IPS Crafting for Excellent Adventurers

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Walkure
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IPS Crafting for Excellent Adventurers

Post by Walkure » Wed Mar 13, 2019 5:34 pm

I'm kicking off this thread in the personal investments subforum for those like myself who are putting HEDGEFUNDIE's theory (original thread here: viewtopic.php?f=10&t=272007) into practice with a portion of their portfolios. Hopefully it will serve as a place to discuss issues specific to actually implementing and staying the course with this strategy apart from the arguments about the theory behind the strategy per se.

Here are a few passages which I have drafted for addition to my IPS:
Leveraged assets are to be invested in long-only [non-inverse] ETFs which cannot lose more than 100%. The equivalent-capital-at-risk (ECaR) in leveraged assets shall never exceed 50% of total portfolio ECaR. For example, a holding of $1000 in a 3x ETF has an ECaR of $3000, and must therefore be offset by $3000 in unleveraged assets in the portfolio. As a practical matter, this results in an upper limit for 3x leverage of 25% of the portfolio. Since the leveraged assets have a higher expected return than the unleveraged assets, they must therefore begin with an initial investment considerably less than 25% so that they do not exceed this threshold over the lifetime of the investment. Analysis based on my antipated investment horizon and relative returns suggest an initial leveraged component equal to approximately 9% of my investable assets is appropriate for this purpose.
Note that I totally made up the term ECaR to describe what I was trying to control. If someone knows of a better or more "proper" term for this quantity, please chime in!
My investment performance will be monitored and reported on a quarterly basis coinciding with the final trading day in each of the months of February, May, August, and November. Any rebalancing, where indicated by this tax and allocation considerations, will be effected on this date. For accounts subject to automatic contributions, new monies shall be directed to underweight portions until the target allocation is reached.
I will continue to edit and adjust this post as my draft develops and to incorporate feedback from the community. Thanks in advance for your wise counsel!

MotoTrojan
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Re: IPS Crafting for Excellent Adventurers

Post by MotoTrojan » Wed Mar 13, 2019 5:42 pm

Personally I’d limit contributions and not overall portfolio size; ie. if this is <25% of your portfolio you can allocate up to XX% of your contributions to it.

Would you withdraw if it returned 30% CAGR and quickly became larger than your unleveraged portfolio?

I’d also add plans for handling closing of funds (2x funds, 25-year strips, etc).

HEDGEFUNDIE
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Re: IPS Crafting for Excellent Adventurers

Post by HEDGEFUNDIE » Wed Mar 13, 2019 5:45 pm

I think the majority view is to treat this as a sunk cost.

No new money, no rebalancing into or out of the account.

This is the only way for it to grow at 20% CAGR for decades and make you filthy rich.

dave_k
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Re: IPS Crafting for Excellent Adventurers

Post by dave_k » Wed Mar 13, 2019 7:15 pm

I bit the bullet and put roughly 5% of investable assets into this last week in IRAs (60% TMF, 40% UPRO as originally specified). I'm not planning to treat it as part of the portfolio that would be subject to rebalancing with the rest, but I think it makes sense to have some limited rules for moving money in and out. I haven't formalized it yet, but my thinking so far is as follows:

Each year the balance is below the original balance, make additional contributions to bring it 25% of the way back to the original balance, with a cap of an additional 25% of the original balance in total. This is mainly because I lump summed into it and if my timing happens to be bad, this would partly make up for it by reducing the average cost basis. This could be done annually, or divided up quarterly when rebalancing (7% of the way back each quarter it's below, which compounds to 25% annual).

Each year the balance is over 5x the original balance, withdraw 5% of the amount over 5x the original balance. This allows for some gains to be taken earlier than waiting for huge returns, but no so much that it kills the long term potential. Since I'm in my late 40s and want to retire early, it may make more sense for me to have a strategy like this than for someone 20-30 years from retirement that can wait longer for the benefits. 100x at 75+ with no benefit before isn't really optimal.

I should add an endpoint (50x?) or maybe another withdrawal tier (10% over 20x?), but I haven't decided yet. Maybe the cutoffs should be in inflation adjusted dollars, but in that case the multipliers should probably be lowered somewhat.

Topic Author
Walkure
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Re: IPS Crafting for Excellent Adventurers

Post by Walkure » Thu Mar 14, 2019 9:09 am

HEDGEFUNDIE wrote:
Wed Mar 13, 2019 5:45 pm
I think the majority view is to treat this as a sunk cost.

No new money, no rebalancing into or out of the account.

This is the only way for it to grow at 20% CAGR for decades and make you filthy rich.
Yes, it seems like the two major questions to answer are (1) how much to sink in the first place, and (2) how to decide when you've won the game and what to do when that happens. In a way, I agree with keeping the mental accounting separate for the purpose of answering my first question, but it seems unhelpful to try to maintain it in planning for the second issue. Dave_k is attempting to do just that with the following proposal, where everything is defined in terms of multiples of the original sunk cost, to the exclusion of the rest of the portfolio:
dave_k wrote:
Wed Mar 13, 2019 7:15 pm
Each year the balance is over 5x the original balance, withdraw 5% of the amount over 5x the original balance. This allows for some gains to be taken earlier than waiting for huge returns, but no so much that it kills the long term potential.
A thought exercise: say you start with 100k. You hit the 5x and keep growing, taking a tiny amount off the table. After a few more years you hit 7.5x, or 750k. So in that year you take 5% of 250k, or 12.5k off the table (I'm assuming that's in inflated dollars). This works out to a withdrawal rate of 1.6%, which isn't going to make a dent in the ongoing growth, nor will it make any appreciable difference in your standard of living if you're already planning for a 3 or 4% SWR from the other 80% of your standard BH portfolio. At best, it's just tinkering around the edges and needlessly complicating the withdrawal strategy.

dave_k
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Re: IPS Crafting for Excellent Adventurers

Post by dave_k » Thu Mar 14, 2019 10:59 am

Walkure wrote:
Thu Mar 14, 2019 9:09 am
dave_k wrote:
Wed Mar 13, 2019 7:15 pm
Each year the balance is over 5x the original balance, withdraw 5% of the amount over 5x the original balance. This allows for some gains to be taken earlier than waiting for huge returns, but no so much that it kills the long term potential.
A thought exercise: say you start with 100k. You hit the 5x and keep growing, taking a tiny amount off the table. After a few more years you hit 7.5x, or 750k. So in that year you take 5% of 250k, or 12.5k off the table (I'm assuming that's in inflated dollars). This works out to a withdrawal rate of 1.6%, which isn't going to make a dent in the ongoing growth, nor will it make any appreciable difference in your standard of living if you're already planning for a 3 or 4% SWR from the other 80% of your standard BH portfolio. At best, it's just tinkering around the edges and needlessly complicating the withdrawal strategy.
Ok, say I start with 100k and that's 5% of a $2M portfolio. If this strategy works out and it outpaces the growth of the rest of the portfolio, it will be much more than the 5% it started out as. At 750k, the 12.5k withdrawn may add 5-10% to the total withdrawn (assuming the rest has grown some as well). Not life changing, but noticeable since it could be 10-20% of discretionary spending. Over $1M it starts to make more of a difference, and eventually it could be very significant.

Maybe this isn't optimal and is "tinkering", but it's far from complicated. The rule and the math are no more complicated than rebalancing or tax brackets. You do have a point that it makes very little dent in the further growth, and not a huge increase in spending (at first anyway). My takeaway from that is I could get away with a larger withdrawal and/or a lower threshold. The point for me is to balance letting a lot of it compound for a long time against getting something from it before I'm too old to care.

As I said in my original post, a withdrawal strategy like this makes less sense for someone with a few decades to go before they would want to touch it at all. I may be too old to take the best advantage of this "excellent adventure", but it seems worthwhile to give it a shot and find some way to benefit if it starts to work out in the next couple decades. I'm certainly open to other ideas for a strategy that could accomplish this.

Topic Author
Walkure
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Re: IPS Crafting for Excellent Adventurers

Post by Walkure » Fri Mar 15, 2019 12:44 pm

dave_k wrote:
Thu Mar 14, 2019 10:59 am
Ok, say I start with 100k and that's 5% of a $2M portfolio. If this strategy works out and it outpaces the growth of the rest of the portfolio, it will be much more than the 5% it started out as. At 750k, the 12.5k withdrawn may add 5-10% to the total withdrawn (assuming the rest has grown some as well). Not life changing, but noticeable since it could be 10-20% of discretionary spending. Over $1M it starts to make more of a difference, and eventually it could be very significant.

Maybe this isn't optimal and is "tinkering", but it's far from complicated. The rule and the math are no more complicated than rebalancing or tax brackets. You do have a point that it makes very little dent in the further growth, and not a huge increase in spending (at first anyway). My takeaway from that is I could get away with a larger withdrawal and/or a lower threshold. The point for me is to balance letting a lot of it compound for a long time against getting something from it before I'm too old to care.

As I said in my original post, a withdrawal strategy like this makes less sense for someone with a few decades to go before they would want to touch it at all. I may be too old to take the best advantage of this "excellent adventure", but it seems worthwhile to give it a shot and find some way to benefit if it starts to work out in the next couple decades. I'm certainly open to other ideas for a strategy that could accomplish this.
Fair enough, Dave, and I understand the appeal of starting withdrawals earlier rather than waiting for decades for an investor closer to retirement age. In my case, and I think this applies to most of us who are jumping onboard with Hedgefundie, the larger concern is that the size of this thing will start to destabilize/overshadow our larger portfolio long before we actually need to start tapping the funds. So in a sense, I face a different kind of decision, if I need to start drawing this down while my primary portfolio is still in accumulation rather than for current spending. I was reacting to your "complexity" of having two withdrawal streams operating independently, whereas my preference would be to let it run for x years, declare victory, then liquidate and merge with my primary portfolio which will be optimized for overall SWR. I suppose that's just a different form of suboptimal :wink:
It seems that Hedgefundie's own approach toward the sunk cost is to totally exclude it from the IPS as if it didn't exist. That's another valid way of treating it. My reason for including it in the IPS is not that I need to do so (indeed, I wouldn't be in this strategy if I couldn't afford to lose it all) but rather because the failure of this strategy going forward is far more likely to come from behavioral mistakes than actual adverse market performance. Consequently, I think that specifying rules in advance will actually improve my odds. In short, my plan does not depend upon success, but success depends on having a plan.

MotoTrojan
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Re: IPS Crafting for Excellent Adventurers

Post by MotoTrojan » Fri Mar 15, 2019 12:49 pm

HEDGEFUNDIE wrote:
Wed Mar 13, 2019 5:45 pm
I think the majority view is to treat this as a sunk cost.

No new money, no rebalancing into or out of the account.

This is the only way for it to grow at 20% CAGR for decades and make you filthy rich.
I’m with you there but only having $20K in Roth right now has me wanting to toss a few more years of contributions in. I think my 30th birthyear could be a good cutoff.

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aj76er
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Re: IPS Crafting for Excellent Adventurers

Post by aj76er » Fri Mar 15, 2019 2:08 pm

Thanks for starting this thread. I have no hard set rules in my IPS yet, but I've been contemplating adding statements similar to the following:
1. Limit of the amount of total principle I can invest in the strategy.
2. Treat the principle invested as a sunk cost.
3. Set an exit point from the strategy when the value reaches a certain target (e.g. $1m, $5m, $10m, etc..) or a preset total time has elapsed (e.g. 15yrs, 20yrs, etc..)

For #1, it's important to think about how much you is willing to lose if the 3X funds go to zero.
For #3, I think it would be hard to risk the amount if it grew as large as a traditional retirement portfolio (e.g. ~$2m). Furthermore, 20yrs of rollercoaster rides would probably be enough regardless of the outcome. After 20yrs, the strategy either failed miserably, kept pace with the unleveraged market (neither fail or succeed), or has made you filthy rich (a resounding success).
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

HEDGEFUNDIE
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Re: IPS Crafting for Excellent Adventurers

Post by HEDGEFUNDIE » Sat Mar 16, 2019 7:31 am

aj76er wrote:
Fri Mar 15, 2019 2:08 pm
Thanks for starting this thread. I have no hard set rules in my IPS yet, but I've been contemplating adding statements similar to the following:
1. Limit of the amount of total principle I can invest in the strategy.
2. Treat the principle invested as a sunk cost.
3. Set an exit point from the strategy when the value reaches a certain target (e.g. $1m, $5m, $10m, etc..) or a preset total time has elapsed (e.g. 15yrs, 20yrs, etc..)

For #1, it's important to think about how much you is willing to lose if the 3X funds go to zero.
For #3, I think it would be hard to risk the amount if it grew as large as a traditional retirement portfolio (e.g. ~$2m). Furthermore, 20yrs of rollercoaster rides would probably be enough regardless of the outcome. After 20yrs, the strategy either failed miserably, kept pace with the unleveraged market (neither fail or succeed), or has made you filthy rich (a resounding success).
+1

HawkeyePierce
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Re: IPS Crafting for Excellent Adventurers

Post by HawkeyePierce » Sun Mar 17, 2019 11:40 am

I've added it to my IPS with a threshold qualifier: "When my portfolio reaches $500,000, I will consider investing between 10% and 15% in a risk parity strategy of 60% leveraged long-term Treasuries and 40% leveraged S&P500 equities. No further contributions to this allocation will be made. I will rebalance quarterly on the same schedule as the rest of my portfolio."

At the moment I'm at about half that amount so it'll be a couple years before I reach that threshold. Moving 15% of my current investable assets seems too small to be worth it.
Last edited by HawkeyePierce on Sun Mar 17, 2019 1:33 pm, edited 1 time in total.

siriusblack
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Re: IPS Crafting for Excellent Adventurers

Post by siriusblack » Sun Mar 17, 2019 12:57 pm

Folks, I've been following this thread and it's pretty tempting to try this with a small % of portfolio. However, I also feel like we're at very high valuations and it just doesn't seem like the right time. Just hate the idea of going into a 3X strategy and then having it immediately turn hugely negative. (I know in theory the bonds will offset at least partially.) I'm thinking about (a) waiting for a correction of 10% or more to dip my toe into the strategy with a small amount (e.g. 10K in one of our Roth IRA's which for me is ~1.5% of portfolio), and (b) waiting for a correction of 20% or more to increase allocation to this strategy to maybe 20K. Thoughts?

HEDGEFUNDIE
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Re: IPS Crafting for Excellent Adventurers

Post by HEDGEFUNDIE » Sun Mar 17, 2019 6:14 pm

siriusblack wrote:
Sun Mar 17, 2019 12:57 pm
Folks, I've been following this thread and it's pretty tempting to try this with a small % of portfolio. However, I also feel like we're at very high valuations and it just doesn't seem like the right time. Just hate the idea of going into a 3X strategy and then having it immediately turn hugely negative. (I know in theory the bonds will offset at least partially.) I'm thinking about (a) waiting for a correction of 10% or more to dip my toe into the strategy with a small amount (e.g. 10K in one of our Roth IRA's which for me is ~1.5% of portfolio), and (b) waiting for a correction of 20% or more to increase allocation to this strategy to maybe 20K. Thoughts?
You should probably ask Market Timer for advice.

EDIT: Or read samsdad’s posts on Bob, the world’s worst market timer, for reassurance.

badapu
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Re: IPS Crafting for Excellent Adventurers

Post by badapu » Tue Mar 19, 2019 11:15 pm

Special considerations for using in taxable account? What would be taxation if I reinvest all dividends? My tax bracket is high. I presume this strategy will lead to a lot of dividend income. Do not have enough money / space in non taxable.
How much should I discount the CAGR on account of taxation?

HEDGEFUNDIE
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Re: IPS Crafting for Excellent Adventurers

Post by HEDGEFUNDIE » Tue Mar 19, 2019 11:17 pm

badapu wrote:
Tue Mar 19, 2019 11:15 pm
Special considerations for using in taxable account? What would be taxation if I reinvest all dividends? My tax bracket is high. I presume this strategy will lead to a lot of dividend income. Do not have enough money / space in non taxable.
How much should I discount the CAGR on account of taxation?
The dividends are not a big deal but the rebalancing will be. You’ll have years with huge capital gains.

If you are doing this in taxable, I would recommend only rebalancing once a year to take advantage of LTCG rates.

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