.7. So, part of his genius in buying National Indemnity and other insurance companies over the years (and very successfully and unusually making underwriting profits) was finding a cheap way to do leverage, allied with some excellent stock picking skills as well.

I would never try to persuade a young investor with strong conviction and solid information from trying a venturesome approach to investing. It's just that a lot of us old timers in the market have scars and have watched scars on others who have doubts about leverage. That said, lessons learned have made us ultimately better investors, which is why we are here on BH. I've seen too many investors, farmers, and developers ruined by leverage to ever entertain the thought of anyone close to me considering it without urging caution. I tend to agree with BobK and Market Timer that favorable views of leverage are a bull market phenom. Best leverage time would have been early March 2009 when the last major crash ended.

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305pelusa
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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 6:17 am

Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.
You should consider reading the book; you'll be pleasantly surprised to see they don't make that mistake. The process to determine how much to invest in stocks is as follows:
1) Sum your current savings to your future savings contributions discounted to the present. This gives you the present value of your "total wealth".
2) Invest a constant percentage of your "total wealth" every year in stocks, recalculating the "total wealth" from the above step every year.

Case in point, if my savings + savings contributions discounted to the present were 1M today, and I wanted to invest 30% in stocks, I just have to hit 300k in stocks today. As years go by, my total wealth will increase (because more of it is in savings and less in discounted future savings contributions). Because I am to hit 30% in stocks, then naturally the dollar value in stocks every year I need to hit increases. In fact, it increases by precisely the discount rate I use on step 1, all other factors equal.

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grayfox
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Re: Lifecycle Investing - Leveraging when young

Post by grayfox » Mon Mar 04, 2019 9:11 am

305pelusa wrote:
Sun Mar 03, 2019 9:06 pm
inbox788 wrote:
Sun Mar 03, 2019 8:00 pm
305pelusa wrote:
Sun Mar 03, 2019 6:34 pm
It'll be a family loan. We settled on 3.2% and it's not callable. This gives me the option to leverage further (although I think I will stick to 2:1) while still not selling during a market downturn.

We started with 30k, which gives me 1.25:1 leverage, just to get things started little by little (no rush here). But in the near future, I will try to increase that. For now, I'm still deciding whether to truly go for it or not.
How long is the duration of the loan? You've got a rate (3.2%) that is slightly lower than the current market rate, with the added benefit it appears to be a fixed rate vs. 3-4% variable margin rate. Borrowing at bond rates (3%) to invest in stock returns (6%) is often a positive yielding endeavor, but carries risk. Having the security of a fixed rate is that much more reason to do it, especially if you can tolerate the illiquidity risk. Also, what happens is rates drop? Are you stuck with the rate or can you refinance/recast?
It'll be 5 years of only interests and then 2-3 years to pay it off a la amortization way. As of now, the interest is fixed but we're both willing to change it as necessary so it's still a good deal for the both of us. Neither one is trying to take advantage of the other and we both fully trust each other. He's in retirement so this is basically a way for him to invest further in stocks through me. I keep all the risk and keep most of the premium.
$30,000, 5-years, 3.20%, interest-only, non-callable loan.

That sounds like about as good borrowing terms you will find today for leveraging an investment. Interest payment is $80 per month ($2.62 per day, 1 cup of coffee). You should have no problem paying that. Just don't miss any payments. :D

Interactive Brokers is Benchmark+1% = 3.4% and that is a standard margin loan with collateral requirements where they sell your position when the market value falls. :x
Right now, a 5-Year Pen Fed CD is yielding 3.01% and they are offering 15-year mortgage loans at 4.000%. So you are borrowing only +19 bsp above what PenFed is borrowing at and they are lending out at as low 4.000% for some mortgage loans.

That takes care of the borrowing part. What about the investment?
:?: What is your proposed investment and what is the expected return, volatility and Max Drawdown?
Last edited by grayfox on Mon Mar 04, 2019 9:48 am, edited 2 times in total.

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Ben Mathew
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Mar 04, 2019 9:45 am

305pelusa wrote:
Mon Mar 04, 2019 6:17 am
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.
You should consider reading the book; you'll be pleasantly surprised to see they don't make that mistake. The process to determine how much to invest in stocks is as follows:
1) Sum your current savings to your future savings contributions discounted to the present. This gives you the present value of your "total wealth".
2) Invest a constant percentage of your "total wealth" every year in stocks, recalculating the "total wealth" from the above step every year.

Case in point, if my savings + savings contributions discounted to the present were 1M today, and I wanted to invest 30% in stocks, I just have to hit 300k in stocks today. As years go by, my total wealth will increase (because more of it is in savings and less in discounted future savings contributions). Because I am to hit 30% in stocks, then naturally the dollar value in stocks every year I need to hit increases. In fact, it increases by precisely the discount rate I use on step 1, all other factors equal.
I did get my notions from their book. :) From page 15:
To see how Andrew's investing strategy reduces his risk, we calculate a new measure of stock market exposure, something we call "Total Dollar Years." Total dollar years is the sum of dollars you have invested in stock each year. If Andrew were to invest $5,000 in year 1, $10,0000 in year 2, and $15,000 in year 3, he would have invested a total of $30,0000 "dollar years." Andrew is much better diversified against temporal fluctuations in the stock market when he invests the total dollar years more evenly across time, here $10,000 in each of three years. The total dollar years are the same, but they are better spread out.
Last edited by Ben Mathew on Mon Mar 04, 2019 10:18 am, edited 2 times in total.

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Re: Lifecycle Investing - Leveraging when young

Post by dknightd » Mon Mar 04, 2019 9:49 am

I don't think is a good idea to leverage for investment in a retirement account.
Further, I don't think it is needed, since by nature, over the course of your retirement savings period you are putting in constant "real dollars".
Instead of thinking about it terms of dollars, how about thinking about in terms of expenses saved.
If you save 15% of your salary every year, you are presumably saving nearly a constant portion of your expenses every year. So a constant rate of savings.

Sure the dollars you put in at 30 will likely be less than the dollars you put in at 60. But the dollars you put in at 30 have more value. They have time to grow (hopefully faster than inflation) and they are in todays dollars not 30 year from now dollars.

That said, when I was starting out I was pretty heavily leveraged. I took out a loan to buy a car, I took out a loan to buy a house, I was still paying off student loans. Rather than try to pay off those loans as fast as possible, I started investing for my retirement. So you could say my retirement savings was leveraged against my loans . . .

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Re: Lifecycle Investing - Leveraging when young

Post by gmaynardkrebs » Mon Mar 04, 2019 10:03 am

@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Mon Mar 04, 2019 10:06 am

gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
I believe the point is it’s no big deal, since you’re young and have a small balance anyway.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 10:15 am

Ben Mathew wrote:
Mon Mar 04, 2019 9:45 am
305pelusa wrote:
Mon Mar 04, 2019 6:17 am
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.
You should consider reading the book; you'll be pleasantly surprised to see they don't make that mistake. The process to determine how much to invest in stocks is as follows:
1) Sum your current savings to your future savings contributions discounted to the present. This gives you the present value of your "total wealth".
2) Invest a constant percentage of your "total wealth" every year in stocks, recalculating the "total wealth" from the above step every year.

Case in point, if my savings + savings contributions discounted to the present were 1M today, and I wanted to invest 30% in stocks, I just have to hit 300k in stocks today. As years go by, my total wealth will increase (because more of it is in savings and less in discounted future savings contributions). Because I am to hit 30% in stocks, then naturally the dollar value in stocks every year I need to hit increases. In fact, it increases by precisely the discount rate I use on step 1, all other factors equal.
I did get my notions from their book. :) From page 15:
To see how Andrew's investing strategy reduces his risk, we calculate a new measure of stock market exposure, something we call "Total Dollar Years." Total dollar years is the sum of dollars you have invested in stock each year. If Andrew were to invest $5,000 in year 1, $10,0000 in year 2, and $15,000 in year 3, he would have invested a total of $30,0000 "dollar years." Andrew is much better diversified against temporal fluctuations in the stock market when he invests the total dollar years more evenly across time, here $10,000 in each of three years. The total dollar years are the same, but they are better spread out.
That's just an example of the thinking behind temporal diversification to try to get the point across. Keep reading and you'll find that once they get more involved in the nitty gritty, every calculation is done via discounting of the future. You invest a constant percentage of your wealth, which consists of current savings and discounted future contributions. Go ahead and read the chapter in implementation. It's pretty clear that you're not picking some arbitrary dollar value and keeping that same number of dollars invested through the years

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Mon Mar 04, 2019 10:19 am

305pelusa wrote:
Mon Mar 04, 2019 10:15 am
Ben Mathew wrote:
Mon Mar 04, 2019 9:45 am
305pelusa wrote:
Mon Mar 04, 2019 6:17 am
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.
You should consider reading the book; you'll be pleasantly surprised to see they don't make that mistake. The process to determine how much to invest in stocks is as follows:
1) Sum your current savings to your future savings contributions discounted to the present. This gives you the present value of your "total wealth".
2) Invest a constant percentage of your "total wealth" every year in stocks, recalculating the "total wealth" from the above step every year.

Case in point, if my savings + savings contributions discounted to the present were 1M today, and I wanted to invest 30% in stocks, I just have to hit 300k in stocks today. As years go by, my total wealth will increase (because more of it is in savings and less in discounted future savings contributions). Because I am to hit 30% in stocks, then naturally the dollar value in stocks every year I need to hit increases. In fact, it increases by precisely the discount rate I use on step 1, all other factors equal.
I did get my notions from their book. :) From page 15:
To see how Andrew's investing strategy reduces his risk, we calculate a new measure of stock market exposure, something we call "Total Dollar Years." Total dollar years is the sum of dollars you have invested in stock each year. If Andrew were to invest $5,000 in year 1, $10,0000 in year 2, and $15,000 in year 3, he would have invested a total of $30,0000 "dollar years." Andrew is much better diversified against temporal fluctuations in the stock market when he invests the total dollar years more evenly across time, here $10,000 in each of three years. The total dollar years are the same, but they are better spread out.
That's just an example of the thinking behind temporal diversification to try to get the point across. Keep reading and you'll find that once they get more involved in the nitty gritty, every calculation is done via discounting of the future. You invest a constant percentage of your wealth, which consists of current savings and discounted future contributions. Go ahead and read the chapter in implementation. It's pretty clear that you're not picking some arbitrary dollar value and keeping that same number of dollars invested through the years
Constant percentage of total discounted wealth gets closer to the optimal risk minimizing strategy, but can still be improved upon. As a benchmark, the ideal strategy that minimizes risk by spreading it out perfectly across all years would be to borrow to invest $X in the stock market early in life and leave it alone without further contributions and withdrawals to the stock market. All subsequent contributions goes towards paying off the debt and then adding to bonds. Of course, this is not achievable in practice. But that would be the benchmark to compare your actual AA against to see if you're underweighted or overweighted in stocks at a given time.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 10:23 am

gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 10:28 am

Ben Mathew wrote:
Mon Mar 04, 2019 10:19 am
305pelusa wrote:
Mon Mar 04, 2019 10:15 am
Ben Mathew wrote:
Mon Mar 04, 2019 9:45 am
305pelusa wrote:
Mon Mar 04, 2019 6:17 am
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
The idea is right, except for one conceptual error that Ayres and Nalebuff make (and I've seen this often stated by others as well). Ayres and Nalebuff assume that you minimize risk if you spread risk out so that you have with a constant dollar value of stock exposure (e.g. $500K constant per year). This should actually be in present value (PV) terms. $500K at age 25 is a lot more money than $500K at age 65. If you estimate you will have $500K of stock exposure at age 65, the PV equivalent for age 25 is much less than $500K of stock exposure.
You should consider reading the book; you'll be pleasantly surprised to see they don't make that mistake. The process to determine how much to invest in stocks is as follows:
1) Sum your current savings to your future savings contributions discounted to the present. This gives you the present value of your "total wealth".
2) Invest a constant percentage of your "total wealth" every year in stocks, recalculating the "total wealth" from the above step every year.

Case in point, if my savings + savings contributions discounted to the present were 1M today, and I wanted to invest 30% in stocks, I just have to hit 300k in stocks today. As years go by, my total wealth will increase (because more of it is in savings and less in discounted future savings contributions). Because I am to hit 30% in stocks, then naturally the dollar value in stocks every year I need to hit increases. In fact, it increases by precisely the discount rate I use on step 1, all other factors equal.
I did get my notions from their book. :) From page 15:
To see how Andrew's investing strategy reduces his risk, we calculate a new measure of stock market exposure, something we call "Total Dollar Years." Total dollar years is the sum of dollars you have invested in stock each year. If Andrew were to invest $5,000 in year 1, $10,0000 in year 2, and $15,000 in year 3, he would have invested a total of $30,0000 "dollar years." Andrew is much better diversified against temporal fluctuations in the stock market when he invests the total dollar years more evenly across time, here $10,000 in each of three years. The total dollar years are the same, but they are better spread out.
That's just an example of the thinking behind temporal diversification to try to get the point across. Keep reading and you'll find that once they get more involved in the nitty gritty, every calculation is done via discounting of the future. You invest a constant percentage of your wealth, which consists of current savings and discounted future contributions. Go ahead and read the chapter in implementation. It's pretty clear that you're not picking some arbitrary dollar value and keeping that same number of dollars invested through the years
Constant percentage of total discounted wealth gets closer to the optimal risk minimizing strategy, but can still be improved upon. As a benchmark, the ideal strategy that minimizes risk by spreading it out perfectly across all years would be to borrow to invest $X in the stock market early in life and leave it alone without further contributions and withdrawals to the stock market. All subsequent contributions goes towards paying off the debt and then adding to bonds. Of course, this is not achievable in practice. But that would be the benchmark to compare your actual AA against to see if you're underweighted or overweighted in stocks at a given time.
I disagree with your benchmark and claim that it will suffer, ironically, from the conceptual error you're bringing up if stocks were to gain/lose anything more/less than the discount rate.

However, I don't have much time to explain why I encourage you to think about it a little further. Perhaps I'm the one not following the logic here as well

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Re: Lifecycle Investing - Leveraging when young

Post by gmaynardkrebs » Mon Mar 04, 2019 10:35 am

305pelusa wrote:
Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
In that case, you don't need to read none of them thar fancy academic books or even think about it, since you get all the upside, and the losses fall on others. Does not get better than that. :happy

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 10:47 am

gmaynardkrebs wrote:
Mon Mar 04, 2019 10:35 am
305pelusa wrote:
Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
In that case, you don't need to read none of them thar fancy academic books or even think about it, since you get all the upside, and the losses fall on others. Does not get better than that. :happy
How exactly does the loss fall on others?

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Re: Lifecycle Investing - Leveraging when young

Post by gmaynardkrebs » Mon Mar 04, 2019 11:05 am

305pelusa wrote:
Mon Mar 04, 2019 10:47 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:35 am
305pelusa wrote:
Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
In that case, you don't need to read none of them thar fancy academic books or even think about it, since you get all the upside, and the losses fall on others. Does not get better than that. :happy
How exactly does the loss fall on others?
If I understand the terms of your loan, your family does not receive their principal back if the collateral is wiped out. Normally, that would be a loss for a lender. Perhaps that was also the plan if the stocks went up as you hope, in which case it was a gift to begin with. Now, no one thinks of a gift as a loss, but from a net worth perspective (to your family) it is. Point is, there is all upside to you, except for a some interest, which looks way below market to me for a no recourse loan on a speculative asset. A below interest loan is also a "loss" from an accounting standpoint, or a "gift" in the personal context.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 11:14 am

gmaynardkrebs wrote:
Mon Mar 04, 2019 11:05 am
305pelusa wrote:
Mon Mar 04, 2019 10:47 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:35 am
305pelusa wrote:
Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote:
Mon Mar 04, 2019 10:03 am
@OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
In that case, you don't need to read none of them thar fancy academic books or even think about it, since you get all the upside, and the losses fall on others. Does not get better than that. :happy
How exactly does the loss fall on others?
If I understand the terms of your loan, your family does not receive their principal back if the collateral is wiped out. Normally, that would be a loss for a lender. Perhaps that was also the plan if the stocks went up as you hope, in which case it was a gift to begin with. Now, no one thinks of a gift as a loss, but from a net worth perspective (to your family) it is. Point is, there is all upside to you, except for a some interest, which looks way below market to me for a no recourse loan on a speculative asset. A below interest loan is also a "loss" from an accounting standpoint, or a "gift" in the personal context.
I think you might have misunderstood the loan. I pay back regardless of what happens in my investments. If for some reason I can't make the payments then I will personally liquidate as needed to meet the monthly payments. But no one is forcing me to sell anything.

The stock market could lose 99% today and remain like that for the next 30 years. My family member will get their full principal back plus interests from my salary.I'm not going to default on it either.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 11:18 am

inbox788 wrote:
Mon Mar 04, 2019 4:15 am

I wish you luck. I don't think you're trying to take advantage of a relative, but it does seem you're getting a good deal. With 7 year CDs earning 3%+, lending it out to an individual for a tiny bit more interest or return doesn't seem like a good risk/reward. Also, I'm not seeing how the lender is participating in any equity upside.
I'm also helping the family member in other ways, which one could give monetary value to but I haven't charged that. But it has built trust and desire for mutual help. let's just say when I showed that person the current CD, corporate and government bond rates vs my proposed 3.2%, the member felt it was very appropriate and liked the idea.


This is starting to stray from the conversation but yes, it's good terms and the overall deal is good for both parties IMO.

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Re: Lifecycle Investing - Leveraging when young

Post by gmaynardkrebs » Mon Mar 04, 2019 11:39 am

305pelusa wrote:
Mon Mar 04, 2019 11:18 am
This is starting to stray from the conversation but yes, it's good terms and the overall deal is good for both parties IMO.
I believe I did misunderstand the arrangement. My kids are now in their late 20s, and if we could help them with a mortgage, whatever, we would. As far as payback, I imagine they would do the same as you out of a sense of moral obligation, but I can't see us ever insisting. Best of luck with your plan!!!

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Re: Lifecycle Investing - Leveraging when young

Post by DesertDiva » Mon Mar 04, 2019 12:22 pm

H-Town wrote:
Sat Mar 02, 2019 8:04 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. The cliffnotes is that if one thinks about every future year as a potential bet, then it's in your best interest to spread out your bets as uniformly as possible across all those years. This means investing, to the best of your ability, the same dollar amount in stocks every year throughout your life. Since people accumulate money as they age, the implication is to use leverage when young to get closer to that target. That increases short term risk but, paradoxically, lowers long term risk. There are some rules set (such as not borrowing on credit, keeping leverage at 2:1 max, taking into account the nature of your income, etc) but that's the general idea.

The paper is here:
http://faculty.som.yale.edu/barrynalebu ... _v2008.pdf

I decided to buy their book. I think their logic is sound and the results are extremely compelling. t was cool to read about MarketTimer since that's the thread that first got me thinking about it.

I found few threads opened in the past on the subject but they're a few years old so I wanted to start a new one to see if anyone is implementing the strategy, hear about other people's thoughts, recommendations for other forums where people implement similar strategies in the case that this forum is not appropriate for the topic, etc. I am basically right on the fence at the moment on whether to use the strategy or not.

Thank you
No offense but when I see trend like this (leverage to invest), things might head towards a crash. It’s like clockwork.
When I see a something like the OP’s original post (reference to another website and a book that runs contrary to Bogleheads principles), I wonder what the motivation is. These people don’t seem to have familiarity with the principles espoused in this community, or at least want to plant doubt as to their relevance. Otherwise they would form and contribute to a site with other like-minded people.

IMHO, I believe these posts are actually planted to sell books, newsletters, seminars and the like. Since the Bogleheads forum has a high number of participants who are actively interested in investing, it’s a natural target.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 2:59 pm

grayfox wrote:
Mon Mar 04, 2019 9:11 am
305pelusa wrote:
Sun Mar 03, 2019 9:06 pm
inbox788 wrote:
Sun Mar 03, 2019 8:00 pm
305pelusa wrote:
Sun Mar 03, 2019 6:34 pm
It'll be a family loan. We settled on 3.2% and it's not callable. This gives me the option to leverage further (although I think I will stick to 2:1) while still not selling during a market downturn.

We started with 30k, which gives me 1.25:1 leverage, just to get things started little by little (no rush here). But in the near future, I will try to increase that. For now, I'm still deciding whether to truly go for it or not.
How long is the duration of the loan? You've got a rate (3.2%) that is slightly lower than the current market rate, with the added benefit it appears to be a fixed rate vs. 3-4% variable margin rate. Borrowing at bond rates (3%) to invest in stock returns (6%) is often a positive yielding endeavor, but carries risk. Having the security of a fixed rate is that much more reason to do it, especially if you can tolerate the illiquidity risk. Also, what happens is rates drop? Are you stuck with the rate or can you refinance/recast?
It'll be 5 years of only interests and then 2-3 years to pay it off a la amortization way. As of now, the interest is fixed but we're both willing to change it as necessary so it's still a good deal for the both of us. Neither one is trying to take advantage of the other and we both fully trust each other. He's in retirement so this is basically a way for him to invest further in stocks through me. I keep all the risk and keep most of the premium.
$30,000, 5-years, 3.20%, interest-only, non-callable loan.

That sounds like about as good borrowing terms you will find today for leveraging an investment. Interest payment is $80 per month ($2.62 per day, 1 cup of coffee). You should have no problem paying that. Just don't miss any payments. :D

Interactive Brokers is Benchmark+1% = 3.4% and that is a standard margin loan with collateral requirements where they sell your position when the market value falls. :x
Right now, a 5-Year Pen Fed CD is yielding 3.01% and they are offering 15-year mortgage loans at 4.000%. So you are borrowing only +19 bsp above what PenFed is borrowing at and they are lending out at as low 4.000% for some mortgage loans.

That takes care of the borrowing part. What about the investment?
:?: What is your proposed investment and what is the expected return, volatility and Max Drawdown?
65/35 Domestic/Int, each with a small cap value tilt. Some REIT and Emerging Markets tilt as well. Nothing too crazy, just index funds.

I have a rough idea of my expected returns, although can't predict volatility or max drawdown. I'm targeting a stock allocation that is pretty conservative so I actually expect my portfolio to earn as much as most others on this forum, but with less long term volatility. The book shows how to increase the stock allocation to achieve higher returns at the same risk level of other portfolios but I'm not interested.

I'm only implementing this to decrease risk over the more traditional allocations. I don't care for higher returns (I don't think I'll even need them). So I'm cashing out all the gains from time diversification as decreased volatility personally speaking.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 6:37 pm

Ben Mathew wrote:
Mon Mar 04, 2019 10:19 am
As a benchmark, the ideal strategy that minimizes risk by spreading it out perfectly across all years would be to borrow to invest $X in the stock market early in life and leave it alone without further contributions and withdrawals to the stock market. All subsequent contributions goes towards paying off the debt and then adding to bonds.
To explain why I don't agree, I'll just give you a counterexample:

You borrow 500k, invest it in stocks and leave as-is. The rest of the years, you only pay for the debt and buy bonds. Let's say stocks stay essentially constant. You will then have 500k invested every year in the stock market. We know this isn't optimal because, as you eloquently put it, 500k at 25 years of age is more money than at 65:
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
$500K at age 25 is a lot more money than $500K at age 65.
As you mentioned before, the trick is to discount all your future contributions, add them to current savings, and invest a set percentage in stocks today (Say, 25 years old). You then have the duty to monitor for the rest of your life. If the stock portion grows at the same speed as the discount rate, then you need not add/subtract anything to it. If it grows slower (or worse, declines from a bear market) then you have to add to it in the future. If it grows faster (which would be ideal and generally expected over the long term), you'll sell some of it from time to time.

You'd get an identical result if every year, you re-did your share calculation like the authors recommend. Every subsequent year, less will be in future contributions and more will be in today's savings. So your current total combined wealth will be larger (less money is discounted and more money you actually have today). So if you invest a constant percentage in stocks, that dollar value will naturally grow as years go by at the discount rate. So if it also happened to grow at the discount rate, no need to add/sell. If anything else happened, you might have to buy/sell more stocks.

And yes, I agree the ideal is to take as big of a loan as you need ASAP to hit the correct number today. Doing anything else (like working up to it slowly with 2:1 leverage) is suboptimal technically speaking. Although still better than not leveraging at all when young (or so the argument goes). I just don't agree with the part that you then leave it as-is. I think you need to continue investing/selling as necessary to maintain the number on target.

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Re: Lifecycle Investing - Leveraging when young

Post by megabad » Mon Mar 04, 2019 7:09 pm

305pelusa wrote:
Fri Mar 01, 2019 12:11 am
...the implication is to use leverage when young to get closer to that target ...
It is my experience that a huge swath of Americans do this to some extent. The majority of American families own a home. The majority of these folks have mortgages. Done.

I love leverage. I hate callable leverage. So I actually agree with levering in as much as I can get low interest, non-callable loans. Turns out, mortgages are one of the only low interest options I have been able to find. I think margin debt is a horrible deal (even at IB). Basically, your lender can call a collateralized debt on a whim anytime they want and I am paying near mortgage rates plus brokerage commissions (sometimes forced). Imagine if banks could just call in huge parts of your mortgage instantly because of one bad appraisal year and then charge you for the privilege of paying that instant call.

Basically the only way to make the call risk acceptable to me would be to shrink the leverage to a point where it was insignificant anyway. Essentially agree with other posters, that it would be simpler and more fruitful to convince everyone to be 100% equities until at least age 40.

I think it is humorous to see these threads pop up every so often. Especially given that some of the responders in this very thread have had other threads where tactics like this have imploded a portfolio in spectacular fashion.

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Re: Lifecycle Investing - Leveraging when young

Post by HEDGEFUNDIE » Mon Mar 04, 2019 8:34 pm

megabad wrote:
Mon Mar 04, 2019 7:09 pm
I love leverage. I hate callable leverage. So I actually agree with levering in as much as I can get low interest, non-callable loans. Turns out, mortgages are one of the only low interest options I have been able to find. I think margin debt is a horrible deal (even at IB). Basically, your lender can call a collateralized debt on a whim anytime they want and I am paying near mortgage rates plus brokerage commissions (sometimes forced). Imagine if banks could just call in huge parts of your mortgage instantly because of one bad appraisal year and then charge you for the privilege of paying that instant call.
The other way to think about it is, you are overpaying for your mortgage because the lender can’t call it. There is no free lunch.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Mon Mar 04, 2019 9:08 pm

HEDGEFUNDIE wrote:
Mon Mar 04, 2019 8:34 pm
megabad wrote:
Mon Mar 04, 2019 7:09 pm
I love leverage. I hate callable leverage. So I actually agree with levering in as much as I can get low interest, non-callable loans. Turns out, mortgages are one of the only low interest options I have been able to find. I think margin debt is a horrible deal (even at IB). Basically, your lender can call a collateralized debt on a whim anytime they want and I am paying near mortgage rates plus brokerage commissions (sometimes forced). Imagine if banks could just call in huge parts of your mortgage instantly because of one bad appraisal year and then charge you for the privilege of paying that instant call.
The other way to think about it is, you are overpaying for your mortgage because the lender can’t call it. There is no free lunch.
That's a great point.
I have to say I tend to lean towards what megabad says though. Personally speaking, the only reason I'm interested in following this strategy is to temporally diversify my stock risk. Like stock diversification, I believe this gives a free lunch as well. But it hinges on not having to sell during market downturns due to margin. If I'm not forced to sell, I know I should get the risk reduction from temporal diversification. If I am forced to sell, it's not as clear to me anymore.

This is my way of saying that I acknowledge there's a premium (but not a free lunch) in opting for callable debt. That's a premium I'm not interested in pursuing with this particular strategy.

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Re: Lifecycle Investing - Leveraging when young

Post by grayfox » Tue Mar 05, 2019 7:23 am

305pelusa wrote:
Mon Mar 04, 2019 2:59 pm


65/35 Domestic/Int, each with a small cap value tilt. Some REIT and Emerging Markets tilt as well. Nothing too crazy, just index funds.

I have a rough idea of my expected returns, although can't predict volatility or max drawdown. I'm targeting a stock allocation that is pretty conservative so I actually expect my portfolio to earn as much as most others on this forum, but with less long term volatility. The book shows how to increase the stock allocation to achieve higher returns at the same risk level of other portfolios but I'm not interested.

I'm only implementing this to decrease risk over the more traditional allocations. I don't care for higher returns (I don't think I'll even need them). So I'm cashing out all the gains from time diversification as decreased volatility personally speaking.
So unlike the other threads that are looking at 40/60, you are looking at 100% stock portfolio? I put in a portfolio something like that into portviz and compared it to 100% VFINX. Link.

VTSMX Vanguard Total Stock Mkt Idx Inv 55.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00%
VISVX Vanguard Small Cap Value Index Inv 5.00%
VEIEX Vanguard Emerging Mkts Stock Idx Inv 5.00%
VGSIX Vanguard Real Estate Index Investor 5.00%

Code: Select all

Portfolio Analysis Results (Jan 1999 - Feb 2019)
                Initial Final   CAGR    Stdev   Best    Worst   Max. DD Sharpe  Sortino US Mkt Corr
Portfolio 1     $10,000 $36,388 6.61%   15.32%  35.87%  -39.70% -54.58% 0.38    0.54    0.98    
100% VFINX      $10,000 $32,580 6.03%   14.52%  32.18%  -37.02% -50.97% 0.36    0.50    0.99 
The STDEV and MAX DD were slightly higher than S&P500. So a little but more risk than large U.S. Stocks. No surprise there. However the return was a little bit higher, also. IMO, past volatility is indicative of what to expect for future volatility. So it would not be a surprise to see 55% drawdown at some point. Not necessarily from your entry point, but at 2:1 leverage, that could still put you underwater. At 3:1, even more upside down. But at least you can't get your position sold out from under you.

As far as expected return, I don't know where to find the numbers, e.g. CAPE, for all those asset classes. I've read foreign stocks have lower valuations than, U.S. stocks, so they should have higher expected return. It probably depends on which country, developed markets vs. emerging markets, etc.

My estimate for S&P500 expected return is about 5.35% before inflation. That would give +215 basis points profit over the 3.20% borrowing costs. This 65/35 portfolio with tilts should be greater than that. I would like to know what CAPE is for those other markets to get a better handle on the expected return for the portfolio.

:idea: Set a hurdle to clear. Decide how much profit is required, given the risk. E.g. For borrowing costs of 3.20%, if the portfolio expected return was 6.20%, that would be +300 bsp profit. If that clears the hurdle, pull the trigger.

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Re: Lifecycle Investing - Leveraging when young

Post by gmaynardkrebs » Tue Mar 05, 2019 9:27 am

grayfox wrote:
Tue Mar 05, 2019 7:23 am
305pelusa wrote:
Mon Mar 04, 2019 2:59 pm


65/35 Domestic/Int, each with a small cap value tilt. Some REIT and Emerging Markets tilt as well. Nothing too crazy, just index funds.

I have a rough idea of my expected returns, although can't predict volatility or max drawdown. I'm targeting a stock allocation that is pretty conservative so I actually expect my portfolio to earn as much as most others on this forum, but with less long term volatility. The book shows how to increase the stock allocation to achieve higher returns at the same risk level of other portfolios but I'm not interested.

I'm only implementing this to decrease risk over the more traditional allocations. I don't care for higher returns (I don't think I'll even need them). So I'm cashing out all the gains from time diversification as decreased volatility personally speaking.
So unlike the other threads that are looking at 40/60, you are looking at 100% stock portfolio? I put in a portfolio something like that into portviz and compared it to 100% VFINX. Link.

VTSMX Vanguard Total Stock Mkt Idx Inv 55.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00%
VISVX Vanguard Small Cap Value Index Inv 5.00%
VEIEX Vanguard Emerging Mkts Stock Idx Inv 5.00%
VGSIX Vanguard Real Estate Index Investor 5.00%

Code: Select all

Portfolio Analysis Results (Jan 1999 - Feb 2019)
                Initial Final   CAGR    Stdev   Best    Worst   Max. DD Sharpe  Sortino US Mkt Corr
Portfolio 1     $10,000 $36,388 6.61%   15.32%  35.87%  -39.70% -54.58% 0.38    0.54    0.98    
100% VFINX      $10,000 $32,580 6.03%   14.52%  32.18%  -37.02% -50.97% 0.36    0.50    0.99 
The STDEV and MAX DD were slightly higher than S&P500. So a little but more risk than large U.S. Stocks. No surprise there. However the return was a little bit higher, also. IMO, past volatility is indicative of what to expect for future volatility. So it would not be a surprise to see 55% drawdown at some point. Not necessarily from your entry point, but at 2:1 leverage, that could still put you underwater. At 3:1, even more upside down. But at least you can't get your position sold out from under you.

As far as expected return, I don't know where to find the numbers, e.g. CAPE, for all those asset classes. I've read foreign stocks have lower valuations than, U.S. stocks, so they should have higher expected return. It probably depends on which country, developed markets vs. emerging markets, etc.

My estimate for S&P500 expected return is about 5.35% before inflation. That would give +215 basis points profit over the 3.20% borrowing costs. This 65/35 portfolio with tilts should be greater than that. I would like to know what CAPE is for those other markets to get a better handle on the expected return for the portfolio.

:idea: Set a hurdle to clear. Decide how much profit is required, given the risk. E.g. For borrowing costs of 3.20%, if the portfolio expected return was 6.20%, that would be +300 bsp profit. If that clears the hurdle, pull the trigger.
You are right -- foreign CAPE is lower. There are some papers on the GMO website about how to allocate based on various CAPES. Sorry, don't have the links immediately on hand.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Tue Mar 05, 2019 12:35 pm

grayfox wrote:
Tue Mar 05, 2019 7:23 am
305pelusa wrote:
Mon Mar 04, 2019 2:59 pm


65/35 Domestic/Int, each with a small cap value tilt. Some REIT and Emerging Markets tilt as well. Nothing too crazy, just index funds.

I have a rough idea of my expected returns, although can't predict volatility or max drawdown. I'm targeting a stock allocation that is pretty conservative so I actually expect my portfolio to earn as much as most others on this forum, but with less long term volatility. The book shows how to increase the stock allocation to achieve higher returns at the same risk level of other portfolios but I'm not interested.

I'm only implementing this to decrease risk over the more traditional allocations. I don't care for higher returns (I don't think I'll even need them). So I'm cashing out all the gains from time diversification as decreased volatility personally speaking.
So unlike the other threads that are looking at 40/60, you are looking at 100% stock portfolio? I put in a portfolio something like that into portviz and compared it to 100% VFINX. Link.

VTSMX Vanguard Total Stock Mkt Idx Inv 55.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00%
VISVX Vanguard Small Cap Value Index Inv 5.00%
VEIEX Vanguard Emerging Mkts Stock Idx Inv 5.00%
VGSIX Vanguard Real Estate Index Investor 5.00%

Code: Select all

Portfolio Analysis Results (Jan 1999 - Feb 2019)
                Initial Final   CAGR    Stdev   Best    Worst   Max. DD Sharpe  Sortino US Mkt Corr
Portfolio 1     $10,000 $36,388 6.61%   15.32%  35.87%  -39.70% -54.58% 0.38    0.54    0.98    
100% VFINX      $10,000 $32,580 6.03%   14.52%  32.18%  -37.02% -50.97% 0.36    0.50    0.99 
The STDEV and MAX DD were slightly higher than S&P500. So a little but more risk than large U.S. Stocks. No surprise there. However the return was a little bit higher, also. IMO, past volatility is indicative of what to expect for future volatility. So it would not be a surprise to see 55% drawdown at some point. Not necessarily from your entry point, but at 2:1 leverage, that could still put you underwater. At 3:1, even more upside down. But at least you can't get your position sold out from under you.

As far as expected return, I don't know where to find the numbers, e.g. CAPE, for all those asset classes. I've read foreign stocks have lower valuations than, U.S. stocks, so they should have higher expected return. It probably depends on which country, developed markets vs. emerging markets, etc.

My estimate for S&P500 expected return is about 5.35% before inflation. That would give +215 basis points profit over the 3.20% borrowing costs. This 65/35 portfolio with tilts should be greater than that. I would like to know what CAPE is for those other markets to get a better handle on the expected return for the portfolio.

:idea: Set a hurdle to clear. Decide how much profit is required, given the risk. E.g. For borrowing costs of 3.20%, if the portfolio expected return was 6.20%, that would be +300 bsp profit. If that clears the hurdle, pull the trigger.
Yes 100% in stocks. The idea of borrowing to then lend money at longer terms/durations doesn't fully satisfy me. It backtests nicely and I get the point but fundamentally, it's not compelling enough for me. At least not like the evidence of lifecycle investing

My strategy is "how do I borrow the minimum possible while diversifying stock risk across time as much as possible?". That ends up being 100% in stocks. I could choose to continue borrowing past my ideal leveraged stock allocation and invest it in bonds but I think that has much smaller and diminishing diversification benefits per unit of borrowing than borrowing for stocks. Less bang for my (borrowed) buck.

The poster from the other thread (Robert?) ended up something like 10% in stocks/90% in bonds and leveraged x26 (!!). I understand if that's ideal but I just don't care to complicate it so much. I believe this strategy gets me well into time diversification without having to borrow too much. I think you'd need to leverage significantly before the term premium of the leveraged bonds start to make an effect. It's just not for me :)

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Re: Lifecycle Investing - Leveraging when young

Post by inbox788 » Tue Mar 05, 2019 3:11 pm

305pelusa wrote:
Tue Mar 05, 2019 12:35 pm
Yes 100% in stocks. The idea of borrowing to then lend money at longer terms/durations doesn't fully satisfy me. It backtests nicely and I get the point but fundamentally, it's not compelling enough for me. At least not like the evidence of lifecycle investing

My strategy is "how do I borrow the minimum possible while diversifying stock risk across time as much as possible?". That ends up being 100% in stocks. I could choose to continue borrowing past my ideal leveraged stock allocation and invest it in bonds but I think that has much smaller and diminishing diversification benefits per unit of borrowing than borrowing for stocks. Less bang for my (borrowed) buck.

The poster from the other thread (Robert?) ended up something like 10% in stocks/90% in bonds and leveraged x26 (!!). I understand if that's ideal but I just don't care to complicate it so much. I believe this strategy gets me well into time diversification without having to borrow too much. I think you'd need to leverage significantly before the term premium of the leveraged bonds start to make an effect. It's just not for me :)
Exactly! You must choose between investing in stocks or investing in bonds, and you can't get stock returns without leveraging up the carry trade. Again, it's an AA problem IMO, and if viewed as such, 26x leverage isn't as crazy as it sounds. If you break it up, 260% stocks is simply a 2X or 3X leveraged stock fund. If the market goes up 10%, you're 26x leveraged 10% AA in equities is expected to go up 26% during that period. On the bond side, if you look at bond traders, leverage ratios and bank capital requirements, they're in the 20:1 or 30:1 range. Currency ratios are even greater at 100:1 or higher. You're competing with the professionals at these levels, so you need to understand what you're up against and institute appropriate risk and liquidity management. Not for the faint of heart.

Remember, these are mostly zero sum games, so if you take more than your fair share of the market gains, it's coming from somewhere or someone. And there are costs involved further reducing the net benefits. Remember what they say about the chump at the poker table.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Tue Mar 05, 2019 9:55 pm

305pelusa wrote:
Mon Mar 04, 2019 6:37 pm
Ben Mathew wrote:
Mon Mar 04, 2019 10:19 am
As a benchmark, the ideal strategy that minimizes risk by spreading it out perfectly across all years would be to borrow to invest $X in the stock market early in life and leave it alone without further contributions and withdrawals to the stock market. All subsequent contributions goes towards paying off the debt and then adding to bonds.
To explain why I don't agree, I'll just give you a counterexample:

You borrow 500k, invest it in stocks and leave as-is. The rest of the years, you only pay for the debt and buy bonds. Let's say stocks stay essentially constant. You will then have 500k invested every year in the stock market. We know this isn't optimal because, as you eloquently put it, 500k at 25 years of age is more money than at 65:
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
$500K at age 25 is a lot more money than $500K at age 65.
As you mentioned before, the trick is to discount all your future contributions, add them to current savings, and invest a set percentage in stocks today (Say, 25 years old). You then have the duty to monitor for the rest of your life. If the stock portion grows at the same speed as the discount rate, then you need not add/subtract anything to it. If it grows slower (or worse, declines from a bear market) then you have to add to it in the future. If it grows faster (which would be ideal and generally expected over the long term), you'll sell some of it from time to time.

You'd get an identical result if every year, you re-did your share calculation like the authors recommend. Every subsequent year, less will be in future contributions and more will be in today's savings. So your current total combined wealth will be larger (less money is discounted and more money you actually have today). So if you invest a constant percentage in stocks, that dollar value will naturally grow as years go by at the discount rate. So if it also happened to grow at the discount rate, no need to add/sell. If anything else happened, you might have to buy/sell more stocks.

And yes, I agree the ideal is to take as big of a loan as you need ASAP to hit the correct number today. Doing anything else (like working up to it slowly with 2:1 leverage) is suboptimal technically speaking. Although still better than not leveraging at all when young (or so the argument goes). I just don't agree with the part that you then leave it as-is. I think you need to continue investing/selling as necessary to maintain the number on target.
Good examples, but the discount rate you're using is not the right one for this application. I'll get to why in a bit. But first, there's a simpler and more direct way to understand how lifecycle investing works. Suppose you put $X into the stock market and leave it alone. You make no further contributions or withdrawals. It will grow to $X(1+r1)(1+r2)...(1+rt) in t years. This formula shows that ri and rj are interchangeable. It does not matter what order the returns come in. A 5% return followed by a 10% return gets the same result as a 10% return followed by a 5% return. There is no sequence of return risk. A 20% gain or loss early is no better or worse than a 20% gain or loss coming in later. That means that this portfolio is not overweight or underweight at any point during the t years. The risk is being spread perfectly evenly across all years.

If, however, an extra contribution is made at some point, any returns after that contribution will have an extra kick. A 20% gain or loss after the extra contribution matters more than a 20% gain or loss before the extra contribution. The portfolio is underweight before contributions, and overweight after.

And vice versa for a withdrawal. Returns prior to the withdrawal have more impact than returns after the withdrawal. So the portfolio is overweight before the withdrawal and underweight after.

The only situation where the order of returns won't matter is the one with no extra contributions or withdrawals. That is the only portfolio that is never underweight or overweight at any point. That's the only strategy which takes the same amount of risk every single year for all t years.

Returning to the issue of discount rates, the right discount rate for this particular application (evaluating the risk exposure of the portfolio over time) is the actual ex-post realized growth rate of the portfolio. This means that if no extra contributions or withdrawals are made, the present value of the stock account will remain constant at $X at t=0. The examples you gave involve a difference between the stock growth rate and the discount rate, which can make sense in some situations, but not in this particular application.

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.

I hope more people take lifecycle investing seriously and figure out how much they can benefit from it. I think it has a lot of potential for risk reduction compared to the traditional approach of starting with X% stock and gliding down to Y% in a straight line over a lifetime.
Last edited by Ben Mathew on Wed Mar 06, 2019 10:57 am, edited 2 times in total.

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Re: Lifecycle Investing - Leveraging when young

Post by mhadden1 » Tue Mar 05, 2019 10:14 pm

Get a girlfriend. Take up fishing. Do not borrow from a family member to leverage investments using a scheme that Paul Samuelson was too dumb to understand.
Oh I can't, can I? That's what they said to Thomas Edison, mighty inventor, Thomas Lindberg, mighty flyer,and Thomas Shefsky, mighty like a rose.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Tue Mar 05, 2019 10:37 pm

mhadden1 wrote:
Tue Mar 05, 2019 10:14 pm
Do not borrow from a family member to leverage investments using a scheme that Paul Samuelson was too dumb to understand.
Freakonomics blog post by Ian Ayres on the Samuelson dis: Did Paul Samuelson Support Leveraged Lifecycle Investing?

From the post:

Samuelson in a journal article in 1969:
[A high salary in the future] does justify leveraged investment financed by borrowing against future earnings. But it does not really involve any increase in relative risk-taking once we have related what is at risk to the proper larger base. (Admittedly, if market imperfections make loans difficult or costly, recourse to volatile, “leveraged” securities may be a rational procedure.)
And Samuelson in a speech at Boston University in 2008:
The ideas that I have been criticizing do not shrivel up and die. They always come back…. Just recently as I was preparing this manuscript, I got one of those innumerable abstracts from the National Bureau of Economic Research and I will name no names but a Yale economist [Nalebuff] and a Yale law school professor [Ayres] have advised the world that when you are young and you have many years horizon ahead of you, you should borrow heavily and go on margin, because that’s the way you get the ready money and with that ready money you are going to make a lot of money.

And I have to remind them with well-chosen counterexamples. I always quote from Warren Buffet … And one of the things that he said, this wise, wise man (from Nebraska of all places), was that in order to first 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 are knocked out of the game.
I can understand the reasoning behind what Samuelson wrote in 1969. I cannot understand the reasoning behind what he said in 2008.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Mar 06, 2019 6:42 am

Ben Mathew wrote:
Tue Mar 05, 2019 9:55 pm
305pelusa wrote:
Mon Mar 04, 2019 6:37 pm
Ben Mathew wrote:
Mon Mar 04, 2019 10:19 am
As a benchmark, the ideal strategy that minimizes risk by spreading it out perfectly across all years would be to borrow to invest $X in the stock market early in life and leave it alone without further contributions and withdrawals to the stock market. All subsequent contributions goes towards paying off the debt and then adding to bonds.
To explain why I don't agree, I'll just give you a counterexample:

You borrow 500k, invest it in stocks and leave as-is. The rest of the years, you only pay for the debt and buy bonds. Let's say stocks stay essentially constant. You will then have 500k invested every year in the stock market. We know this isn't optimal because, as you eloquently put it, 500k at 25 years of age is more money than at 65:
Ben Mathew wrote:
Mon Mar 04, 2019 2:18 am
$500K at age 25 is a lot more money than $500K at age 65.
As you mentioned before, the trick is to discount all your future contributions, add them to current savings, and invest a set percentage in stocks today (Say, 25 years old). You then have the duty to monitor for the rest of your life. If the stock portion grows at the same speed as the discount rate, then you need not add/subtract anything to it. If it grows slower (or worse, declines from a bear market) then you have to add to it in the future. If it grows faster (which would be ideal and generally expected over the long term), you'll sell some of it from time to time.

You'd get an identical result if every year, you re-did your share calculation like the authors recommend. Every subsequent year, less will be in future contributions and more will be in today's savings. So your current total combined wealth will be larger (less money is discounted and more money you actually have today). So if you invest a constant percentage in stocks, that dollar value will naturally grow as years go by at the discount rate. So if it also happened to grow at the discount rate, no need to add/sell. If anything else happened, you might have to buy/sell more stocks.

And yes, I agree the ideal is to take as big of a loan as you need ASAP to hit the correct number today. Doing anything else (like working up to it slowly with 2:1 leverage) is suboptimal technically speaking. Although still better than not leveraging at all when young (or so the argument goes). I just don't agree with the part that you then leave it as-is. I think you need to continue investing/selling as necessary to maintain the number on target.
Good examples, but the discount rate you're using is not the right one for this application. I'll get to why in a bit. But first, there's a simpler and more direct way to understand how lifecycle investing works. Suppose you put $X into the stock market and leave it alone. You make no further contributions or withdrawals. It will grow to $X(1+r1)(1+r2)...(1+rt) in t years. This formula shows that ri and rj are interchangeable. It does not matter what order the returns come in. A 5% return followed by a 10% return gets the same result as a 10% return followed by a 5% return. There is no sequence of return risk. A 20% gain or loss early is no better or worse than a 20% gain or loss coming in later. That means that this portfolio is not overweight or underweight at any point during the t years. The risk is being spread perfectly evenly across all years.

If, however, an extra contribution is made at some point, any returns after that contribution will have an extra kick. A 20% gain or loss after the extra contribution matters more than a 20% gain or loss before the extra contribution. The portfolio is underweight before contributions, and overweight after.

And vice versa for a withdrawal. Returns prior to the withdrawal have more impact than returns after the withdrawal. So the portfolio is overweight before the withdrawal and underweight after.

The only situation where the order of returns won't matter is the one with no extra contributions or withdrawals. That is the only portfolio that is never underweight or overweight at any point. That's the only strategy which takes the same amount of risk every single year for all t years.

Returning to the issue of discount rates, the right discount rate for this particular application (evaluating the risk exposure of the portfolio over time) is the actual ex-post realized growth rate of the portfolio. This means that if no extra contributions or withdrawals are made, the present value of the stock account will remain constant at $X at t=0. The examples you gave involve a difference between the stock growth rate and the discount rate, which can make sense in some situations, but not in this particular application.

The ideal risk-minimizing strategy of borrowing and investing in $X 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.

I hope more people take lifecycle investing seriously and figure out how much they can benefit from it. I think it has a lot of potential for risk reduction compared to the traditional approach of starting with X% stock and gliding down to Y% in a straight line over a lifetime.
Your post has given me pause. I will think about it further. The idea that sequence of returns not affecting the outcome is precisely equivalent to being perfectly diversified across time is a way of putting this strategy very concisely and neatly. Thank you very much for your post.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Wed Mar 06, 2019 10:13 am

305pelusa wrote:
Wed Mar 06, 2019 6:42 am
The idea that sequence of returns not affecting the outcome is precisely equivalent to being perfectly diversified across time is a way of putting this strategy very concisely and neatly.
Yes, it's not widely recognized, but lifecycle investing and the sequence of return risk problem are really one and the same. People generally worry about sequence of return risk during retirement years. That's because withdrawals cause the portfolio to be overweight in the early years of retirement and underweight in the later years. So returns in the early years have a disproportionate impact. Ideally, you'd like to leave the stock account alone and live on bonds in the early part of retirement. That's not entirely feasible, but the idea would be to try to get closer to that benchmark. That's why the proposed solutions to the sequence of return problem during retirement involves flatter or even upward sloping equity glidepaths.

The lifecycle investing strategy proposed by Ayres and Nalebuff can be seen as an attempt to address the same sequence of risk problem during the accumulation phase by shifting risk from the overweight middle years closer to retirement to the underweight early years.

Basically, over the course of your life, you want stocks to come in early and stay late. It would ideally be the first investment in, and the last investment out. That's hard to do. But trying to get closer to that benchmark will help spread out stock risk more evenly and thereby reduce total lifetime investment risk.

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Re: Lifecycle Investing - Leveraging when young

Post by acegolfer » Wed Mar 06, 2019 1:20 pm

I didn't read all the posts or the OP's referenced article. Seems to me that the idea is similar to dollar cost averaging (which is diversification in time dimension) lowers overall risk.

In practice, our economy system encourages ppl to leverage when young and invest equal amount over time. 2 examples: Buying a house with mortgage is essentially leveraging. Maximizing IRA/401k contribution is dollar cost averaging over long run.

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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew » Wed Mar 06, 2019 2:43 pm

acegolfer wrote:
Wed Mar 06, 2019 1:20 pm
I didn't read all the posts or the OP's referenced article. Seems to me that the idea is similar to dollar cost averaging (which is diversification in time dimension) lowers overall risk.
Dollar cost averaging (DCA-ing) and lifecycle investing are diametrically opposed strategies. DCA-ing involves withholding money you have available to invest from the market. Lifecycle investing involves borrowing money you don't have available in order to get market exposure earlier--or short of that, at least trying to get into the market as early as possible and staying in it for as long as possible. By delaying market exposure, DCA-ing concentrates risk into the later time periods. Holding expected return constant, lifecycle investing would reduce risk whereas DCA-ing would increase it.

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Re: Lifecycle Investing - Leveraging when young

Post by acegolfer » Wed Mar 06, 2019 3:19 pm

Ben Mathew wrote:
Wed Mar 06, 2019 2:43 pm
acegolfer wrote:
Wed Mar 06, 2019 1:20 pm
I didn't read all the posts or the OP's referenced article. Seems to me that the idea is similar to dollar cost averaging (which is diversification in time dimension) lowers overall risk.
Dollar cost averaging (DCA-ing) and lifecycle investing are diametrically opposed strategies. DCA-ing involves withholding money you have available to invest from the market. Lifecycle investing involves borrowing money you don't have available in order to get market exposure earlier--or short of that, at least trying to get into the market as early as possible and staying in it for as long as possible. By delaying market exposure, DCA-ing concentrates risk into the later time periods. Holding expected return constant, lifecycle investing would reduce risk whereas DCA-ing would increase it.
I understand your point about the difference. Nevertheless, both methods involve diversifying across time.

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Re: Lifecycle Investing - Leveraging when young

Post by 305pelusa » Wed Mar 06, 2019 9:27 pm

market timer wrote:
Sun Mar 03, 2019 8:53 pm

One important condition for the application of Kelly is that the portfolio does not have any inflows or outflows (savings or withdrawals). Clearly, this is not the case with lifecycle investing, since we are generally either adding to the portfolio with savings or subtracting from it. Accumulating investors could apply more leverage than what is optimal under Kelly due to savings.
Just finished the book. Absolutely fascinating. Let me see if I follow your logic now:

Historically, people have determined that the Kelly Criterion was found at 1.17 of leverage. A poster in this thread found it to be 1.5:1. Now these results refer to someone having a certain starting bankroll (whatever that is) and tells how much to bet of it day after day, year after year.

But they don't account for saving flow to the bankroll. Inflow of cash is akin to every possible scenario of stock returns to be that more profitable over the above analysis. The stock market returns are identical, but no matter what you get, it's like they also bring a little bonus of money. Every possibility pays more (or does not make you lose as much) because of this additional cash inflow. This stacks the odds and edge in your favor over the regular returns without savings inflow. Because the odds are effectively more in your favor than before, the Kelly Criterion would tell you to bet even more (in this case, borrow further).

Is that about right?

It was nice to see the book make mention about the Kelly Criterion getting used in situations where the chance of total loss are zero (like the stock market). I previously thought that invalidated it. Now I realize that's what leads the Criterion to recommend leverage.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Thu Mar 07, 2019 6:57 am

305pelusa wrote:
Wed Mar 06, 2019 9:27 pm
Is that about right?
Yes, that's correct

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » 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?

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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 9:42 am

bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
What is it about the above you have trouble understanding?
I don't understand why Samuelson thought what he said in 2008 had anything to do with the concepts behind "Lifecycle Investing" as described by Ayres and Nalebuff.

I suspect, as those authors do, that Samuelson hadn't actually read their research but instead was reacting to the title and/or abstract alone.
"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 bobcat2 » Thu Mar 07, 2019 9:51 am

vineviz wrote:
Thu Mar 07, 2019 9:42 am
bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
What is it about the above you have trouble understanding?
I don't understand why Samuelson thought what he said in 2008 had anything to do with the concepts behind "Lifecycle Investing" as described by Ayres and Nalebuff.

I suspect, as those authors do, that Samuelson hadn't actually read their research but instead was reacting to the title and/or abstract alone.
It seems to me what Samuelson said had everything to do with their proposal and was a sharp rebuke using only a couple of paragraphs. Please explain why what he said was not on point.

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.


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Re: Lifecycle Investing - Leveraging when young

Post by vineviz » Thu Mar 07, 2019 10:07 am

bobcat2 wrote:
Thu Mar 07, 2019 9:51 am
vineviz wrote:
Thu Mar 07, 2019 9:42 am
bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
What is it about the above you have trouble understanding?
I don't understand why Samuelson thought what he said in 2008 had anything to do with the concepts behind "Lifecycle Investing" as described by Ayres and Nalebuff.

I suspect, as those authors do, that Samuelson hadn't actually read their research but instead was reacting to the title and/or abstract alone.
It seems to me what Samuelson said had everything to do with their proposal and was a sharp rebuke using only a couple of paragraphs. Please explain why what he said was not on point.
I think you just repeated the same quote you posted earlier. There's nothing in there that addresses what Ayres and Nalebuff described in their book.
"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 pezblanco » Thu Mar 07, 2019 10:10 am

bobcat2 wrote:
Thu Mar 07, 2019 9:51 am
vineviz wrote:
Thu Mar 07, 2019 9:42 am
bobcat2 wrote:
Thu Mar 07, 2019 9:36 am
What is it about the above you have trouble understanding?
I don't understand why Samuelson thought what he said in 2008 had anything to do with the concepts behind "Lifecycle Investing" as described by Ayres and Nalebuff.

I suspect, as those authors do, that Samuelson hadn't actually read their research but instead was reacting to the title and/or abstract alone.
It seems to me what Samuelson said had everything to do with their proposal and was a sharp rebuke using only a couple of paragraphs. Please explain why what he said was not on point.

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.


BobK
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.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » Thu Mar 07, 2019 10:18 am

BobK, I think we argued about this 9 years ago, so I am not optimistic about my chances of success at persuasion.
Samuelson wrote: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.[/b][/i]
Though Kelly criterion was mentioned a few times in this thread, Lifecycle Investing really has nothing to do with Kelly. Lifecycle Investing is not about maximizing geometric mean returns or investors becoming more risk tolerant over longer periods of time. Samuelson effectively argued against those concepts 40-50 years ago, e.g., here: http://www.nccr-finrisk.uzh.ch/media/pd ... BF1979.pdf

Lifecycle Investing is about trying to maintain constant risk over time.

Surely, you understand the distinction between these two concepts. Samuelson certainly did in the 60s and 70s when he was actively writing about them.

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Re: Lifecycle Investing - Leveraging when young

Post by market timer » 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

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Re: Lifecycle Investing - Leveraging when young

Post by bobcat2 » Thu Mar 07, 2019 10:34 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.
Maximizing the geometric mean is a good idea if the difference between finishing first and second is wide, such as Samuelson's example of a pistol duel. It is not such a good idea when the difference between first and second is small. In the case of retirement planning the difference between first and second is relatively small and attempting to finish first using the geometric mean opens the investor up to possible much bigger losses in the long run.

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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 bobcat2 » Thu Mar 07, 2019 10:37 am

I hope everyone catches the following from market timer.
market timer wrote:
Thu Mar 07, 2019 10:18 am
Though Kelly criterion was mentioned a few times in this thread, Lifecycle Investing really has nothing to do with Kelly. Lifecycle Investing is not about maximizing geometric mean returns or investors becoming more risk tolerant over longer periods of time.
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 CULater » Thu Mar 07, 2019 11:11 am

Dr. Bernstein has written insightfully about this in his book "Ages of the Investor." He points out that the essence of Ayres and Nalebuff's finding is that investing a lump sum at the start of one's investment horizon has no sequence of returns risk. That's the explanation of A&N's findings. Since we can't do this unless we inherit a lump sum from our rich uncle when we're young, approximating this by maintaining a constant dollar amount over the investment horizon will somewhat approximate a "lump sum" and reduce sequence of return risk. Leveraging during the first part of one's investment horizon is how A&N suggest doing this.

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.
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