A different approach to asset allocation

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
gchan
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Post by gchan » Sat Mar 21, 2009 1:25 pm

Or, put it another way, you managed to find a really bad way to invest.

Increasing leverage as the market goes down is almost guaranteed to lose you almost all your money. It also helps somewhat to use low diversification and/or very high leverage via options.

Your strategy may have short bursts of extremely good performance, but suffers from gambler's ruin. The strategy has an extremely high chance of going to zero (or rather, less than zero if you are borrowing from credit card companies, relatives, etc.).

2- The paper written by the Yale professors is a bad strategy, but you've managed to find a variation/implementation of it that is much, much worse.

It bears a lot of similarity to the Martingale betting system as somebody else pointed out.

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DRiP Guy
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Post by DRiP Guy » Sat Mar 21, 2009 1:29 pm

Once again, with your mental hedging of reality -- the very behavior that brought you to such dire straits in the first place.

"the Carrot of Debt Repayment"

Puhlease.

Let me explain something -- if you believe at all in capitalism, and/or free and honest trade, and/or barter on a recurrent basis, or the idea of an honest exchange being important to commerce between individuals, then you must realize that trust is the bedrock of all human transactions. If now that you have lost your huge bets and find yourself up the creek without a proverbial paddle, you are going to start making noises about how 'paying of debt is silly when money is an illusion anyway'; 'my health is worth more than clearing some chit at a faceless corporation', 'I refuse to generate filthy lucre for the benefit of others' etc., then you are just doing the same avoidance of reality that got you into this mess.

YOU decided to take on the leverage. YOU decided the upside was oh-so-pretty, and weren't we all chumps for not doing clever moves like you were...

Well, no one was going to step in and take away your money if those bets came in, but apparently they didn't (assuming this is not just one giant Mind Eff___) So now you need to make good on it -- those who don't make good on an obligation are lying cowards, are they not?

You seem to love gettin' all esoteric and eastern philosophy zen on us, and deep into the various mental angles, so heck let's just boil it down to brass tacks and call a spade a spade, and be done with it:

What is a man if his word is worthless? Would I want to travel through life being that man? IS that a man?


If you believe in Karma or something like it, then what is (or should be) in store for that individual when, in his darkest hour of bitter need, he reaches out to accept a hand he expects to be helpful? The circle will be unbroken, by and by... [with apologies to Billy Joel] Old Testament, New Testament, Visha, Khrishna, it's still rock-n-roll to me.

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market timer
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Post by market timer » Sat Mar 21, 2009 2:59 pm

A thought experiment in response to gchan

Consider the value of your stock portfolio. Let's take it to be $500K for this example, and assume those are your only assets. This weekend, suppose the government announces it will offer risk-free securities that yield 10% annually. How much of your portfolio do you sell to buy these new securities? Here's the catch: the bonds mature in a week, and you won't be offered that 10% rate next week.

Like most of you, I'd be concerned about selling much of my stocks to buy these high yielding bonds, since the market could rally the week I'm out of the market. Going back to my original asset allocation would mean that I'm effectively short the market for the week I'm out of it. Perhaps I'd sell $100K of stock, take out $420K as cash to buy the bonds, and leverage the remaining $80K 5x.

If you are familiar with the Kelly criterion, as gchan is, note that it doesn't apply in this case, because we don't intend to use 5x leverage for the long run. Likewise, it doesn't apply to MYR when we are dealing with finite time frames and have cash inflows. Certainly, 5x leverage is a bad policy in the long run, but for a week? Should be fine.

Moreover, note that you would likely choose to have some equity exposure even if the one-week risk-free rate was well above the expected return of equities, such as 16%. This is why it was possible to justify borrowing at 16% for the short run back in October.

Once you are confident that you will own a $500K portfolio, and that becomes your default framework, your risk preferences change. There are cases where you should be willing to pay interest rates that are even above the expected return of equities, if you are certain that you will buy those stocks in the future.

hewhomustnotbenamed
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Post by hewhomustnotbenamed » Sat Mar 21, 2009 3:31 pm

MT, It's not too late to implement my strategy(leveraged emerging markets).

No margin calls and (IMHO) decidedly greater upside potential (than futures) as a result.
I might be crazy but, I ain't stupid.

gchan
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Post by gchan » Sat Mar 21, 2009 5:05 pm

Certainly, 5x leverage is a bad policy in the long run, but for a week? Should be fine.
Not true. In 1987, this would have wiped you out in a day.

There was also a 5-day period last year where the S&P 500 lost 17.5%. (There might be an even worse 5-day period.)

2- The Kelly criterion does apply in the short run. / The same concepts apply.
Like most of you, I'd be concerned about selling much of my stocks to buy these high yielding bonds, since the market could rally the week I'm out of the market.
Uh... making 10% risk-free is a REALLY good investment. Jack Bogle would likely tell you to put 100% of your portfolio into such an investment if there were no transaction costs, taxes, and if such a security existed.
Almost all people on this board would agree that it makes sense to pay off any credit card debt. Failing to pay off credit card debt means that interest rates escalate, you get hit with unfair fees, and there is damage to your credit score.
note that it doesn't apply in this case
You should apply the salient concepts of the Kelly criterion. Don't overbet/overleverage. From what I can tell, you leverage 3 ways: (A) through borrowing money through your broker (B) options (C) borrowing from family + credit card companies. When you do all three things, it is almost certainly too much leverage.
There are cases where you should be willing to pay interest rates that are even above the expected return of equities
This does not make any sense financially. It should be obvious that you should go with the option that has both a higher expected return AND lower risk.

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Post by market timer » Sat Mar 21, 2009 7:25 pm

gchan wrote:You should apply the salient concepts of the Kelly criterion. Don't overbet/overleverage.
Well, I certainly can't argue with that. It is good not to overbet. Of course, the tough part is determining the appropriate bet size.
There are cases where you should be willing to pay interest rates that are even above the expected return of equities
This does not make any sense financially. It should be obvious that you should go with the option that has both a higher expected return AND lower risk.
It does seem paradoxical, huh? You have to frame risk in terms of what you're actually buying, not the volatility of returns. I'll give you an example to clear up this point, where you would borrow at the same rate as the expected return on a risky asset.

Here is a mathematical example. Please ignore the rounding issues. You will be able to save $98 this year and $99 next year, and need to have $200 in today's dollars to fund retirement in the third year. Then you die. There are zero-coupon two-year TIPS that cost $98 and return $100 in two years in today's dollars. The market price of these two-year TIPS fluctuates, so you don't know what they will cost after one year, but based on the real yield curve, they have an expected value of $99 after one year. You can borrow and lend at 1% this year.

What is the least risky way to invest your money? You might tell me just to lend at 1% for the next year, since the NAV for TIPS is volatile, and your money market yields the expected return of the TIPS. In reality, the only way you can guarantee you'll meet your retirement goal is to take your $98 and borrow another $98 at 1% to buy $196 of TIPS and hold them for two years. Then use next year's savings to pay back your 1% loan.

The analysis is similar for equities, real estate, and commodities. Far from an excuse just to use massive leverage, MYR is an attempt to pre-buy as much of my future consumption and investment as possible. I expect to carry six- or seven-figure debts for most of my life.

hewhomustnotbenamed
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Post by hewhomustnotbenamed » Sat Mar 21, 2009 10:38 pm

market timer wrote: I expect to carry six- or seven-figure debts for most of my life.
Well then , it appears you are right on target. :shock:

Just remember credit/(margin requirement), dries/(rises) up just when you need it most esp if you overindulged during boom times.
I might be crazy but, I ain't stupid.

gchan
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Post by gchan » Sun Mar 22, 2009 12:15 am

It does seem paradoxical, huh? You have to frame risk in terms of what you're actually buying, not the volatility of returns. I'll give you an example to clear up this point, where you would borrow at the same rate as the expected return on a risky asset.
You have 2 flawed assumptions here:

A- Is consumption inelastic? In the real world, I think consumption is elastic. If $200 for retirement is unrealistic, you reduce your goals.

Also, you have clearly changed your spending patterns in light of what has happened so I think consumption is definitely elastic / needs to be elastic.

B- In your example, the retirement goal is unreasonable.

An extreme example would be if your retirement goal was $25 Million. To reach that goal, one might have to do really 'stupid' things to have a shot of hitting that goal. You'd have to swing for the fences, and in doing so you might have to do silly stuff like buy lottery tickets.

But that is the wrong way of looking at things here.

2- Let's face it... you've stumbled across one of the best ways to lose money and reduce your retirement funds.

Increasing leverage when the market is down is not a good idea.

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Post by cjking » Sun Mar 22, 2009 6:01 am

This thread is beginning to persuade me that I should buy shares in a small British company called IG Index.

I wonder how many people here are familiar with British spread-betting companies? I don't think anything like them exists in the US, as they would probably be illegal. Despite what you might suppose, they exist primarily to allow people to trade financial markets. The oldest, IG Index, was in fact founded to enable people to trade gold at a time when it was illegal to own it directly.

IG Index allows you to go long or short of almost any major stock, index, currency of commodity traded anywhere in the world. There are probably other things you can trade that slip my mind at the moment. You may use leverage if you wish.

When I opened an account with a couple of spread-betting companies in the 1990's, I recall one of the brochures reassuring me that I shouldn't be nervous about trading against them, that because they hedged their bets in the underlying markets, they were indifferent as to how they turned out. They made their money from quoting marginally wider spreads than they could in turn get in the underlying markets. However, when IG Index went public, on page 13 of the prospectus in a paragraph entitled "Hedging", they explained that, within constraints set by available capital and prudence, they tried as far as possible not to hedge their exposure to customer bets by trading in the underlying markets. They gave as a reason that "The company operates on the assumption that clients are not able to outperform the market in the long run."

A lightbulb went on above my head. This highly successful company, that has been around for decades, relies for its success on the fact that intelligent people, given unfettered access to markets, at fair prices, will consistently lose money. (When I say intelligent people, note that many of their biggest customers are people whose day job it is to trade for institutions.)

IG Index's shares have always been too expensive to tempt me, however they fell recently, and if they fall again, I'm tempted to buy some. This will be my chance to own a portion of what is in effect a hedge fund, one that exists to take the other side of whatever clever people like MT decide to get up to in the markets.

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United
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Post by United » Sun Mar 22, 2009 10:31 pm

Why is there so much MT bashing? His strategy, while flawed in implementation, still seems sound to me. Risk should be measured in dollars, not percent. I'm curious about the associated costs implicit in various forms of leverage (futures, LEAPs, loans, etc).

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Random Musings
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Post by Random Musings » Sun Mar 22, 2009 10:42 pm

United wrote:
Why is there so much MT bashing? His strategy, while flawed in implementation, still seems sound to me. Risk should be measured in dollars, not percent. I'm curious about the associated costs implicit in various forms of leverage (futures, LEAPs, loans, etc).
The problem is with respect to strategy and implementation. Consider a typical "Boglehead" (if there is such one) who is 50/50 equities and bonds who has a reasonable strategy. Perhaps the individual does "stray" from the strategy a little bit, for example they tactically move 5% of their assets based on some valuation methodology or get a little emotional on occasion once or twice and again stray a little bit away from their strategy. End result, probably slightly lower returns but not the end of the world.

With MT's strategy, which you consider "sound", smaller flaws can do far greater damage.

That in itself is a problem. Most investors slightly stray - and some more than others.

RM

hewhomustnotbenamed
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Post by hewhomustnotbenamed » Sun Mar 22, 2009 10:52 pm

United wrote:Why is there so much MT bashing? His strategy, while flawed in implementation, still seems sound to me. Risk should be measured in dollars, not percent. I'm curious about the associated costs implicit in various forms of leverage (futures, LEAPs, loans, etc).
The strategy was not sound to start with, it was doomed to fail in a bear market.

The ironic thing is it's much better to have failed initially than to have waited until 7-10yrs out to blowup.
MT should be thanking his lucky stars.
I might be crazy but, I ain't stupid.

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Post by market timer » Sun Mar 22, 2009 11:03 pm

I'll answer the remaining questions next weekend and post the essay about applied mental accounting. I've never considered myself a market timer, definitely a Boglehead with peculiar ideas on leverage, but will soon make a bet that I believe is correct vs. the market.

cjking
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Post by cjking » Mon Mar 23, 2009 5:31 am

United wrote:Why is there so much MT bashing? His strategy, while flawed in implementation, still seems sound to me. Risk should be measured in dollars, not percent. I'm curious about the associated costs implicit in various forms of leverage (futures, LEAPs, loans, etc).
I don't mean to be a basher, I was slightly supportive of the strategy in principal, at one point. I think I temporarily overlooked something I already knew; blow-up risk should not be taken at all if it isn't necessary. I think I'm frustrated because he appears to want to just resume digging.

Given that the S&P 500 index doesn't know whether you've leveraged your investment in it, presumably it follows that its expected return doesn't compensate you for the blow-up risk the leverage creates. (By way of contrast, it is expected to compensate you for risk in the form of volatility, which is intrinsic to investing in it.)

gchan
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Post by gchan » Mon Mar 23, 2009 8:51 am

Why is there so much MT bashing?
A- I think some people find the behaviour irresponsible.
It may also be contrary to their beliefs (e.g. active management + leverage is un-Boglelike).
B- I think the right thing to do is to point out the flaws in his strategy since it can be so devastating. People were saying that he was going to blow up before he did so.
His strategy, while flawed in implementation, still seems sound to me.
Assuming that the underlying idea is good... I'd point out that a good trade can be overleveraged into a bad one. As in the simplistic 100%/-50% example, overbetting is a bad idea. Leveraging that bet via debt would lead to you losing money instead of making it.

Also, in hindsight, the active management picks did not pan out.

2- Behaviorally, losing a lot of money really fast might cause distress and/or cause you to do stupid things (e.g. credit card debt).
but will soon make a bet that I believe is correct vs. the market.
Oh no....

Even if you're correct, would it really put you ahead? The smarter move is likely to pay off all credit card debt first and repair your credit. Then cancel all but the one card with the lowest limit, and close your IB account. What you're doing probably doesn't make sense.
Last edited by gchan on Mon Mar 23, 2009 9:00 am, edited 1 time in total.

gchan
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Post by gchan » Mon Mar 23, 2009 8:56 am

A lightbulb went on above my head. This highly successful company, that has been around for decades, relies for its success on the fact that intelligent people, given unfettered access to markets, at fair prices, will consistently lose money.
Just because the customers may be stupid doesn't necessarily make the company worth buying. There are casinos that are going out of business.

2- Even if the underlying business is great, its price may exceed its value. You need to make sure you're not overpaying.

3- Market timer uses Interactive Brokers.

4- If you avoid active stock selection, you can beat 90%+ of professional money managers with very little effort. That ain't bad.

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Post by corvus » Mon Mar 23, 2009 9:00 am

cjking wrote: A lightbulb went on above my head. This highly successful company, that has been around for decades, relies for its success on the fact that intelligent people, given unfettered access to markets, at fair prices, will consistently lose money.
Now that's about the surest bet I can think of. With the corollary (exemplified to perfection by MT) that the smarter you think you are, the more money you are going to lose. Being smart is a fine thing, but the test of a person is how they react when they finally find themselves in the company of people at least as smart as they are (and by definition, this is where you are when you are trying to beat the market.) Some people develop a healthy humility, and some cling to a self-destructive delusion that they are the smartest guy in the world, regardless of evidence to the contrary.

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Post by DRiP Guy » Mon Mar 23, 2009 10:15 am

United wrote:Why is there so much MT bashing? His strategy, while flawed in implementation, still seems sound to me. Risk should be measured in dollars, not percent. I'm curious about the associated costs implicit in various forms of leverage (futures, LEAPs, loans, etc).
I can only speak for me:


1) As long as he is talking about his scheme, then my input is pretty much a quizzical and bemused nudge from time to time, about how improbable I think success will be. If that is 'bashing', sorry, but I don't see it that way.

2) However, once he starts indicating, hinting, or otherwise mentioning that a crisis followed by personal default is a 'walk-away and shrug' situation to him, then you bet that gets my own Protestant work-ethic ire up, and I will indeed vociferously comment about moral hazard, personal responsibility and all that. Since I think the ability to shirk responsibility for gambling with other people's funds is EXACTLY what left the global financial situation in it's current tatters, I frankly also would take exception to referring to calling him to task on that point as 'bashing' as well.


Opinions vary.

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DRiP Guy
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Post by DRiP Guy » Mon Mar 23, 2009 10:17 am

market timer wrote:
will soon make a bet that I believe is correct vs. the market.


With what will he be placing this bet? His personal finances are already well underwater, so the 'bet' will necessarily be placed (if he is indeed for real on this or on anything) to be done with other people's money. MT gets the upside if it occurs, but unless I am totally misreading him, he is also more than willing to declare personal bankruptcy and 'clear the slate' if the downside roll comes up.

QED.

gchan
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Post by gchan » Mon Mar 23, 2009 11:56 am

Now that's about the surest bet I can think of.
Let me tell you about those casinos going bankrupt....

And actually, the world's #12 richest person made his money by shifting the emphasis of casinos away from gambling. See
http://www.forbes.com/lists/2008/10/bil ... _ER9O.html

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Post by sommerfeld » Mon Mar 23, 2009 12:30 pm

United wrote:Why is there so much MT bashing?
I'm using MT as a groundhog-like proxy for market sentiment. I think the bear market won't turn around until he sees his shadow and pays off all his debt. I don't think that will happen until either he capitulates voluntarily, or he starts defaulting on loans and people stop lending him money; the latter seems more likely -- if he's still able to borrow or roll over his current debt then the credit bubble still isn't fully deflated.
His strategy, while flawed in implementation, still seems sound to me.
I must disagree. His strategy is a loser's strategy. It will most likely leave him poorer in the long run than simple buy-and-hold investing.

One big problem with leverage is that the market can remain irrational longer than you can remain solvent. The founders of LTCM figured that out the hard way in 1998.

If his strategy were correct, then he'd be getting a free lunch from the banks enabling his leverage -- and in the real world, there ain't no such thing as a free lunch. In reality he's very likely to pay more in interest than he makes from the investments.

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Post by 3CT_Paddler » Tue Mar 24, 2009 1:52 pm

Alex Frakt wrote:
People are swayed by results, not logic. The scale of my losses is beyond what most would consider reasonable, even if I can point to a theoretical justification written by two Yale professors.
Au contraire, it was your logic that various Bogleheads have been arguing with since the day you announced this hypothesis.

As I mentioned back in October[/url], your hypothesis is based on several completely unwarranted assumptions. (Which unfortunately appears to be par for the course among economists.) Chief among them is the assumption that someone embarking on this journey will be able to borrow large multiples of their net worth at the risk-free rate. Your ability to do this was a market failure that will not soon be repeated.

Actually, your credit requirements neatly guarantees the failure of your plan. For it only at times of extremely easy credit that you would be able to accomplish this at all (at least without absurd amounts of leverage, which will also give you a large chance of going broke with the normal movements of the market). Extremely easy credit is one of the defining characteristics of bubbles and is usually followed by a bust that drags down all equities. So the ability to execute your plan is highly correlated with market conditions that will lead to its failure within a a year or two.

I also believe you underestimate the behavioral issues with your plan. We've already seen what happens when things go south, you abandoned your professed limits and repeatedly doubled down on your bets in an attempt to get whole. But what if the markets had gone up? I don't believe for a minute you would have taken your winnings off the table. Instead you would have convinced yourself of your genius in discovering this free lunch and let it ride.

Finally, on your list of signs of gambling problems, you have forgotten the most important one of all. Are you playing with money you can't afford to lose? We have already established that the entire experiment was unnecessary, your current and future earnings were more than sufficient to fund a comfortable lifestyle now and comfortable retirement later by following the type of conventional retirement plan we recommend here. It appears that your future earnings may be sufficient to pull you out of this whole after a couple of years of penury, but it is grossly irresponsible to recommend your path to the approx. 90% who will never earn enough to be able to dig out of such a large hole and still fund their retirements.
Great point about easy credit setting him up for a fall Alex! Like someone else said earlier Market Timer is fortunate to learn these lessons now as opposed to 10 years down the road with more on the line. The only problem is I am not sure you will see the error of your ways.

I look at Market Timer as a living example of what has gone wrong with the big financial players and has produced so much illusionary wealth. He came up with a sophisticated investing scheme using leverage and tons of risk with other people's money and a little bit of his. When the market does well he can reap a tremendous windfall, but a decent drop in the market and his gig is up. He will get bailed out by some family member and never really suffer the consequences of his foolishness because the rest of the family does not want to see their family torn apart.

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Post by gchan » Sat May 02, 2009 1:05 pm

Hmm I think that there is another danger to leverage, in that your broker will make things really bad for you when you do get margin called.

I recently signed up for an Interactive Brokers account and read their customer agreement (I had a lot of time on my hands). READ IT! Basically, Interactive Brokers is allowed to trade against you and they are allowed to put their interests first.

I believe that is why their margin rates are very low and why they are so aggressive about liquidating margin account. They appear to be lower cost than their competitors by a huge margin, but the hidden costs are substantial. (Though it may work out that they are lower cost anyways.)

I believe most brokers engage in some form of sleaziness in one way or another, e.g. payment for order flow (a way for them to receive kickbacks).

Actually, market timer already figured this out already:
IB is a large market maker, and I believe they profit handsomely from the forced liquidations. Since they can control when you sell when you have a deficient margin balance, they have the power to round up the overleveraged investors like cattle and drive us into the arms of market makers in illiquid after-hours markets. The dual broker/market maker functions is a conflict of interest I have not seen mentioned previously. Wide spreads and poor order execution during forced liquidation are hidden costs of leverage, just like insomnia.
I'm not sure why MT is a happy IB customer though.
Last edited by gchan on Sat May 02, 2009 1:15 pm, edited 1 time in total.

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Post by market timer » Sat May 02, 2009 1:13 pm

gchan wrote:Hmm I think that there is another danger to leverage, in that your broker will make things really bad for you when you do get margin called.
I agree and gave a potential mechanism in December:

http://www.bogleheads.org/forum/viewtop ... 341#342341

Anecdotally, I received many margin calls in the after-hours futures markets, which are less liquid and so more easily manipulated. Nowadays, I'm so concerned about the less liquid after-hours markets that I've been using investments that do not trade overnight.

Incidentally, I've taken a hiatus from this thread until my net worth has been increased substantially. Too many people are assuming I'm a deadbeat. My trip to Mexico has been derailed by swine flu (talk about bad timing), so I'm probably going to Spain to pay Don Quixote a visit.

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Post by cjking » Sun Jun 07, 2009 1:37 pm

I've just finished reading Dostoyevsky's "The Gambler."

(Don't read on if you don't want to know plot details.)

I was puzzled why the central character, having won a large fortune, large enough to be turned away from the tables twice because the casino has hit the maximum daily loss it is allowed to sustain, and having run off to Paris with a parasitic floozy who rapidly begins to spend all his money, doesn't care at all about the way she's spending it. She tells him in advance that she's going to spend it, and speaks defensively about her spending, until she realises that he has no interest in monitoring or criticising her.

It's only in thinking back that I realised this was possibly explained in the final pages.
"...No doubt you are in want of money? Here are ten louis d'or from me, I won't give you more, for you'll gamble it away in any case. Take it and good-bye! Take it!"
"No, Mr Astley, after all you have said."
"Ta-ake it!", he cried. "I believe that you are still an honourable man, and I give it as a true friend gives to another friend. If I were sure that you would throw up gambling, leave Homburg and would return to your own country, I would give you a thousand pounds to begin a new career. But I don't give you a thousand pounds: I give you only ten louis d'or just because a thousand pounds and ten louis d'or are just the same to you now; it's all the same, you'll just gamble it away. Take it and good-bye."
I post this here, because aspects of "The Gambler" made me think of this thread, and it reminded me that just because one plays a game with a better expected return than roulette, it doesn't mean a lot of other aspects of what it means to be a gambler don't apply.

It's a short, fast-paced book, an easy and worthwhile read. (Dostoyevsky was a compulsive gambler at one time, he knows his subject.)

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Post by azxcvbnm321 » Mon Jun 08, 2009 8:55 am

But we're all gamblers, at least those of us who have more than 20% of our savings invested in the stock market. Think of what happened during the past year and a half, could you really afford to lose what you did from peak to bottom? Most of us would have to answer no.

We're all gamblers, you can't get an above risk-free return without taking risk.

Give me those ten louis d'or and I'll place them on emerging market. Come on baby, daddy needs a new foreclosed house.

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Post by market timer » Mon Jun 08, 2009 10:14 am

You're right, cjking, I identify with the Alexei Ivanovich character as with many of Dostoevsky's. Gambling not only reduces the mental cost of spending, but also the pleasure of earning. It is a novacaine numbing our sense of responsibility. As the market descended in October, I turned down a side job that paid $150/hr. Why? I'd just lost $150K in two weeks. My savings would be trivial in comparison. It took several months to reset mentally to the point where my savings had any meaning.

Critical to all of this is how risk is framed. Sound framing of risk-taking will preserve the sense that our savings have meaning. I haven't seen anything written about the consequences of asset allocation on motivation, but there may be an argument for a highly conservative allocation if it encourages greater saving. My first experiment in this area will be discussed in "The Carrot of Debt Repayment."

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Post by Ariel » Mon Jun 08, 2009 11:29 am

market timer wrote:Critical to all of this is how risk is framed. Sound framing of risk-taking will preserve the sense that our savings have meaning. I haven't seen anything written about the consequences of asset allocation on motivation, but there may be an argument for a highly conservative allocation if it encourages greater saving.
Hi MT,

Quite some time ago, and on this board, I started a thread and poll about expressing one's equity allocation as a multiple of one's salary. It was my effort to reframe risk in terms of time and work. See link below.

I think it is one approach to connecting motivation to allocation, since we all know our lives are finite and our work lives more or less demanding, more or less rewarding, and in any case also finite.

Best of luck.

http://www.bogleheads.org/forum/viewtopic.php?t=11558
Do what you will, the capital is at hazard ... - Justice Samuel Putnam (1830), as quoted by John Bogle (1994)

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Post by tadamsmar » Mon Jun 08, 2009 1:50 pm

Seems that increased time-diversification of equity holdings for retirement might be a good thing. And, a young investor could reasonably take on leverage of 5-fold for retirement savings in something as risky as US stocks. 10-fold would probably be too much given the history of the market in the 20th century.

Note that this would have to be for retirement-only savings, not some sort of multipurpose savings that was also acting as crypto-disability-insurance. You might have to carry insurance eliminate any shorter term needs for the retirement-savings.

I'd like to see a worked out plan for how one could do this. I am open-minded that this could reduce one's overall risks.

(BTW, I have notice that retirement savings is almost never really pure retirement savings. When young, it might be disability insurance. For the retiree, its a legacy for the kids.)

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Post by chaz » Mon Jun 08, 2009 2:57 pm

tadamsmar wrote:Seems that increased time-diversification of equity holdings for retirement might be a good thing. And, a young investor could reasonably take on leverage of 5-fold for retirement savings in something as risky as US stocks. 10-fold would probably be too much given the history of the market in the 20th century.

Note that this would have to be for retirement-only savings, not some sort of multipurpose savings that was also acting as crypto-disability-insurance. You might have to carry insurance eliminate any shorter term needs for the retirement-savings.

I'd like to see a worked out plan for how one could do this. I am open-minded that this could reduce one's overall risks.

(BTW, I have notice that retirement savings is almost never really pure retirement savings. When young, it might be disability insurance. For the retiree, its a legacy for the kids.)
Only for those of us that have kids and who want to leave a legacy.
Chaz | | “Money is better than poverty, if only for financial reasons." Woody Allen | | http://www.bogleheads.org/wiki/index.php/Main_Page

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Post by DRiP Guy » Mon Jun 08, 2009 6:08 pm

market timer wrote: My first experiment in this area will be discussed in "The Carrot of Debt Repayment."
Most people don't feel the need to either experiment, nor even to write about what they consider the "OBLIGATION of Debt Repayment."

Not quite so exciting, is it?

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Post by hewhomustnotbenamed » Mon Jun 08, 2009 7:24 pm

tadamsmar wrote:Seems that increased time-diversification of equity holdings for retirement might be a good thing. And, a young investor could reasonably take on leverage of 5-fold for retirement savings in something as risky as US stocks. 10-fold would probably be too much given the history of the market in the 20th century.
500% constant leveraging would guarantee blowing out your account in the mildest of bear markets. Only the luckiest of all timers would survive the first bear and you'd better hope you cashed out before the next one.

I love leverage but even double edged swords have a hilt for a reason.
I might be crazy but, I ain't stupid.

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Post by billern » Mon Jun 08, 2009 7:33 pm

DRiP Guy wrote:
market timer wrote: My first experiment in this area will be discussed in "The Carrot of Debt Repayment."
Most people don't feel the need to either experiment, nor even to write about what they consider the "OBLIGATION of Debt Repayment."

Not quite so exciting, is it?
No, it is not exciting. That is why I haven't bought a house! :lol:

But that isn't true for most of my peers who are now significantly underwater on the homes they acquired over the past 5 years. Don't think that market timer is alone in using hazardous amounts of leverage to buy something now and pay for it later.

I'm sure that there are plenty of people who have recently lost $200+K in the housing market.

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Post by DRiP Guy » Mon Jun 08, 2009 10:51 pm

billern wrote:I'm sure that there are plenty of people who have recently lost $200+K in the housing market.
If I believed Zillow, I suppose I could count myself among those who "lost" $120,000.00....

Image

Of course, the way I look at it, I paid off a mortgage of less than 100K off in less than 15 years, and have a paid off home worth about twice what I paid for it. Not bad, and completely acceptable for a guy who thinks of housing as a place to live, not an investment or retirement vehicle.

So, I also did not take out a liar loan, get cash back at close, or default on multiple homes bought in the hopes of flipping them for a quick profit...

So some say that heavy leverage is good, eh? Well, maybe ol' MT can figure out why that is so for him, but for this simple boy I say "Thanks, but no thanks."

8)

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Post by tadamsmar » Tue Jun 09, 2009 3:36 pm

DRiP Guy wrote:
billern wrote:I'm sure that there are plenty of people who have recently lost $200+K in the housing market.
If I believed Zillow, I suppose I could count myself among those who "lost" $120,000.00....

Image

Of course, the way I look at it, I paid off a mortgage of less than 100K off in less than 15 years, and have a paid off home worth about twice what I paid for it. Not bad, and completely acceptable for a guy who thinks of housing as a place to live, not an investment or retirement vehicle.

So, I also did not take out a liar loan, get cash back at close, or default on multiple homes bought in the hopes of flipping them for a quick profit...

So some say that heavy leverage is good, eh? Well, maybe ol' MT can figure out why that is so for him, but for this simple boy I say "Thanks, but no thanks."

8)
So, you don't believe in leverage and your argument against leverage is that you used leverage to buy your home and it turned out really good for you?

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Post by DRiP Guy » Fri Jun 12, 2009 10:26 pm

tadamsmar wrote:
DRiP Guy wrote:
billern wrote:I'm sure that there are plenty of people who have recently lost $200+K in the housing market.
If I believed Zillow, I suppose I could count myself among those who "lost" $120,000.00....

Image

Of course, the way I look at it, I paid off a mortgage of less than 100K off in less than 15 years, and have a paid off home worth about twice what I paid for it. Not bad, and completely acceptable for a guy who thinks of housing as a place to live, not an investment or retirement vehicle.

So, I also did not take out a liar loan, get cash back at close, or default on multiple homes bought in the hopes of flipping them for a quick profit...

So some say that heavy leverage is good, eh? Well, maybe ol' MT can figure out why that is so for him, but for this simple boy I say "Thanks, but no thanks."

8)
So, you don't believe in leverage and your argument against leverage is that you used leverage to buy your home and it turned out really good for you?
My loan was secured with the home at all times, with 20% actual cash down at the start, on a property taking less than 30% of my working net income for mort+tax+ins. I hardly consider that to be heavily leveraged.

You did note the word 'heavy' right? We are trying to debate/discuss honestly, and not use silly unreasonable constructs like equating the naked borrowed funds with no visible means of support approach that some take (MT), to an employed person buying a single conventional primary residence, via conventional mortgage, while living in the home. Right?

:shock:

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Post by mbrasher1 » Sat Jun 13, 2009 12:07 am

I have followed with some interest MT's foray into leveraged positions and have enjoyed his frank commentary.

Nearly every investor still working and saving will make ever larger bets on the stock market, as he contributes more. If we were trying to reduce volatility over one's life, would it not be better to borrow to invest when one is young, and gradually pay down this "investment mortgage" as one ages?

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Post by mtl325 » Sat Jun 13, 2009 12:39 am

mbrasher1 wrote:I have followed with some interest MT's foray into leveraged positions and have enjoyed his frank commentary.

Nearly every investor still working and saving will make ever larger bets on the stock market, as he contributes more. If we were trying to reduce volatility over one's life, would it not be better to borrow to invest when one is young, and gradually pay down this "investment mortgage" as one ages?
I think MT's saga highlights the dangers of this thought process. It increases vol not deceases it. Additionally, it assumes that margin rate < CAGR.

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Post by tadamsmar » Sat Jun 13, 2009 4:52 am

mtl325 wrote:
mbrasher1 wrote:I have followed with some interest MT's foray into leveraged positions and have enjoyed his frank commentary.

Nearly every investor still working and saving will make ever larger bets on the stock market, as he contributes more. If we were trying to reduce volatility over one's life, would it not be better to borrow to invest when one is young, and gradually pay down this "investment mortgage" as one ages?
I think MT's saga highlights the dangers of this thought process. It increases vol not deceases it. Additionally, it assumes that margin rate < CAGR.
You are answering the wrong questions.

Does it increase or decrease an investors likelihood of reaching a retirement goal? Surely you know that avoiding vol can decrease that likelihood.

I have not seen any good analysis on this thread of MTs idea of increasing time diversification via leverage. I know time diversification is a good thing, but I perhaps it's offset by the negatives of youthful leverage.

What I mostly see on this thread are the typical knee-jerk reactions indicating brains in idle.

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Post by market timer » Sat Jun 13, 2009 8:59 am

Not MYR related
Last edited by market timer on Wed Jan 22, 2014 4:02 am, edited 1 time in total.

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Post by norak » Sat Jun 13, 2009 9:16 am

I haven't had time to read this whole thread. I have just read the Mortgage Your Retirement document. I think it makes a lot of sense. Conventional wisdom says you start off with 100% stocks and then move move into bonds. This is based on the assumption that stocks in the long run go up. The historical performance of e.g. the Dow certainly suggests this is the case.

Therefore, if stocks go up in the long run, when you are young you should in theory be leveraged to the max.

The problem I think with this idea is that there is that putting yourself into debt early in life can be dangerous because you may lose your job in a recession.

Furthermore, there is no guarantee that stocks go up in the long run. Even if you diversify over time, that is no guarantee. Efficient market hypothesis states that stock prices should be random. Hence time is irrelevant. Each day is an independent event.

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Post by jeffyscott » Sat Jun 13, 2009 9:34 am

norak wrote:Furthermore, there is no guarantee that stocks go up in the long run.
I think it is even worse. The problem there is even less certainty of stocks going up in the short run. If you are leveraged, you may be wiped out by this short run even though stocks turn out to go up in the long run.

This short run problem was more likely to occur in this particular instance because stock prices were high by historical standards when the MYR began. This would, perhaps, be a less likely problem today (or a few months ago), but the new problem with the concept may be the inability of a young person with no assets to borrow large amounts of money at low interest rates.
press on, regardless - John C. Bogle

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Post by hewhomustnotbenamed » Sat Jun 13, 2009 10:17 am

norak wrote:Furthermore, there is no guarantee that stocks go up in the long run.
Even if it were axiomatic that stocks go up in the long run it's a moot point if too much leverage is employed at any point during the investment time period.

I suspect the plan was doomed to fail even if perfect timing at the outset was made.
That just would have meant the blowout would have happened in the next bear. MT systematically increased risk when he should have reduced it. It stands to reason to me that had MT been successul originally, he would have increased leverage because "the plan had proven wildly profitable"and therefore sealing his fate to an even worse outcome.
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Post by DRiP Guy » Sat Jun 13, 2009 11:01 am

tadamsmar wrote:What I mostly see on this thread are the typical knee-jerk reactions indicating brains in idle.
Like equating a single family primary residence 5.375% APR fixed rate conventional 20% down mortgage, secured with the home, as a 'heavily leveraged' investment of the type MT is fooling about with? Really?

Physician, heal thyself!

:lol:

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Post by gchan » Sat Jun 13, 2009 11:51 am

Does it increase or decrease an investors likelihood of reaching a retirement goal?
In theory it might make sense. But in practice, we've seen it go terribly wrong.

Why mortgage your retirement is a bad idea:

A- If you have financial gambling addictions, MYR justifies it. That is bad.
B- Interactive Brokers will pick you apart every time they liquidate your account. Also, I believe they sell order flow information so evil traders may try to take advantage of that and move prices to force liquidations to profit off them.
C- Gambler's ruin / you need to make sure you don't overbet, otherwise you will be losing money.
D- Future volatility may be higher than past volatility.
etc. etc. etc.

Interesting idea, but now that we've seen it play out, we should recognize that it is a failed idea. And we shouldn't be throwing good money after bad ideas.
Last edited by gchan on Sat Jun 13, 2009 12:10 pm, edited 3 times in total.

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Post by tadamsmar » Sat Jun 13, 2009 12:01 pm

norak wrote:I haven't had time to read this whole thread. I have just read the Mortgage Your Retirement document. I think it makes a lot of sense. Conventional wisdom says you start off with 100% stocks and then move move into bonds. This is based on the assumption that stocks in the long run go up. The historical performance of e.g. the Dow certainly suggests this is the case.

Therefore, if stocks go up in the long run, when you are young you should in theory be leveraged to the max.

The problem I think with this idea is that there is that putting yourself into debt early in life can be dangerous because you may lose your job in a recession.

Furthermore, there is no guarantee that stocks go up in the long run. Even if you diversify over time, that is no guarantee. Efficient market hypothesis states that stock prices should be random. Hence time is irrelevant. Each day is an independent event.
MT is trying to make the long run longer because stocks go up in the long run.

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Post by tadamsmar » Sun Jun 14, 2009 6:25 am

A young person could take risks by seeking employment with small startups that have a chance to grow. If you make a mark at a growing firm then you can end up with a large income and valuable stock. That would perhaps be a better plan.

If you have a good secure job when you are young (say, a federal job) that you want to stay with, then leveraging some of your retirement savings might be OK.

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Post by market timer » Fri Jul 17, 2009 3:42 pm

Image

Net worth: -$157K, up $31K this quarter and $53K since Q4 2008

Second quarter earnings boosted by trading gains from the IRBLTG Fund and higher than expected demand for MT Services.

Initially, IRBLTG was using a naive scalping technique in a variety of futures markets: bonds, stocks, currencies, and commodities. It is unclear whether I added any value ex ante. I was lucky not to lose my shirt (again) before developing a couple of arbitrage strategies, which I first thought about while watching how markets traded during the crash. IRBLTG was started in March due in part to seeing Ariel's trading success on the Time Is Now thread and being fed up with losing money on S&P futures. Even with these successful strategies, my portfolio experienced volatility from discretionary trades that were perhaps ill-advised. Now I'm focusing exclusively on trades where I have a clear advantage, and IRBLTG is up 800%. This may very well become a hedge fund at some point. Risk has been kept low and withdrawals have been taken to pay for living expenses.

MYR was a mistake. I misunderstood the concept of risk and imagined a future too similar to my past.

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Post by Ariel » Sat Jul 18, 2009 10:00 am

Congratulations, MT, on your excellent recent returns. And according to the updated summary post at the beginning of this thread, on paying off your high interest debt.

Now, given the steep and steady slope of your recent returns, are you concerned that you may be taking on more risk than you intend?

Regarding a future hedge fund, two central questions: Do you think the strategy you have is a scalable one? And do you think the strategy is a peristent one, or one that just works well given the particular features of the present market?
Do what you will, the capital is at hazard ... - Justice Samuel Putnam (1830), as quoted by John Bogle (1994)

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Post by market timer » Sat Jul 18, 2009 10:46 am

Ariel wrote:Congratulations, MT, on your excellent recent returns. And according to the updated summary post at the beginning of this thread, on paying off your high interest debt.
Thanks, Ariel. It was discouraging paying 16% interest from October 2008 - May 2009, and having essentially no credit or liquidity for a while, but that gave me the motivation I needed to focus on making money for the first time in my life. I stumbled on a small business idea that is remarkably profitable, could probably earn over $200K/year doing that, plus this trading account is growing like crazy. But I was lucky to get a great job, so I'm going to start in the corporate world.
Now, given the steep and steady slope of your recent returns, are you concerned that you may be taking on more risk than you intend?
Risk management has been critical, because I needed this account to fund European travel and living expenses over the summer. Seriously, this is my rent money. I have a good idea for my risk, but after MYR, I have lost some trust in my future self, and now believe in setting up safeguards to prevent stupid decisions. So I've been withdrawing money, paying back debts, and not really letting profits compound. That's why I chose a linear y-axis instead of logarithmic.
Regarding a future hedge fund, two central questions: Do you think the strategy you have is a scalable one? And do you think the strategy is a peristent one, or one that just works well given the particular features of the present market?
Probably not scalable to $50 million without having to worry about market impact, but certainly scalable to $500K. So, actually, this particular set of ideas isn't as well suited to a hedge fund structure as many others. My philosophy now is that any opportunity is fleeting, so enjoy it while it lasts, and keep an eye open for the next trade. This is such a small account and short trading period that I'm skeptical as well -- in other words, not dropping everything to trade full-time. Too bad I didn't try this last year when I had $100K. Will be interesting to see where things go from here.

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