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Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 12:11 am
by 305pelusa
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:

https://poseidon01.ssrn.com/delivery.ph ... 23&EXT=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

UPDATE: I am following this strategy and will update every 3 months.

May 2019
Stock Exposure = 235k
Debt = 92k
Equity in the exposure = 143k
Leverage = 1.64

Aug 2019
Stock Exposure = 251k
Debt = 101k
Equity in the exposure = 150k
Leverage = 1.68

Nov 2019
Stock Exposure = 412k
Effective Debt = 233k
Equity in the exposure = 179k
Leverage = 2.29

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 12:32 am
by Day9
Two threads of note are:

HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs] and

Should I use margin to buy a balanced fund? by Rob Bertram

These two go for a more risk parity approach and leverage a stock & bond portfolio, whereas if I recall correctly Ayers just suggests leveraging stocks only. HEDGEFUNDIE uses leveraged ETFs and Rob Bertram uses futures. Ayers suggests using LEAPS (Long Term Equity Anticipation Security).

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 12:47 am
by DonIce
If you could get leverage for free it would be a no brainer. But no leverage comes for free.

You're either borrowing money, in which case you are paying interest, which reduces your return on the invested amount by the interest rate and exposes you to additional risk. Also as a young investor you're likely not getting amazing borrowing rates (you can tap your home equity with a HELOC and invest that, but even then, the rate isn't that awesome, and you have to lie and say you're not planning to use the HELOC for investing).

You could buy options (including LEAPS) but these have time decay. You stand to lose a lot of money if the markets go down in a given option time period, which you can't get back later like you would if you had invested directly in the market and just held.

Leveraged ETFs mathematically just don't work for long term buy and hold (this is apparently up for debate in hedgefundie's thread but as far as I can tell its a mathematical truism given that their goal is to provide leveraged daily returns).

As far as I can tell, futures are the cheapest form of leverage available to the individual investor. Holding futures effectively just costs the risk-free rate and (small) trading costs. However, you would have to have the discipline to keep rolling your futures contracts systematically every month/quarter even when the markets seem to be against you, which is probably a lot more psychologically difficult for most people than just investing in an ETF and forgetting about it.

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 10:04 am
by 305pelusa
Day9 wrote:
Fri Mar 01, 2019 12:32 am
Two threads of note are:

HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs] and

Should I use margin to buy a balanced fund? by Rob Bertram

These two go for a more risk parity approach and leverage a stock & bond portfolio, whereas if I recall correctly Ayers just suggests leveraging stocks only. HEDGEFUNDIE uses leveraged ETFs and Rob Bertram uses futures. Ayers suggests using LEAPS (Long Term Equity Anticipation Security).
I had seen the first thread but had not seen the second one. Thanks.

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 7:35 pm
by 305pelusa
DonIce wrote:
Fri Mar 01, 2019 12:47 am
If you could get leverage for free it would be a no brainer. But no leverage comes for free.

You're either borrowing money, in which case you are paying interest, which reduces your return on the invested amount by the interest rate and exposes you to additional risk. Also as a young investor you're likely not getting amazing borrowing rates (you can tap your home equity with a HELOC and invest that, but even then, the rate isn't that awesome, and you have to lie and say you're not planning to use the HELOC for investing).

You could buy options (including LEAPS) but these have time decay. You stand to lose a lot of money if the markets go down in a given option time period, which you can't get back later like you would if you had invested directly in the market and just held.

Leveraged ETFs mathematically just don't work for long term buy and hold (this is apparently up for debate in hedgefundie's thread but as far as I can tell its a mathematical truism given that their goal is to provide leveraged daily returns).

As far as I can tell, futures are the cheapest form of leverage available to the individual investor. Holding futures effectively just costs the risk-free rate and (small) trading costs. However, you would have to have the discipline to keep rolling your futures contracts systematically every month/quarter even when the markets seem to be against you, which is probably a lot more psychologically difficult for most people than just investing in an ETF and forgetting about it.
Yeah that makes sense. I think for myself, I'm considering margin as the most likely route. The rates don't seem bad at Interactive Brokers

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 8:04 pm
by Wiggums
Margin allows you to increase your "buying power"—the amount of money available in your account to purchase marginable securities. For example, if you have $50,000 in your money market settlement fund, your buying power is actually $100,000, because you're required to deposit just 50% when buying or selling short* most marginable securities.

To keep your line of credit open, you must maintain a certain amount of equity—the current value of your assets less the amount of the margin loan—in your account at all times. Margin trading can increase your return on an investment, but there's also the potential for significant loss.

A few things you should be aware of:

1) there is a base rate plus an interest rate. I believe that the current margin rate is 8.75%, but this varies by brokerage house. You have trading fees too.

2) you can only borrow based on a percentage of equity in your account. If your account balance goes down, do you have cash to transfer to your account bring the account ratio back into compliance?

3) Margin is a loan that can be called by the broker at anytime.

Good luck to you

Re: Lifecycle Investing - Leveraging when young

Posted: Fri Mar 01, 2019 9:23 pm
by packer16
The book also mentions including your human capital in the decision to incur leverage. If you are in a government job you are in the best position to be levered however if you are an investment banker you may want to have a bond heavy portfolio to diversify your total risk (human & financial capital).

Packer

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 12:20 am
by 305pelusa
Wiggums wrote:
Fri Mar 01, 2019 8:04 pm
Margin allows you to increase your "buying power"—the amount of money available in your account to purchase marginable securities. For example, if you have $50,000 in your money market settlement fund, your buying power is actually $100,000, because you're required to deposit just 50% when buying or selling short* most marginable securities.

To keep your line of credit open, you must maintain a certain amount of equity—the current value of your assets less the amount of the margin loan—in your account at all times. Margin trading can increase your return on an investment, but there's also the potential for significant loss.

A few things you should be aware of:

1) there is a base rate plus an interest rate. I believe that the current margin rate is 8.75%, but this varies by brokerage house. You have trading fees too.

2) you can only borrow based on a percentage of equity in your account. If your account balance goes down, do you have cash to transfer to your account bring the account ratio back into compliance?

3) Margin is a loan that can be called by the broker at anytime.

Good luck to you
Great thoughts! The rate I'm seeing at Interactive Brokers is 3.4%, which I think is pretty reasonable. As for margin calls and equity, the strategy recommends selling if needed to maintain the leverage at 2:1. Ideally, my savings rate can make up any market drops to maintain the correct leverage without having to sell.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 12:28 am
by market timer
Day9 wrote:
Fri Mar 01, 2019 12:32 am
Two threads of note are:

HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs] and

Should I use margin to buy a balanced fund? by Rob Bertram

These two go for a more risk parity approach and leverage a stock & bond portfolio, whereas if I recall correctly Ayers just suggests leveraging stocks only. HEDGEFUNDIE uses leveraged ETFs and Rob Bertram uses futures. Ayers suggests using LEAPS (Long Term Equity Anticipation Security).
For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

For larger accounts, I think futures are best, as Rob Bertram is doing. It gets more complicated if this is done partly inside taxable accounts vs. retirement accounts.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 12:56 am
by HEDGEFUNDIE
market timer wrote:
Sat Mar 02, 2019 12:28 am
Day9 wrote:
Fri Mar 01, 2019 12:32 am
Two threads of note are:

HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs] and

Should I use margin to buy a balanced fund? by Rob Bertram

These two go for a more risk parity approach and leverage a stock & bond portfolio, whereas if I recall correctly Ayers just suggests leveraging stocks only. HEDGEFUNDIE uses leveraged ETFs and Rob Bertram uses futures. Ayers suggests using LEAPS (Long Term Equity Anticipation Security).
For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

For larger accounts, I think futures are best, as Rob Bertram is doing. It gets more complicated if this is done partly inside taxable accounts vs. retirement accounts.
Glad to see you following my thread market timer. :D

Hope you’re doing well these days.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:56 am
by NTropy
I'm a BH lurker who just made an account because actual examples of lifecycle investing seem to be rare.

I read Ayres and Nalebuff a few years ago and found it very persuasive. I spent a solid year looking over the numbers and creating my own simulations to see the impact of leverage on future portfolio values. In general, I (like them) found benefits to risk and return by diversifying across time. Just before implementing the leverage strategy I found markettimer's legendary thread which reinforced the need to approach the topic with caution.

Ayres and Nalebuff suggest limiting leverage to 2x, which means (correct me if I'm wrong) there are three stages to the strategy, based on a target final portfolio value:

Stage 1: 0% to 50% of portfolio target, using 2x leverage
Stage 2: 50% to 100% of portfolio target, with leverage decreasing from 2x to 1x
Stage 3: At 100% of portfolio target, you are delevered

One year ago I took the plunge and purchased LEAPS to move from 100% equity to 200%. I'm early in my career and have a relatively small portfolio size. I buy LEAPS that are 18 months from expiry, at about 75% ITM. To meet my AA I hold LEAPS options on SPY and EFA for US/International exposure, as well as ETFs for those markets plus emerging markets and Canada. One drawback of this method is the need to monitor the leverage as prices change; I track my total equity exposure monthly and buy/sell to stay close to 2x leverage. The first LEAPS I purchased expire later this month so I'll need to roll them over for another 18 months or so when that happens.

My last LEAPS purchase was around 3.2% implied interest, which is much better than what my broker offers in a margin account. In theory it should match the risk-free rate. In the book the authors mentioned futures and leveraged ETFs as other tools to achieve leverage which have been discussed above. I think I'm following Ayers and Nalebuff closer than most, and it looks like you have the same thing in mind. Let me know if you have questions about implementing the portfolio, as I found there are not many places online which discuss the book's strategy.

Re: Lifecycle Investing - Leveraging when young

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

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

In October of 2008 Paul Samuelson attended an economics conference on lifecycle investing. I believe it was the last economics conference Samuelson attended. Here is what Paul Samuelson said about the investing strategy of Ayres and Nalebuff at that conference.
Many analysts argue that when you average over many investment periods, so favorable are the long-run returns of stocks that while you are still young, you should borrow substantially to hold large positions in stocks and you should do so because some kind of “stochastic dominance” is supposed to justify it.

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

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

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

Shame on them. Shame.

BobK

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

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

BobK

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 9:22 am
by bobcat2
Ayers and Nalebuff claim that their strategy is based on research by both Paul Samuelson and Robert Merton. Paul Samuelson, while he was alive, most certainly did not agree with that assessment. Here is what Zvi Bodie has to say about Merton's research and Ayers and Nalebuff's strategy.
My own research with Merton and Bill Samuelson (Paul's son), which is cited in the Ayers & Nalebuff working paper, concludes that economic theory would support leveraging equities in a retirement portfolio only for individuals whose human capital is relatively safe. Do you know such young people?
Even Ayers and Nalebuff concede that young people with credit card or student loan debt should not use this strategy. So here we have an investment strategy that applies to nearly no one, and that is supposedly built on research by two acclaimed economists who flatly reject that their research supports this strategy. Is there anything right about this picture?

BobK

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 12:57 pm
by 305pelusa
market timer wrote:
Sat Mar 02, 2019 12:28 am
Day9 wrote:
Fri Mar 01, 2019 12:32 am
Two threads of note are:

HEDGEFUNDIE's excellent adventure [risk parity strategy using 3x leveraged ETFs] and

Should I use margin to buy a balanced fund? by Rob Bertram

These two go for a more risk parity approach and leverage a stock & bond portfolio, whereas if I recall correctly Ayers just suggests leveraging stocks only. HEDGEFUNDIE uses leveraged ETFs and Rob Bertram uses futures. Ayers suggests using LEAPS (Long Term Equity Anticipation Security).
For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

For larger accounts, I think futures are best, as Rob Bertram is doing. It gets more complicated if this is done partly inside taxable accounts vs. retirement accounts.
I do not like the daily rebalancing and high fees of the leveraged ETFs. The authors are also not big fans of them and recommend less frequent rebalancing. My account would be larger than 100k any ways, so I'm not considering these as options atm. Thanks for the thoughts on them.
As for the futures, my limited understanding is that they offer much larger leverage than 2:1. They also seem to get traded outside of trading hours, which is not a plus in my book. That might get stressful. Do I have the correct understanding here?
NTropy wrote:
Sat Mar 02, 2019 8:56 am
I'm a BH lurker who just made an account because actual examples of lifecycle investing seem to be rare.

I read Ayres and Nalebuff a few years ago and found it very persuasive. I spent a solid year looking over the numbers and creating my own simulations to see the impact of leverage on future portfolio values. In general, I (like them) found benefits to risk and return by diversifying across time. Just before implementing the leverage strategy I found markettimer's legendary thread which reinforced the need to approach the topic with caution.

Ayres and Nalebuff suggest limiting leverage to 2x, which means (correct me if I'm wrong) there are three stages to the strategy, based on a target final portfolio value:

Stage 1: 0% to 50% of portfolio target, using 2x leverage
Stage 2: 50% to 100% of portfolio target, with leverage decreasing from 2x to 1x
Stage 3: At 100% of portfolio target, you are delevered

One year ago I took the plunge and purchased LEAPS to move from 100% equity to 200%. I'm early in my career and have a relatively small portfolio size. I buy LEAPS that are 18 months from expiry, at about 75% ITM. To meet my AA I hold LEAPS options on SPY and EFA for US/International exposure, as well as ETFs for those markets plus emerging markets and Canada. One drawback of this method is the need to monitor the leverage as prices change; I track my total equity exposure monthly and buy/sell to stay close to 2x leverage. The first LEAPS I purchased expire later this month so I'll need to roll them over for another 18 months or so when that happens.

My last LEAPS purchase was around 3.2% implied interest, which is much better than what my broker offers in a margin account. In theory it should match the risk-free rate. In the book the authors mentioned futures and leveraged ETFs as other tools to achieve leverage which have been discussed above. I think I'm following Ayers and Nalebuff closer than most, and it looks like you have the same thing in mind. Let me know if you have questions about implementing the portfolio, as I found there are not many places online which discuss the book's strategy.
Very glad to see someone else follow this. I hope we can stay in communication through the years as I follow this process. I'm still not fully decided on it but it's a good chance I will do it after all.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 1:23 pm
by 2015
bobcat2 wrote:
Sat Mar 02, 2019 9:22 am
...So here we have an investment strategy that applies to nearly no one, and that is supposedly built on research by two acclaimed economists who flatly reject that their research supports this strategy. Is there anything right about this picture?

BobK
Not at all surprising. Happens all the time (see the book "Wrong", for one). This is why I view those who write about investing, personal finance, and microeconomics with a jaundiced eye. Much of the time their interests are diametrically opposed to my own. But this type of stuff will always be posted here because no one wants to get rich slowly (Buffett) and because appeal to authority prevents people from seeing Toto pull the curtain back on the man behind the curtain.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 1:25 pm
by David Jay
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 1:51 pm
by MotoTrojan
market timer wrote:
Sat Mar 02, 2019 12:28 am

For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

Curious what deviation would target a rebalance? I am doing quarterly rebalances as well but was debating doing monthly contributions using M1, which would automatically do this to balance target AA.

Nobody seems to have found a good target point for rebalancing that beats quarterly in backtesting, peculiar indeed.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 1:53 pm
by MotoTrojan
David Jay wrote:
Sat Mar 02, 2019 1:25 pm
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).
I am 100/0 in unleveraged and 120/180 in leveraged. Depending on how the decline occurs a 3x daily rebalanced equity fund may actually drop less than a 3x a standard equity fund. Feel free to check in with me.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 1:53 pm
by AlphaLess
DonIce wrote:
Fri Mar 01, 2019 12:47 am
If you could get leverage for free it would be a no brainer. But no leverage comes for free.

You're either borrowing money, in which case you are paying interest, which reduces your return on the invested amount by the interest rate and exposes you to additional risk. Also as a young investor you're likely not getting amazing borrowing rates (you can tap your home equity with a HELOC and invest that, but even then, the rate isn't that awesome, and you have to lie and say you're not planning to use the HELOC for investing).

You could buy options (including LEAPS) but these have time decay. You stand to lose a lot of money if the markets go down in a given option time period, which you can't get back later like you would if you had invested directly in the market and just held.

Leveraged ETFs mathematically just don't work for long term buy and hold (this is apparently up for debate in hedgefundie's thread but as far as I can tell its a mathematical truism given that their goal is to provide leveraged daily returns).

As far as I can tell, futures are the cheapest form of leverage available to the individual investor. Holding futures effectively just costs the risk-free rate and (small) trading costs. However, you would have to have the discipline to keep rolling your futures contracts systematically every month/quarter even when the markets seem to be against you, which is probably a lot more psychologically difficult for most people than just investing in an ETF and forgetting about it.
Excellent post.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 2:21 pm
by MotoTrojan
AlphaLess wrote:
Sat Mar 02, 2019 1:53 pm
DonIce wrote:
Fri Mar 01, 2019 12:47 am
If you could get leverage for free it would be a no brainer. But no leverage comes for free.

You're either borrowing money, in which case you are paying interest, which reduces your return on the invested amount by the interest rate and exposes you to additional risk. Also as a young investor you're likely not getting amazing borrowing rates (you can tap your home equity with a HELOC and invest that, but even then, the rate isn't that awesome, and you have to lie and say you're not planning to use the HELOC for investing).

You could buy options (including LEAPS) but these have time decay. You stand to lose a lot of money if the markets go down in a given option time period, which you can't get back later like you would if you had invested directly in the market and just held.

Leveraged ETFs mathematically just don't work for long term buy and hold (this is apparently up for debate in hedgefundie's thread but as far as I can tell its a mathematical truism given that their goal is to provide leveraged daily returns).

As far as I can tell, futures are the cheapest form of leverage available to the individual investor. Holding futures effectively just costs the risk-free rate and (small) trading costs. However, you would have to have the discipline to keep rolling your futures contracts systematically every month/quarter even when the markets seem to be against you, which is probably a lot more psychologically difficult for most people than just investing in an ETF and forgetting about it.
Excellent post.
Agreed but would be curious to hear more about the mathematical truism on daily leveraged funds. I was previously quick to repeat what I had heard that they rebalance daily and are only meant to be held for short-term trades, but the more I read the more I realize they can be effective for long-term buy & hold as well and often the daily-rebalancing can come out ahead (both in up and down markets) relative to a naive-return (3x the overall return).

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 4:29 pm
by 305pelusa
@packer16: Yes, the nature of the human capital is very relevant. I would argue it's more than just the correlation to the stock market; if the salary is in some way inconsistent or unreliable, I would say that should be taken into account. The strategy seems like a good fit for salaries that are uncorrelated with the market and reliable.

@bobcat2: Based on Samuelson's critique, It's my personal opinion that Samuelson did not take the time to read the book properly and report. After reading some of Samuelson's writings, I think it is a consistent fit. I seem to recall Samuelson only read the abstract but don't quote me on that.

That most people would not meet the requirements to use the strategy does not take away from its effectiveness for those that would be good fits. Personally, I don't carry credit card debt and my salary does not come from the finance/banking field. I don't know how common that is I suppose.

Regardless, the strategy does not just apply to youth. If you're 45 and will plan to work for another 15+ years, it's likely you would be recommended to use a much larger percentage of stocks than typically recommended to diversify effectively across time. Hopefully the number of 45 year olds with credit card debt is lower than 25 year olds, so it might be even more applicable to those populations.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 7:53 pm
by 305pelusa
David Jay wrote:
Sat Mar 02, 2019 1:25 pm
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).
The uncertainty of the market crashes is a big reason why this strategy appeals to me. By diversifying across time, I can decrease my risk while maintaining the same returns. The more volatile the times, the more helpful it is. I have a hard time rationalizing against the lifecycle model of the authors personally.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 7:58 pm
by David Jay
305pelusa wrote:
Sat Mar 02, 2019 7:53 pm
David Jay wrote:
Sat Mar 02, 2019 1:25 pm
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).
The uncertainty of the market crashes is a big reason why this strategy appeals to me. By diversifying across time, I can decrease my risk while maintaining the same returns. The more volatile the times, the more helpful it is. I have a hard time rationalizing against the lifecycle model of the authors personally.
I wish you well.
In 'Where are the Customers' Yachts', Fred Schwed wrote:There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:04 pm
by H-Town
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.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:37 pm
by market timer
305pelusa wrote:
Sat Mar 02, 2019 12:57 pm
As for the futures, my limited understanding is that they offer much larger leverage than 2:1. They also seem to get traded outside of trading hours, which is not a plus in my book. That might get stressful. Do I have the correct understanding here?
Yes, an individual futures contract gives much more than 2:1 leverage. An S&P e-mini contract currently requires about $6K of cash to get exposure to $140K of equities (50x S&P 500), so 23:1 leverage. However, you should think of this in the context of your entire account. As the S&P fluctuates day to day, cash will be moved to or from your account at the end of the day. If you don't have $6K in cash to maintain your position, you'll be forced to sell in a margin call. You could fully collateralize the position by depositing $140K of cash and buying an S&P e-mini. This would ensure you aren't forced to sell.

In a retirement account, I'd be inclined to use futures. In a taxable account, you lose the ability to defer capital gains taxes when you use futures, since they must be rolled quarterly.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:46 pm
by bobcat2
Hi 305pelusa,

I doubt very much if Paul Samuelson, one of the greatest economists of all time, misunderstood what Ayes and Nalebuff wrote. He simply disagreed with it. After all Samuelson wasn’t asked about it at the conference, but instead he brought it up as a classic example of poor financial reasoning that comes back every time there is an extended bull market.

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

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

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

Lifecycle investing does call for a high percentage of investible assets be invested in risky assets for young investors no older than their early thirties, because so much of their wealth is in relatively safe human capital rather than financial capital. But their financial wealth wouldn’t be leveraged or even 100% because they need some safe assets to deal with bad financial states such as unemployment and bad health. For a young person to reasonably leverage their assets would require that she has no student debt, no credit card or other consumer debt such as car loan or lease, very stable employment such as tenured professor, physician, or law partner, employment not correlated with financial markets, and that she be very knowledgeable about financial markets and investing. The percentage of young investors that fit that leverage profile would appear to be less than 1% of the population of adults no older than their early thirties.

By the ages of 45-50 lifecycle finance calls for a smaller percentage of the portfolio to be invested in stocks than is conventionally recommended because the human capital portion of the investor’s wealth is so much smaller than it was when they were younger. For many investors around age 30 the relevant portion of their human capital devoted to retirement income dwarfs their financial wealth, but by their late 40’s financial wealth is likely much greater than their rapidly diminishing remaining safe human capital. You should be able to grasp this important aspect of lifecycle finance since you believe "human capital is very relevant".

BobK

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:51 pm
by market timer
MotoTrojan wrote:
Sat Mar 02, 2019 1:51 pm
market timer wrote:
Sat Mar 02, 2019 12:28 am

For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

Curious what deviation would target a rebalance? I am doing quarterly rebalances as well but was debating doing monthly contributions using M1, which would automatically do this to balance target AA.

Nobody seems to have found a good target point for rebalancing that beats quarterly in backtesting, peculiar indeed.
Optimizing backtesting results strikes me as overfitting.

I haven't put together a spreadsheet to optimize for the various complications: taxes, attention, trading fees, etc. In terms of general guidelines, I would:
1. Direct new contributions to the asset class most below target.
2. Have % rebalancing bands, similar to what many already use here, which would force a sale and purchase.
3. To the extent possible, use retirement accounts for rebalancing purposes, which could lead to very different allocations between retirement and taxable.
4. Try to maximize tax deferral by buying ETFs in taxable that I plan to hold for decades (e.g., VTI), then building leverage around these core holdings. For example, the taxable account might hold 95% VTI, 5% cash, and an ultra bond future (~30x leverage).

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:53 pm
by market timer
H-Town wrote:
Sat Mar 02, 2019 8:04 pm
No offense but when I see trend like this (leverage to invest), things might head towards a crash. It’s like clockwork.
Yes, we are seeing a lot of interest in leverage and risk parity these days. Suggests cash might not be such a bad asset class to overweight.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:57 pm
by HEDGEFUNDIE
305pelusa wrote:
Sat Mar 02, 2019 4:29 pm
@packer16: Yes, the nature of the human capital is very relevant. I would argue it's more than just the correlation to the stock market; if the salary is in some way inconsistent or unreliable, I would say that should be taken into account. The strategy seems like a good fit for salaries that are uncorrelated with the market and reliable.
Here is the irony. The people who have reliable incomes uncorrelated with the stock market probably took those jobs because of their conservative financial attitudes. Government, academic jobs come to mind first.

These are also the people least likely to be leveraging anything in their investment portfolio.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 8:58 pm
by MotoTrojan
market timer wrote:
Sat Mar 02, 2019 8:51 pm
MotoTrojan wrote:
Sat Mar 02, 2019 1:51 pm
market timer wrote:
Sat Mar 02, 2019 12:28 am

For small accounts (<$100K), the leveraged ETF approach makes sense. I believe HEDGEFUNDIE is doing quarterly rebalancing, though I'd recommend rebalancing based on deviations from target AA and with new contributions, rather than a time-based approach.

Curious what deviation would target a rebalance? I am doing quarterly rebalances as well but was debating doing monthly contributions using M1, which would automatically do this to balance target AA.

Nobody seems to have found a good target point for rebalancing that beats quarterly in backtesting, peculiar indeed.
Optimizing backtesting results strikes me as overfitting.

I haven't put together a spreadsheet to optimize for the various complications: taxes, attention, trading fees, etc. In terms of general guidelines, I would:
1. Direct new contributions to the asset class most below target.
2. Have % rebalancing bands, similar to what many already use here, which would force a sale and purchase.
3. To the extent possible, use retirement accounts for rebalancing purposes, which could lead to very different allocations between retirement and taxable.
4. Try to maximize tax deferral by buying ETFs in taxable that I plan to hold for decades (e.g., VTI), then building leverage around these core holdings. For example, the taxable account might hold 95% VTI, 5% cash, and an ultra bond future (~30x leverage).
Makes sense. Specific to the Hedgefundie 3x leveraged ETF strategy one thought I had recently was that a time-based rebalance allows large momentum driven deviations to materialize while ensuring that SOME rebalancing happens during less volatile (or at-least lower magnitude) times. This allows you to capture large rebalance bonuses and also small ones during those range-bound periods, which could help to offset volatility drag. A combination of these may be best (time-based plus a large absolute delta). For now I am happy with the quarterly approach.

Also fwiw taxes and trading fees aren't an issue for my setup, and attention favors the time-based approach. I do agree with the new contributions idea but that will be short-lived as I don't plan to continue contributing to this side-portfolio forever.

Thanks for the input!

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 9:10 pm
by market timer
305pelusa wrote:
Sat Mar 02, 2019 4:29 pm
Regardless, the strategy does not just apply to youth. If you're 45 and will plan to work for another 15+ years, it's likely you would be recommended to use a much larger percentage of stocks than typically recommended to diversify effectively across time. Hopefully the number of 45 year olds with credit card debt is lower than 25 year olds, so it might be even more applicable to those populations.
Yes, the core audience for this strategy is really investors approaching middle age, say 20-40% toward their ultimate net worth target. It's not people just starting out with under 10% saved. Leveraging a small portfolio 2:1 is not going to change much.

Re: Lifecycle Investing - Leveraging when young

Posted: Sat Mar 02, 2019 9:44 pm
by 305pelusa
bobcat2 wrote:
Sat Mar 02, 2019 8:46 pm
Hi 305pelusa,

I doubt very much if Paul Samuelson, one of the greatest economists of all time, misunderstood what Ayes and Nalebuff wrote. He simply disagreed with it. After all Samuelson wasn’t asked about it at the conference, but instead he brought it up as a classic example of poor financial reasoning that comes back every time there is an extended bull market.
That he was very intelligent doesn't mean he fully took the time to read/understand the paper. He was in his 90s and surely a busy fella. That he brought it up himself instead of being asked about it also doesn't convince me.

What does convince me a bit is that the authors say they corresponded with Samuelson, who admitted had only read the abstract. Additionally, in the past, Samuelson wrote in one of his papers:
"[The businessman] can look forward to a high salary in the future; and with so high a present discounted value of wealth, it is only prudent for him to put more into common stocks compared to his present tangible wealth, borrowing if necessary for the purpose, or accomplishing the same thing by selecting volatile stocks that widows shun."

You can read more about the story here:
http://freakonomics.com/2010/07/06/did- ... investing/

Either way, I don't think there's much point speculating in what Samuelson truly meant. I'm sure you'll find many other econ professors who oppose the strategy as well.
bobcat2 wrote:
Sat Mar 02, 2019 8:46 pm
For a young person to reasonably leverage their assets would require that she has no student debt, no credit card or other consumer debt such as car loan or lease, very stable employment such as tenured professor, physician, or law partner, employment not correlated with financial markets, and that she be very knowledgeable about financial markets and investing. The percentage of young investors that fit that leverage profile would appear to be less than 1% of the population of adults no older than their early thirties.
I agree with a few of these. I believe the loans depend on the rates. Credit card rates tend to be much higher, so you'll effectively get more bang for your buck by paying them off than investing in the market. I don't know what car/lease loans go for these days but as long as they're lower than the cost to borrow on margin/implied interest of LEAPS, then I don't see why you couldn't lifecycle while having those on the side.

Once again, I have absolutely no clue what percentage of people fit the criteria. But as mentioned before, whether many or few people are "cleared" to follow the strategy has no bearing on how effective the strategy is for those that meet the requirements.

To be frank, the biggest reason I think that would "deny" you of this strategy is probably behavioral (what authors refer as "fear to lose money"). Finding people who can handle 100% equites, let alone 200%, is most likely the biggest filter in my opinion. It's interesting you don't even mention this factor; I think it's the most important and hardest to gauge one.
bobcat2 wrote:
Sat Mar 02, 2019 8:46 pm
By the ages of 45-50 lifecycle finance calls for a smaller percentage of the portfolio to be invested in stocks than is conventionally recommended because the human capital portion of the investor’s wealth is so much smaller than it was when they were younger. For many investors around age 30 the relevant portion of their human capital devoted to retirement income dwarfs their financial wealth, but by their late 40’s financial wealth is likely much greater than their rapidly diminishing remaining safe human capital. You should be able to grasp this important aspect of lifecycle finance since you believe "human capital is very relevant".
This makes sense but I'm afraid I've missed your point. If you're simply recapping the advice to make sure I follow it, then it makes sense to me. But perhaps you meant something else with this paragraph so let me know if I've missed something here.

Thank you for your comments

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 9:46 am
by 305pelusa
MotoTrojan wrote:
Sat Mar 02, 2019 1:53 pm
David Jay wrote:
Sat Mar 02, 2019 1:25 pm
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).
I am 100/0 in unleveraged and 120/180 in leveraged. Depending on how the decline occurs a 3x daily rebalanced equity fund may actually drop less than a 3x a standard equity fund. Feel free to check in with me.
I had somehow missed this comment. What exactly is a 120/180 leverage? You're buying bonds with the loaned money?

Also, I believe daily rebalancing helps if the market continues to go down or up. It's the up-then-down that deliver lower returns. So I guess in this light, it's more about picking your poison.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 11:47 am
by pezblanco
I've always been interested in leverage and have started a couple of threads on using the Kelley Criterion (aka the maximizing geometric mean). I've ordered the Ayres and Nalebuff book and look forward to reading it. I've contributed a bit to the Hedgefundie thread which I think is a very interesting idea. Some thoughts:

1) The benefits of leveraging are typically massively overstated. Averaged over the last 50 years, the optimal (in the geometric mean sense) leverage on the S&P is something like 1.5 This is making assumptions about reasonable borrow rates (1-month T-bill + 1). By doing that, instead of a long term real rate of return of 7, you can get up to 9.

If you leverage up stock/bond portfolio, you can do better ... higher leverage ratios are optimal (it seems to be 3 to 5 ish) and you can get one or two more percentage points of return.

2) We have had an extraordinary bull bond market for several decades .... there has been an extraordinary stock bull market going on (still?). Backtests based on the last 30 years or so (as Portfolio Visualizer does) gives a very rosy picture of leverage. I would proceed with extreme caution with results that depend heavily on especially the the bull bond market of the last few decades. Interest rates really can't fall much farther to keep getting those great returns on long term treasuries.

3) For implementation, borrowing costs are crucial. It seems that futures will allow you to borrow very close to the Libor rate over the time that the contract is in force. One e-mini 500 contract wields like 140,000 dollars right now. So if you wanted a leverage on 3 on stocks you need to come up with 47K. If you wanted say the optimal 1.5 leverage, you need to put in 93K. For my little portfolio, these are big contracts! The LEAPS seem to be much more appealing. One year Libor is 2.98% ... I thought NTropy's numbers were very interesting:
NTropy wrote:
Sat Mar 02, 2019 8:56 am

One year ago I took the plunge and purchased LEAPS to move from 100% equity to 200%. I'm early in my career and have a relatively small portfolio size. I buy LEAPS that are 18 months from expiry, at about 75% ITM. To meet my AA I hold LEAPS options on SPY and EFA for US/International exposure, as well as ETFs for those markets plus emerging markets and Canada. One drawback of this method is the need to monitor the leverage as prices change; I track my total equity exposure monthly and buy/sell to stay close to 2x leverage. The first LEAPS I purchased expire later this month so I'll need to roll them over for another 18 months or so when that happens.

My last LEAPS purchase was around 3.2% implied interest, which is much better than what my broker offers in a margin account. In theory it should match the risk-free rate. In the book the authors mentioned futures and leveraged ETFs as other tools to achieve leverage which have been discussed above. I think I'm following Ayers and Nalebuff closer than most, and it looks like you have the same thing in mind. Let me know if you have questions about implementing the portfolio, as I found there are not many places online which discuss the book's strategy.
To get 3.2% money is not paying much of a premium over a futures contract I wouldn't think ... and the smaller possible contract sizes gives you a chance to get your feet wet. I still don't feel comfortable with the idea of trying to leverage a bond/stock portfolio with options mainly because of the bond side. You get no dividends with a bond option. And if there are no dividends, you are basically speculating on interest rates. I'm not going to do that.

4) I respect the people working, investing, and trying to understand the 3x leveraged ETFs. My impression is that they are relatively expensive and have features that are not really desirable. The daily resets on the leverage while allowing for some compounding benefits also create losses in up-down sidewise moving markets. I personally just think there are too many moving parts to the strategy. Certainly the backtests over the last 30 years are impressive with this strategy.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 1:35 pm
by inbox788
IMO, leveraging makes little sense if your asset allocation isn't 100% equities or you're investing in bonds. It's all about the borrowing rates and how much you can borrow and the liquidity risk you want to take. Just like the perennial question of whether you should pay off your mortgage or invest instead (or borrow from your home to invest), it's all about the rates, and whether the risk/benefit is worth it for you.

The basic way I see it is if you're using leverage, you're borrowing to invest, so in effect you're a bond seller. If you're a bond investor (i.e. part of your AA is bonds), you're a bond buyer. Being on both sides of the trade only make sense if you can arbitrage the interest rate to overcome any trading fees. (And if you can successfully do that, you should just stick to trading/hedging bonds and scale up to the max without the added risk of equities)

OP, how do you intend to leverage, and what is your borrowing cost and capacity? Where can you beat 3-4% margin up to 50% (at Interactive Brokers) or 2X leverage for stocks? How will you deal with margin calls that could force you to sell low?
pezblanco wrote:
Sun Mar 03, 2019 11:47 am
1) The benefits of leveraging are typically massively overstated. Averaged over the last 50 years, the optimal (in the geometric mean sense) leverage on the S&P is something like 1.5 This is making assumptions about reasonable borrow rates (1-month T-bill + 1). By doing that, instead of a long term real rate of return of 7, you can get up to 9.

If you leverage up stock/bond portfolio, you can do better ... higher leverage ratios are optimal (it seems to be 3 to 5 ish) and you can get one or two more percentage points of return.
I'm not sure what all this refers to, but a 2% annual difference over 50 years is a 100% or doubling in end result. If you're able to leverage a 1.5X SP500 that returns 7% over 50 years, you'd be getting 10.5% return, so the borrowing rate is about 1.5% similar to the up to 2% gains from leveraging (compounding will alters this simple math). What AA would you be leveraging 3-5X? IMO, there's no point in leveraging a 20/80 AA 5X and paying for all those borrowing costs when you can simply invest in a 100/0 AA and likely do better.

Using Options and Futures carries their own risks and costs, and managing them over turbulent periods can be challenging. Over the long run, if you can borrow at a lower rate than the return of your investment, and you can remain solvent, you will come out ahead. You just need to find a path that doesn't dead end, which is a big danger of using too much leverage. (I think even a 1.5X leverage of SP500 could have resulted in a margin call in 2008?)

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 1:39 pm
by MotoTrojan
305pelusa wrote:
Sun Mar 03, 2019 9:46 am
MotoTrojan wrote:
Sat Mar 02, 2019 1:53 pm
David Jay wrote:
Sat Mar 02, 2019 1:25 pm
I will check back on this thread after the next 40% decline in the market (which will come, we just don’t know when).
I am 100/0 in unleveraged and 120/180 in leveraged. Depending on how the decline occurs a 3x daily rebalanced equity fund may actually drop less than a 3x a standard equity fund. Feel free to check in with me.
I had somehow missed this comment. What exactly is a 120/180 leverage? You're buying bonds with the loaned money?

Also, I believe daily rebalancing helps if the market continues to go down or up. It's the up-then-down that deliver lower returns. So I guess in this light, it's more about picking your poison.
120/180 is a 40/60 equity/bond portfolio levered up 3x on both sides. I am not borrowing money.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 1:41 pm
by inbox788
MotoTrojan wrote:
Sun Mar 03, 2019 1:39 pm
120/180 is a 40/60 equity/bond portfolio levered up 3x on both sides. I am not borrowing money.
How are you able to implement this? What is the cost? A 3X ETF? Doesn't return 3X underlying after fees. Implicitly, you're borrowing somewhere.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 2:19 pm
by MotoTrojan
inbox788 wrote:
Sun Mar 03, 2019 1:41 pm
MotoTrojan wrote:
Sun Mar 03, 2019 1:39 pm
120/180 is a 40/60 equity/bond portfolio levered up 3x on both sides. I am not borrowing money.
How are you able to implement this? What is the cost? A 3X ETF? Doesn't return 3X underlying after fees. Implicitly, you're borrowing somewhere.
viewtopic.php?f=10&t=272007

The ETF is borrowing at 1-month libor, correct. Depends on the period but since inception I believe UPRO has returned >5x it's underlying index thanks to compounded daily returns (but it can also do worse than 1x the underlying in other flatter periods).

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 2:25 pm
by pezblanco
inbox788 wrote:
Sun Mar 03, 2019 1:35 pm
pezblanco wrote:
Sun Mar 03, 2019 11:47 am
1) The benefits of leveraging are typically massively overstated. Averaged over the last 50 years, the optimal (in the geometric mean sense) leverage on the S&P is something like 1.5 This is making assumptions about reasonable borrow rates (1-month T-bill + 1). By doing that, instead of a long term real rate of return of 7, you can get up to 9.

If you leverage up stock/bond portfolio, you can do better ... higher leverage ratios are optimal (it seems to be 3 to 5 ish) and you can get one or two more percentage points of return.
I'm not sure what all this refers to, but a 2% annual difference over 50 years is a 100% or doubling in end result. If you're able to leverage a 1.5X SP500 that returns 7% over 50 years, you'd be getting 10.5% return, so the borrowing rate is about 1.5% similar to the up to 2% gains from leveraging (compounding will alters this simple math). What AA would you be leveraging 3-5X? IMO, there's no point in leveraging a 20/80 AA 5X and paying for all those borrowing costs when you can simply invest in a 100/0 AA and likely do better.
I don't quite follow what you're saying. I'm not saying you're wrong. I just don't follow it completely. Calculating the average returns from leverage is not just a simple scaling of the average unleveraged returns, right? Volatility matters a lot! The optimal AA for leveraging 3-5x is something between 40/60 and 50/50 ... There are lots of assumptions here (check my thread on leveraging stock/bond portfolios and the Kelly criterion). Basically, what you're missing here is that the bond parts of the portfolio are assumed to be long term treasuries .... borrow rates are based on short term instruments .... so you're "not just borrowing at the bond rate, to leverage and buy at the bond rate". Diversifying a portfolio (even a leveraged one) brings about a lot of benefits ....

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 3:42 pm
by inbox788
MotoTrojan wrote:
Sun Mar 03, 2019 2:19 pm
inbox788 wrote:
Sun Mar 03, 2019 1:41 pm
MotoTrojan wrote:
Sun Mar 03, 2019 1:39 pm
120/180 is a 40/60 equity/bond portfolio levered up 3x on both sides. I am not borrowing money.
How are you able to implement this? What is the cost? A 3X ETF? Doesn't return 3X underlying after fees. Implicitly, you're borrowing somewhere.
viewtopic.php?f=10&t=272007

The ETF is borrowing at 1-month libor, correct. Depends on the period but since inception I believe UPRO has returned >5x it's underlying index thanks to compounded daily returns (but it can also do worse than 1x the underlying in other flatter periods).
The total return looks impressive, but annualized returns 1 and 5 years are only 2.6X and 2.2X. To me, that's one of the hidden costs. Another is SPXU (ProShares UltraPro Short S&P500), which you may avoid, but the short sell has paid for it. I'm not sure how they're achieving their daily 3X goal, especially when the complement funds aren't balancing out, but besides the heavily active daily management cost, they have to take the extra 2% from somewhere whenever the index moves 1%. With 50% margin, you might be able to leverage up to 2X more cheaply by paying margin interest rates and a low cost SP500 index.
PERFORMANCE [as of 02/28/19] 1 MONTH 3 MONTHS YTD 1 YEAR 3 YEARS 5 YEARS 10 YEARS
UPRO 9.28% -0.15% 35.39% -0.85% 39.76% 23.98% --
UPRO (NAV) 9.19% -0.68% 35.47% -0.93% 39.55% 23.95% --
S&P 500 3.21% 1.42% 11.48% 4.68% 15.28% 10.68%
https://www.etf.com/UPRO

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 4:03 pm
by inbox788
pezblanco wrote:
Sun Mar 03, 2019 2:25 pm
I don't quite follow what you're saying. I'm not saying you're wrong. I just don't follow it completely. Calculating the average returns from leverage is not just a simple scaling of the average unleveraged returns, right? Volatility matters a lot! The optimal AA for leveraging 3-5x is something between 40/60 and 50/50 ... There are lots of assumptions here (check my thread on leveraging stock/bond portfolios and the Kelly criterion). Basically, what you're missing here is that the bond parts of the portfolio are assumed to be long term treasuries .... borrow rates are based on short term instruments .... so you're "not just borrowing at the bond rate, to leverage and buy at the bond rate". Diversifying a portfolio (even a leveraged one) brings about a lot of benefits ....
I'm oversimplifying the complexity, which I'm sure introduces lots of errors, but the gist my argument is that the whole is the sum of the parts. When you borrow to invest in a stock/bond portfolio, you're doing 3 things.

1) You're investing in equities
2) You're in bonds
3) You're rebalancing and diversifying

My premise is #1 is the major factor and you shouldn't bother with bonds. If the SP went up 10% and your 50/50 AA portfolio leveraged 4X went up 20%, how much is attributable to what component? Would you expect much different from 20%?

There may be minor contributions from bonds or diversification and rebalancing, but to me, they confuse heart of the matter.

As far as #2, if you're borrowing short term bonds and investing long term, you're basically in the same boat as the banks. What will happen when the yield curve inverts? One may ask, is this a good investment, risk/return, as a stand alone investment and how does it compare to other investment options? Why not borrow at short term interest and invest in long term treasury bonds?

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 5:00 pm
by pezblanco
inbox788 wrote:
Sun Mar 03, 2019 4:03 pm

I'm oversimplifying the complexity, which I'm sure introduces lots of errors, but the gist my argument is that the whole is the sum of the parts. When you borrow to invest in a stock/bond portfolio, you're doing 3 things.

1) You're investing in equities
2) You're in bonds
3) You're rebalancing and diversifying

My premise is #1 is the major factor and you shouldn't bother with bonds. If the SP went up 10% and your 50/50 AA portfolio leveraged 4X went up 20%, how much is attributable to what component? Would you expect much different from 20%?

As I said before, volatility matters a lot. A stock/bond mix allows for a lowering a volatility and thus more leverage which actually gives you a greater long term geometric mean than just leveraging a stock fund alone. This is counterintuitive but true.
inbox788 wrote:
Sun Mar 03, 2019 4:03 pm
There may be minor contributions from bonds or diversification and rebalancing, but to me, they confuse heart of the matter.
No, not at all. They are the heart of the matter.
inbox788 wrote:
Sun Mar 03, 2019 4:03 pm
As far as #2, if you're borrowing short term bonds and investing long term, you're basically in the same boat as the banks. What will happen when the yield curve inverts? One may ask, is this a good investment, risk/return, as a stand alone investment and how does it compare to other investment options? Why not borrow at short term interest and invest in long term treasury bonds?


This is exactly what is being proposed for all of the leveraged stock/bond schemes.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 6:34 pm
by 305pelusa
pezblanco wrote:
Sun Mar 03, 2019 11:47 am
I've always been interested in leverage and have started a couple of threads on using the Kelley Criterion (aka the maximizing geometric mean). I've ordered the Ayres and Nalebuff book and look forward to reading it.
Yes, I've read your analysis on the Kelly Criterion. To be completely honest (and I will admit I could be totally wrong and I accept that), I'm not quite sure I follow how the Kelly Criterion applies to leveraging stocks. Many assumptions seem to be key in the Kelly game that aren't in stocks.

The Kelly Criterion arises from a coin flip game where when you lose, you lose the entire bet. When you win, you get some extra over your bet. If the game was to be played infinitely, the correct strategy is to bet p-q fraction of your wealth on every flip (p being chances of a win while q are chances of a loss).

Investing in the stock market isn't an infinite number of bets; I only live so many years. I also don't lose the entire quantity on bad years. Nor am I assured a certain payoff on good years. All in all, I can only presume a lot of the the Kelly Criterion boils down to a very simple answer precisely due to many of these simplifying assumptions.

People come up with the 1.17 or 1.5 leverage number from backtesting. That's another reason it's unconvincing to me. I don't want to base a strategy based on what worked best, using a theoretical game that I'm unsure really applies. Again, I will admit right now, it's just my intial impression.

What I CAN say is that given a game with 50 independent coin tosses where you don't know the odds or payoffs of any of them, the game that minimizes the standard deviation of results is one where you bet the same amount on every coin toss. So I want to do that. That might mean I leverage 2:1 when young, 1.5:1 when older, and use no leverage at all when close to retirement.

inbox788 wrote:
Sun Mar 03, 2019 1:35 pm

OP, how do you intend to leverage, and what is your borrowing cost and capacity? Where can you beat 3-4% margin up to 50% (at Interactive Brokers) or 2X leverage for stocks? How will you deal with margin calls that could force you to sell low?
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.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 6:43 pm
by rhe
I believe that out of the people here who actually hold some sort of leveraged position, mine is among the most conservative.

I understand the basic argument that a secure future income stream should be considered when deciding on investments. The problem, as many posters (and paul samuelson) have pointed out, is that a leveraged investment in a brokerage account comes with a risk of ruin. The only way to (mostly) avoid this is to keep a constant leverage ratio, selling into losses and buying into gains... but you don't want to have to sell when the market crashes, if your whole justification for holding the position in the first place is that your future income stream makes it the right position to hold.

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.

There is a leveraged investment that effectively uses your future income as collateral. One of my friends (with a government job) bought a multifamily apartment building and lived in one of the units. In a real estate crash, the bank does not go back and check the market value of the building and foreclose if it is too low. As long as you can make the mortgage payments out of your income you are safe. In his case he could cover the mortgage even if the other units were empty.

Basically, it seems to me that if you want to invest based on your future income, you need to get the type of loan that considers (and hopefully verifies!) that income.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 8:00 pm
by inbox788
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?
pezblanco wrote:
Sun Mar 03, 2019 5:00 pm
inbox788 wrote:
Sun Mar 03, 2019 4:03 pm
Why not borrow at short term interest and invest in long term treasury bonds?

This is exactly what is being proposed for all of the leveraged stock/bond schemes.
I ask the question in isolation, not as part of a package where the sum of the parts is greater than the whole. I think the sum of the parts is equal to the whole, and each part can stand on it's own merit. One can evaluate each part and rank them in order of benefit and choose the one that the investor thinks gives him the best risk/reward. If you're only trading bonds, you can decide to stop or exit if the yield curve flattens or inverts. As part of a more complex package, that option isn't so clear.

One has limited capital to invest and I'm not convinced that a 100% equity portfolio is all that difference from a 2X leveraged 50/50 AA, and the stock and bond portions can largely be viewed independently. [Not sure how to model this in portfolio visualizer. Tried 50% ULPIX vs 100% VFINX and the rest CASHX or 25% ULPIX/50% VFINX, but something still seems wrong. Is there a suitable proxy fund for borrowing rate?]

Anyway, I view leveraging as an AA question, and investing in bonds vs stocks and either or question, not both. YMMV.
305pelusa wrote:
Sun Mar 03, 2019 6:34 pm
People come up with the 1.17 or 1.5 leverage number from backtesting. That's another reason it's unconvincing to me. I don't want to base a strategy based on what worked best, using a theoretical game that I'm unsure really applies. Again, I will admit right now, it's just my intial impression.

What I CAN say is that given a game with 50 independent coin tosses where you don't know the odds or payoffs of any of them, the game that minimizes the standard deviation of results is one where you bet the same amount on every coin toss. So I want to do that. That might mean I leverage 2:1 when young, 1.5:1 when older, and use no leverage at all when close to retirement.
I've come across the number 1.6 somewhere as the maximum historic survivable leverage ratio, also from backtesting, but don't recall where. As far as independent coin tosses, daily market fluctuations do appear to be independent, but I'm not convinced they truly are. After 5 or 15 straight up days in a row, do you really think the next day is independent? It's no fair coin or well balanced roulette wheel AFAIK.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 8:06 pm
by HEDGEFUNDIE
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.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 8:24 pm
by inbox788
I may have found a way to model or compare different strategies. Begin with $100k cash and only invest a portion to see the differences. In all cases, about $10k is invested in equities.

Portfolio 1 "borrow" $10k and invests $20k in 50/50 AA
Portfolio 2 invests $5k in 2X fund and $5k in BND
Portfolio 3 invests $10k in SP500

https://www.portfoliovisualizer.com/bac ... tion7_1=10

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 8:53 pm
by market timer
305pelusa wrote:
Sun Mar 03, 2019 6:34 pm
pezblanco wrote:
Sun Mar 03, 2019 11:47 am
I've always been interested in leverage and have started a couple of threads on using the Kelley Criterion (aka the maximizing geometric mean). I've ordered the Ayres and Nalebuff book and look forward to reading it.
Yes, I've read your analysis on the Kelly Criterion. To be completely honest (and I will admit I could be totally wrong and I accept that), I'm not quite sure I follow how the Kelly Criterion applies to leveraging stocks. Many assumptions seem to be key in the Kelly game that aren't in stocks.

The Kelly Criterion arises from a coin flip game where when you lose, you lose the entire bet. When you win, you get some extra over your bet. If the game was to be played infinitely, the correct strategy is to bet p-q fraction of your wealth on every flip (p being chances of a win while q are chances of a loss).

Investing in the stock market isn't an infinite number of bets; I only live so many years. I also don't lose the entire quantity on bad years. Nor am I assured a certain payoff on good years. All in all, I can only presume a lot of the the Kelly Criterion boils down to a very simple answer precisely due to many of these simplifying assumptions.
Due to its historic association with the game of blackjack, where Ed Thorp famously applied the Kelly criterion to "Beat the Dealer," people often think of Kelly as useful only to bets. However, the concept of optimizing for geometric mean returns, equivalent to maximizing the expected value of the logarithm of wealth, can be applied over any probability distribution. A very good book on the history of this technique is Poundstone's Fortune's Formula. There are many applications outside of gambling/investing, such as signal processing and entropy.

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.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 9:06 pm
by 305pelusa
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.
inbox788 wrote:
Sun Mar 03, 2019 8:00 pm
I've come across the number 1.6 somewhere as the maximum historic survivable leverage ratio, also from backtesting, but don't recall where. As far as independent coin tosses, daily market fluctuations do appear to be independent, but I'm not convinced they truly are. After 5 or 15 straight up days in a row, do you really think the next day is independent? It's no fair coin or well balanced roulette wheel AFAIK.
I can believe daily market fluctuations are not independent. But I have no way of determining that relationship. So the best I can do with the information I have is to treat it as a coin toss game.

Unlike a coin toss event, however, because they are not independent, it will be possible to look back after 50 years and realize my strategy was nowhere near ideal. I should've bet more on the 23th "toss" (a bull year) and less on the 24th "toss" (a bear year), had I known a bear year was much more likely after a bull (let's just say that's the dependence I learned in retrospect). This is in stark contrast to a coin game where regardless of the results after 50 tosses, if you were to look back at your strategy, you'd know betting uniformly was still ideal.

But I'm cool with that. I do the best with what I have and I know it won't be the ideal; but ideal is only possible to find in retrospect. That's my take.

Re: Lifecycle Investing - Leveraging when young

Posted: Sun Mar 03, 2019 9:13 pm
by 305pelusa
market timer wrote:
Sun Mar 03, 2019 8:53 pm
305pelusa wrote:
Sun Mar 03, 2019 6:34 pm
pezblanco wrote:
Sun Mar 03, 2019 11:47 am
I've always been interested in leverage and have started a couple of threads on using the Kelley Criterion (aka the maximizing geometric mean). I've ordered the Ayres and Nalebuff book and look forward to reading it.
Yes, I've read your analysis on the Kelly Criterion. To be completely honest (and I will admit I could be totally wrong and I accept that), I'm not quite sure I follow how the Kelly Criterion applies to leveraging stocks. Many assumptions seem to be key in the Kelly game that aren't in stocks.

The Kelly Criterion arises from a coin flip game where when you lose, you lose the entire bet. When you win, you get some extra over your bet. If the game was to be played infinitely, the correct strategy is to bet p-q fraction of your wealth on every flip (p being chances of a win while q are chances of a loss).

Investing in the stock market isn't an infinite number of bets; I only live so many years. I also don't lose the entire quantity on bad years. Nor am I assured a certain payoff on good years. All in all, I can only presume a lot of the the Kelly Criterion boils down to a very simple answer precisely due to many of these simplifying assumptions.
Due to its historic association with the game of blackjack, where Ed Thorp famously applied the Kelly criterion to "Beat the Dealer," people often think of Kelly as useful only to bets. However, the concept of optimizing for geometric mean returns, equivalent to maximizing the expected value of the logarithm of wealth, can be applied over any probability distribution. A very good book on the history of this technique is Poundstone's Fortune's Formula. There are many applications outside of gambling/investing, such as signal processing and entropy.

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.
Very interesting, especially that last sentence. I will check out the book. I like reading about this sort of thing and will admit know nowhere near enough of it to intelligently discuss it.