Lifecycle Investing - Leveraging when young

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Re: Lifecycle Investing - Leveraging when young

Post by EfficientInvestor »

Steve Reading wrote: Thu Jun 18, 2020 1:03 pm That's my bad, I definitely misspoke there. Around 1.4% is what I found a week ago when looking at some options. I didn't mean to say that was the case with futures. I just plugged some in my spreadsheet and I see a financing rate of 0.41% so pretty close to what you say.
The 60/40 unfortunately brutalizes me but great catch nonetheless. If I assume stocks go up 6% per year, a 60/40 takes a chunk of almost a third of that in my bracket. It's like paying 0.41% in financing, 1-2% in taxes. Meh.

As for the options strategy, you're talking about establishing a collar right? I gave it a bit of thought actually (it has been talked about before in this forum). I have to think it a little more.

Also, question for you. I do have a Roth. I'd be willing to leverage that using futures. With two E Micros, I could hit 2:1 (thank god for those tiny contracts). What place is good to trade futures in a Roth? Just tell me where, I know you're the guy who has given this a million hours of thought haha.
Yes, it's effectively a collar strategy. I would say it's a modified collar because you are not using the same expiration for the put and call. Here are some numbers to give you a head start on the analysis:

Let's assume you are leveraged 2:1 and want to insure against a risk of ruin. SPY is currently 311. If you are leveraged 2:1, you want to avoid a situation where the S&P drops by 50%. Therefore, lets assume you want to buy a 160 PUT.

- The price for the June 2022 SPY 160 PUT = $6.02 (this is current MID and there is a sizable spread that deep in the money, so you might only be able to get a fill around 6.20 or so). Theta = -1.495.
- The Theta on the June 2021 SPY 160 PUT = -1.804. Therefore, your average theta decay over the next year might be around -1.65.
- Note that you could get an even lower theta if you use the Dec 2022 contracts. You'll just have to pay more up front for the contract.
- Now let's assume you want to sell some ~30 delta calls to offset the premium. The SPY 322 call that expires in 29 days is going for $3.69. It has a delta of 0.30 and a theta of 11.43. That means you would only have to sell about 1 call for every 7 puts in order to offset the -1.65 theta you're paying for the puts. Take this with a grain of salt though given the elevated pricing due to the VIX being so high. In more normal times (VIX around 15), you would probably be able to offset theta decay by selling 1 call for every 4 puts.
- If you wanted to buy even more insurance, you could roll up to a higher price for the puts, but you'll have to pay out a higher theta for that privilege.

As for brokerage...my favorite is TastyWorks. Their whole platform is geared towards the individual option/futures trader and they allow you to trade options on futures in a retirement account. Interactive Brokers is also good, but I like the user experience better on TastyWorks.
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Steve Reading
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

EfficientInvestor wrote: Thu Jun 18, 2020 1:27 pm
Steve Reading wrote: Thu Jun 18, 2020 1:03 pm That's my bad, I definitely misspoke there. Around 1.4% is what I found a week ago when looking at some options. I didn't mean to say that was the case with futures. I just plugged some in my spreadsheet and I see a financing rate of 0.41% so pretty close to what you say.
The 60/40 unfortunately brutalizes me but great catch nonetheless. If I assume stocks go up 6% per year, a 60/40 takes a chunk of almost a third of that in my bracket. It's like paying 0.41% in financing, 1-2% in taxes. Meh.

As for the options strategy, you're talking about establishing a collar right? I gave it a bit of thought actually (it has been talked about before in this forum). I have to think it a little more.

Also, question for you. I do have a Roth. I'd be willing to leverage that using futures. With two E Micros, I could hit 2:1 (thank god for those tiny contracts). What place is good to trade futures in a Roth? Just tell me where, I know you're the guy who has given this a million hours of thought haha.
Yes, it's effectively a collar strategy. I would say it's a modified collar because you are not using the same expiration for the put and call. Here are some numbers to give you a head start on the analysis:

Let's assume you are leveraged 2:1 and want to insure against a risk of ruin. SPY is currently 311. If you are leveraged 2:1, you want to avoid a situation where the S&P drops by 50%. Therefore, lets assume you want to buy a 160 PUT.

- The price for the June 2022 SPY 160 PUT = $6.02 (this is current MID and there is a sizable spread that deep in the money, so you might only be able to get a fill around 6.20 or so). Theta = -1.495.
- The Theta on the June 2021 SPY 160 PUT = -1.804. Therefore, your average theta decay over the next year might be around -1.65.
- Note that you could get an even lower theta if you use the Dec 2022 contracts. You'll just have to pay more up front for the contract.
- Now let's assume you want to sell some ~30 delta calls to offset the premium. The SPY 322 call that expires in 29 days has a delta of 0.30 and a theta of 11.43. That means you would only have to sell about 1 call for every 7 puts in order to offset the -1.65 theta. Take this with a grain of salt though given the elevated pricing due to the VIX being so high. In more normal times (VIX around 15), you would probably be able to offset theta decay by selling 1 call for every 4 puts.
- If you wanted to buy even more insurance, you could roll up to a higher price for the puts, but you'll have to pay out a higher theta for that privilege.

As for brokerage...my favorite is TastyWorks. Their whole platform is geared towards the individual option/futures trader and they allow you to trade options on futures in a retirement account. Interactive Brokers is also good, but I like the user experience better on TastyWorks.
Thanks, very helpful that you've gone through an example. It's ultimately the same as just doing a Bull Spread if I'm not mistaken. I think you might've suggested that back when I was considering using just call options, but didn't like the high implicit financing. One issue is that the short call has reasonable delta. At 0.3, that's 30% chance it finishes ITM and starts to produce losses. These losses are effectively expressed in the financing rate of the strategy. And the reverse for the puts of course.

It's still attractive in that my financing costs become more like 1.2% most of the time, they become much less if SPY drops (puts begin to appreciate) and increases past 1.2% if SPY rises. To the extent I'm ok paying more to borrow if stocks go up, it's an attractive proposition.

If buying 7 puts and selling 1 call allows me to leverage another 700 shares, then it's still overwhelmingly positive delta (+7 - 7*0.05 - 0.3 = +6.45) so it works in that sense. The collar would let me get increased exposure to stocks, today, without the risk of forced liquidation, at the cost of paying more in financing if SPY does rise. Would that be a fair summary?

Will consider IB I think. Keeping everything integrated.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by EfficientInvestor »

Steve Reading wrote: Thu Jun 18, 2020 1:56 pm Thanks, very helpful that you've gone through an example. It's ultimately the same as just doing a Bull Spread if I'm not mistaken. I think you might've suggested that back when I was considering using just call options, but didn't like the high implicit financing. One issue is that the short call has reasonable delta. At 0.3, that's 30% chance it finishes ITM and starts to produce losses. These losses are effectively expressed in the financing rate of the strategy. And the reverse for the puts of course.

It's still attractive in that my financing costs become more like 1.2% most of the time, they become much less if SPY drops (puts begin to appreciate) and increases past 1.2% if SPY rises. To the extent I'm ok paying more to borrow if stocks go up, it's an attractive proposition.

If buying 7 puts and selling 1 call allows me to leverage another 700 shares, then it's still overwhelmingly positive delta (+7 - 7*0.05 - 0.3 = +6.45) so it works in that sense. The collar would let me get increased exposure to stocks, today, without the risk of forced liquidation, at the cost of paying more in financing if SPY does rise. Would that be a fair summary?

Will consider IB I think. Keeping everything integrated.
I'd say it is a fair enough summary. But I would say that you don't necessarily pay higher financing if SPY rises. For instance, as long as SPY stays below 322 in 29 days, you keep all the premium and then get to roll up and out another month. If SPY really spikes up and your short goes from a .30 delta to a .90 delta as you get closer to expiration, you don't have to roll out to the .30 delta for the following month. You could roll up just part of the way to maybe the .70 delta and give SPY a chance to come back down to you. Or just keep doing that partial roll up until you catch back up to the underlying price. On the other hand, if you just keep selling the .30 delta call every month regardless (like the BXMD index does) you are susceptible to getting whipsawed back and forth.
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Re: Lifecycle Investing - Leveraging when young

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EfficientInvestor wrote: Thu Jun 18, 2020 1:27 pm Yes, it's effectively a collar strategy. I would say it's a modified collar because you are not using the same expiration for the put and call
Ok thought about it and came to the following conclusion. I think I can analyze each part of the strategy in chunks:
- The purpose of the put is to increase leverage at the expense of increased financing rate. Buying puts gets me closer to my target for two reasons: it increases borrowing costs (lower desired allocation to stocks) and allows me to leverage further safely. So because I can't hit my desired target right now with 1.5:1 leverage and no puts, it stands to reason the logical thing would be to buy puts and leverage further until I hit the perfect balance between additional financing costs and stock allocation with such financing costs. The benefits of temporal diversification would make up for it.

- Selling calls, I think, could be thought of as something apart from the above. I could sell some very OTM, some close-to-the-money, and at some arbitrary expiration date. All that does is decrease the "financing" costs of margin + puts. I could even sell more calls than even needed to offset the put premiums and effectively achieve a lower financing costs than just margin. I could even achieve negative financing cost.

So I think the question is "once I've hit the combined leverage + put that achieves temporal diversification, does it make sense to sell calls to reduce financing, making it more desirable to get back to higher stock allocations?". And I think the answer is "no, it doesn't". I'm not sure there's a free lunch apart from temporal diversification. Selling a call must reduce financing costs by the same amount that it makes the stock allocation less attractive in the Merton equation (due to the limited upside).

It makes more sense in my head but I'm thinking Lifecycle Investing here might be these stages:
1) Use leverage and puts to achieve your desired exposure since the beginning, today.
2) As you save, use slightly less leverage and fewer puts to hit your target allocation.
3) At some point, you can hit your target with just leverage, no puts (financing cost is the lowest it will ever get).
4) Now delever.
5) Once fully delevered, begin to buy bonds.

It makes sense in my head at least. Curious as to your thoughts.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

EfficientInvestor wrote: Thu Jun 18, 2020 2:34 pm
Steve Reading wrote: Thu Jun 18, 2020 1:56 pm Thanks, very helpful that you've gone through an example. It's ultimately the same as just doing a Bull Spread if I'm not mistaken. I think you might've suggested that back when I was considering using just call options, but didn't like the high implicit financing. One issue is that the short call has reasonable delta. At 0.3, that's 30% chance it finishes ITM and starts to produce losses. These losses are effectively expressed in the financing rate of the strategy. And the reverse for the puts of course.

It's still attractive in that my financing costs become more like 1.2% most of the time, they become much less if SPY drops (puts begin to appreciate) and increases past 1.2% if SPY rises. To the extent I'm ok paying more to borrow if stocks go up, it's an attractive proposition.

If buying 7 puts and selling 1 call allows me to leverage another 700 shares, then it's still overwhelmingly positive delta (+7 - 7*0.05 - 0.3 = +6.45) so it works in that sense. The collar would let me get increased exposure to stocks, today, without the risk of forced liquidation, at the cost of paying more in financing if SPY does rise. Would that be a fair summary?

Will consider IB I think. Keeping everything integrated.
I'd say it is a fair enough summary. But I would say that you don't necessarily pay higher financing if SPY rises. For instance, as long as SPY stays below 322 in 29 days, you keep all the premium and then get to roll up and out another month. If SPY really spikes up and your short goes from a .30 delta to a .90 delta as you get closer to expiration, you don't have to roll out to the .30 delta for the following month. You could roll up just part of the way to maybe the .70 delta and give SPY a chance to come back down to you. Or just keep doing that partial roll up until you catch back up to the underlying price. On the other hand, if you just keep selling the .30 delta call every month regardless (like the BXMD index does) you are susceptible to getting whipsawed back and forth.
Yes, I know the "higher financing cost" isn't a certainty. But it's certainly a possibility, that's why they pay you to sell it.

I agree there's other things that I could do. If I sell a large enough call that offsets the puts completely and the calls never go ITM, that would obviously be having my cake and eating it too. But something tells me that selling the calls shouldn't have an effect on my desired allocation to stocks. It decreases the financing costs by offsetting the puts, but it must somehow cap upside of stocks by a similar amount.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

Steve Reading wrote: Thu Jun 18, 2020 2:56 pm 1) Use leverage and puts to achieve your desired exposure since the beginning, today.
I just did the math. If I leveraged 2:1 and bought puts at SPY 200, I would be way over my lifecycle stock recommended allocation (the borrowing cost is too high). If I leveraged 1.75:1 and bought puts at SPY 170, my borrowing costs go up to 2.5% roughly. This decreases my desired allocation to stocks which, combined with the 1.75 leverage, actually works out. So I suppose right now, I could leverage up to 1.75 and buy puts.

The difference between leveraging 1.5 and 1.75 right now is just an extra 80k in stocks. I think I'd rather just stay at 1.5 leverage, save the money on the puts and accept that I'll be a little un-diversified temporally. Close enough is close enough.

Once again, completely independent of that, I could sell some calls to further reduce my financing costs but since I wouldn't do that even if unleveraged, I'm not sure it makes sense when leveraged either. The additional premium, in my mind, must be offset by the limited participation in stocks somehow.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

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Steve Reading wrote: Wed Jun 17, 2020 5:40 pm Got a question you might be able to answer.

Currently considering moving to IB and using margin. After-tax, it's the cheapest route for me right now.

Looking to use about 1.4:1 leverage. That could withstand about a 60%+ drop without a margin call. I feel all right with that.
But I am concerned about a flash crash like that of 2010 where some of my positions (say, VBR or FNDE, etc) suddenly drop 90%+ for a couple of minutes and then get back to normal. I mean, IWF traded for a penny during 2010. If IB just liquidates me, that would be a huge problem.

My understanding is the LULD (which does include all of my ETFs right now) should prevent this issue. So it would appear I'm OK after all. I could sign up for portfolio margin to increase my margin requirement cushion as well.

Any thoughts on this and how IB handles this sort of stuff? Am I overthinking it (i.e. LULD basically does solve my problem), or is this an actual problem that basically every IB margin trader has to consider?
Yes, I believe this is a risk. IB aggressively liquidates positions, so a flash crash leaves you exposed to liquidation risk if you have any margin. I am not sure how IB handled the May 2010 flash crash in particular. My guess is they did not liquidate ETF holders (and certain stocks) en masse during those few moments of panic, or else we would have heard about it.
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Re: Lifecycle Investing - Leveraging when young

Post by Callisto »

I read the discussion related to LETFs vs options and futures ~5 pages back. I don't know if I missed it somewhere in the earlier pages, or if I have fundamental misunderstandings, but I'm wondering if LETFs could situationally be the most tax efficient, given you could sell and realize the LTCG significantly later in life. I'm already 100% Hedgefundie in my tax advantaged accounts, so everything below refers to a standard taxable account.

For example, I'm 25, single, living in Massachusetts. My total income is 170-190k, which puts me in the 15% federal and ~5% state LTCG bracket. My plan is to retire relatively early, meet and marry someone, move to a state with no state capital gains tax, and live at the tip of the 0% federal capital gains bracket.

If I used futures or options, I feel like I'd be in a world of hurt as while I'm accumulating in the next few years, I'll be paying a heft federal and state LTCG. So instead, I've been buying SSO, since I don't need to realize those LTCG until much later in life and pay 0%.

I remember from the discussion a few pages back that I'll need to more actively manage my leverage with LETFs due to the daily rebalancing, which I plan to do by using my bimonthly paychecks. I'll only sell and incur LTCG if my leverage ratio deviates super heavily.

So if a person's plan is to FIRE, LETFs(maybe even in conjunction with options/futures) might make sense? It seems to me that the the tax advantages would be far more significant than the higher borrowing costs, and that unless the market is extremely volatile, they wouldn't rebalance so much that they end up paying more taxes.
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Re: Lifecycle Investing - Leveraging when young

Post by whodidntante »

market timer wrote: Fri Jun 19, 2020 3:30 am IB aggressively liquidates positions, so a flash crash leaves you exposed to liquidation risk if you have any margin. I am not sure how IB handled the May 2010 flash crash in particular. My guess is they did not liquidate ETF holders (and certain stocks) en masse during those few moments of panic, or else we would have heard about it.
Was anyone on this forum actually able to buy at flash crash prices or actually sold (for trailing stop or any reason) at those prices? My understanding is was more of a theoretical concern and that very few transactions occurred at those prices. If I had a buy order at 50% of the market price during the flash crash, I would not have expected it to get filled, so it's one of those prices you can never get.

So even if IB is aggressive and you get liquidated, it won't be at flash crash prices. At least that's my conjecture. There would be nothing stopping one from buying back the shares, though you might have lost a modest percentage.

If flash crash prices are actually attainable, I think I'll leave a bottom fishing GTC limit buy order open in all my accounts. Just in case. :happy
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew »

whodidntante wrote: Sun Jun 28, 2020 12:49 pm If flash crash prices are actually attainable, I think I'll leave a bottom fishing GTC limit buy order open in all my accounts. Just in case. :happy
Intriguing possibility.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

whodidntante wrote: Sun Jun 28, 2020 12:49 pm
market timer wrote: Fri Jun 19, 2020 3:30 am IB aggressively liquidates positions, so a flash crash leaves you exposed to liquidation risk if you have any margin. I am not sure how IB handled the May 2010 flash crash in particular. My guess is they did not liquidate ETF holders (and certain stocks) en masse during those few moments of panic, or else we would have heard about it.
Was anyone on this forum actually able to buy at flash crash prices or actually sold (for trailing stop or any reason) at those prices? My understanding is was more of a theoretical concern and that very few transactions occurred at those prices. If I had a buy order at 50% of the market price during the flash crash, I would not have expected it to get filled, so it's one of those prices you can never get.

So even if IB is aggressive and you get liquidated, it won't be at flash crash prices. At least that's my conjecture. There would be nothing stopping one from buying back the shares, though you might have lost a modest percentage.

If flash crash prices are actually attainable, I think I'll leave a bottom fishing GTC limit buy order open in all my accounts. Just in case. :happy
Put them in for VTI, VBR and FNDC. If I’m gonna get liquidated by a flash crash, I’d feel better if it was fellow BHs that ended up with my shares.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by market timer »

whodidntante wrote: Sun Jun 28, 2020 12:49 pmWas anyone on this forum actually able to buy at flash crash prices or actually sold (for trailing stop or any reason) at those prices? My understanding is was more of a theoretical concern and that very few transactions occurred at those prices. If I had a buy order at 50% of the market price during the flash crash, I would not have expected it to get filled, so it's one of those prices you can never get.

So even if IB is aggressive and you get liquidated, it won't be at flash crash prices. At least that's my conjecture. There would be nothing stopping one from buying back the shares, though you might have lost a modest percentage.

If flash crash prices are actually attainable, I think I'll leave a bottom fishing GTC limit buy order open in all my accounts. Just in case. :happy
According to Wikipedia, 8 companies in the S&P 500 traded at $0.01 during the flash crash: https://en.wikipedia.org/wiki/2010_flash_crash

I don't know the volume that was traded at $0.01. The SEC ended up nullifying many of these trades.
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Re: Lifecycle Investing - Leveraging when young

Post by RayKeynes »

Can someone list all relevant studies concerning what leverage ratio is best for good long-term results aka 25 years?
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Re: Lifecycle Investing - Leveraging when young

Post by langlands »

RayKeynes wrote: Thu Jul 02, 2020 1:02 pm Can someone list all relevant studies concerning what leverage ratio is best for good long-term results aka 25 years?
Pretty broad question, and probably depends on how you define "good long-term" results, i.e. you need to define your utility function. If my understanding of this entire thread of lifecycle investing is roughly correct, the point isn't to find the optimal overall leverage ratio. The idea is that you decide on an overall leverage ratio (~0.75 to 1 for a lot of people) and then you spread that leverage out over time to decrease risk (so you take on very high leverage, possibly greater than 2 when young, and then decrease it to below 1 when old).

If your interest isn't lifecycle investing but instead the best leverage ratio to maximize CAGR for a fixed portfolio (no new money coming in), then the following two articles might be of interest:

https://www.bradford-delong.com/2017/07 ... ompos.html

http://ddnum.com/articles/leveragedETFs.php

My interpretation of all of this is that a leverage somewhere between 1.5-2 for the S&P 500 is very aggressive but likely to present out-sized returns over the next 25 years. Note that this analysis is orthogonal, but not in contradiction with lifecycle investing. Having decided that an overall leverage ratio of 1.5-2 is what you desire, you can then go down a path of "high-octane" lifecycle investing. This might call for leverage up to even 5-10x when younger...of course this is risky for all sorts of reasons and caution is well advised.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

langlands wrote: Thu Jul 02, 2020 3:55 pm
RayKeynes wrote: Thu Jul 02, 2020 1:02 pm Can someone list all relevant studies concerning what leverage ratio is best for good long-term results aka 25 years?
Pretty broad question, and probably depends on how you define "good long-term" results, i.e. you need to define your utility function. If my understanding of this entire thread of lifecycle investing is roughly correct, the point isn't to find the optimal overall leverage ratio. The idea is that you decide on an overall leverage ratio (~0.75 to 1 for a lot of people) and then you spread that leverage out over time to decrease risk (so you take on very high leverage, possibly greater than 2 when young, and then decrease it to below 1 when old).

If your interest isn't lifecycle investing but instead the best leverage ratio to maximize CAGR for a fixed portfolio (no new money coming in), then the following two articles might be of interest:

https://www.bradford-delong.com/2017/07 ... ompos.html

http://ddnum.com/articles/leveragedETFs.php

My interpretation of all of this is that a leverage somewhere between 1.5-2 for the S&P 500 is very aggressive but likely to present out-sized returns over the next 25 years. Note that this analysis is orthogonal, but not in contradiction with lifecycle investing. Having decided that an overall leverage ratio of 1.5-2 is what you desire, you can then go down a path of "high-octane" lifecycle investing. This might call for leverage up to even 5-10x when younger...of course this is risky for all sorts of reasons and caution is well advised.
Using the Ayres and Nalebuff data, and assuming callable debt (i.e. you have to reset leverage monthly), 1.5-2x leverage was about as high as you'd want to go historically. Any more and you actually end up accumulating less at the same level of risk. So most of what you say makes sense: there is an optimal leverage if you don't contribute to the account (based on your links). But even if you do have a salary and are accumulating, you probably don't want to go any higher than 2x any ways. Historically, it has not been a good idea. They actually show this in the paper when they show leverage of 3x was inferior to 2x, a rather paradoxical finding.

I believe this effect is purely because the debt is callable (you have to reset back to a leverage). If the debt was not callable, then sky is the limit. You should borrow everything today, regardless of your leverage multiple (even if you had negative net worth aka infinite leverage). And those who have a long-term target of using leverage based on your links would borrow even far more than that.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by White Oak »

Callisto wrote: Fri Jun 19, 2020 8:53 pm I read the discussion related to LETFs vs options and futures ~5 pages back. I don't know if I missed it somewhere in the earlier pages, or if I have fundamental misunderstandings, but I'm wondering if LETFs could situationally be the most tax efficient, given you could sell and realize the LTCG significantly later in life. I'm already 100% Hedgefundie in my tax advantaged accounts, so everything below refers to a standard taxable account.

For example, I'm 25, single, living in Massachusetts. My total income is 170-190k, which puts me in the 15% federal and ~5% state LTCG bracket. My plan is to retire relatively early, meet and marry someone, move to a state with no state capital gains tax, and live at the tip of the 0% federal capital gains bracket.

If I used futures or options, I feel like I'd be in a world of hurt as while I'm accumulating in the next few years, I'll be paying a heft federal and state LTCG. So instead, I've been buying SSO, since I don't need to realize those LTCG until much later in life and pay 0%.

I remember from the discussion a few pages back that I'll need to more actively manage my leverage with LETFs due to the daily rebalancing, which I plan to do by using my bimonthly paychecks. I'll only sell and incur LTCG if my leverage ratio deviates super heavily.

So if a person's plan is to FIRE, LETFs(maybe even in conjunction with options/futures) might make sense? It seems to me that the the tax advantages would be far more significant than the higher borrowing costs, and that unless the market is extremely volatile, they wouldn't rebalance so much that they end up paying more taxes.
Hi Callisto,

It sounds like we are following a similar approach. I have most of my long-term savings at 50/50 UPRO/TMF (now also some TQQQ because of TLH, see below). Currently I have about 400k in that allocation, and another 100k in various other index funds (for example, in my 401k where I can't buy UPRO or TMF). Once we get to 3M total exposure, I'll start deleveraging. Hopefully that will be in 3-6 years.

I agree that futures or options do not seem optimal for tax purposes, although I'm not sure if most here are using them in taxable accounts or tax-sheltered accounts.

We are different in that I'm also following the UPRO/TMF strategy in taxable, whereas it sounds like you are only SSO in taxable. I'm curious why you chose this. Is it because you are trying to avoid the tax hit of rebalancing?

I'm planning to rebalance with monthly contributions and eventually donating appreciated shares of the overweight asset. If I still need to rebalance after those 2 methods, then I'll only do it infrequently, maybe annually.

Whether you do UPRO/TMF or 100% SSO in taxable, both allow good opportunities for tax loss harvesting. In the last few months I sold a bunch of UPRO at a loss and bought TQQQ as a replacement.
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Re: Lifecycle Investing - Leveraging when young

Post by Callisto »

White Oak wrote: Sat Jul 04, 2020 4:18 pm
Hi Callisto,

It sounds like we are following a similar approach. I have most of my long-term savings at 50/50 UPRO/TMF (now also some TQQQ because of TLH, see below). Currently I have about 400k in that allocation, and another 100k in various other index funds (for example, in my 401k where I can't buy UPRO or TMF). Once we get to 3M total exposure, I'll start deleveraging. Hopefully that will be in 3-6 years.

I agree that futures or options do not seem optimal for tax purposes, although I'm not sure if most here are using them in taxable accounts or tax-sheltered accounts.
I'm not too sure either, though I do get the impression more people here (compared to Hedgefundie) are doing it in taxable. I guess it just depends on how long a person expects to be earning. The higher cost of leveraging through LETFs is a theme here, and I think it makes sense for someone who expects to be generating an income for most of their life. It just seems to me that for someone who does not expect to be able to generate a high income for their whole life, the tax consequences might be more significant to me than the higher cost of leverage.
White Oak wrote: Sat Jul 04, 2020 4:18 pm We are different in that I'm also following the UPRO/TMF strategy in taxable, whereas it sounds like you are only SSO in taxable. I'm curious why you chose this. Is it because you are trying to avoid the tax hit of rebalancing?
Yea, don't wanna rebalance.

I guess the other part of it is I'm also in the Hedgefundie strategy, but its already 100% of my tax advantaged accounts. While its done better than a plain 1x S&P500 so far, I do have reservations of literally going all in on it.
White Oak wrote: Sat Jul 04, 2020 4:18 pm I'm planning to rebalance with monthly contributions and eventually donating appreciated shares of the overweight asset. If I still need to rebalance after those 2 methods, then I'll only do it infrequently, maybe annually.

Whether you do UPRO/TMF or 100% SSO in taxable, both allow good opportunities for tax loss harvesting. In the last few months I sold a bunch of UPRO at a loss and bought TQQQ as a replacement.
I strongly considered employing this strategy as well, I'm also in a position where I'm constantly contributing and could help use that to reduce the amount of selling I need to do to rebalance. Combined with TLH opportunities, I suspect the tax drag, at least in the short term, wouldn't be too bad. Annual rebalancing was also brought up as a good idea somewhere in the Hedgefundie thread, but it was calculated as less optimal than the commonly recommended quarterly schedule, though iirc it was not significantly worse.

I guess for me it comes down to my previous point, where I'm just afraid of employing the strategy across my entire portfolio. I also think that the strategy described in this thread is fundamentally different from Hedgefundie's, even though I'm using LETFs for both.
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Re: Lifecycle Investing - Leveraging when young

Post by White Oak »

Callisto wrote: Sun Jul 05, 2020 10:21 am
I guess for me it comes down to my previous point, where I'm just afraid of employing the strategy across my entire portfolio. I also think that the strategy described in this thread is fundamentally different from Hedgefundie's, even though I'm using LETFs for both.
That makes sense -- not putting all your eggs in one basket.

One other question that's been on my mind: what is your strategy for deleveraging in taxable? You mentioned only cashing out enough to hit the 0% LTCG tax bracket each year. I'm guessing that gradually selling like that will eventually leave you with a higher leverage ratio than you'd want.

This would be a good problem to have, and it is still several years in the future for me, but I've been thinking about what the best approach would be.
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Re: Lifecycle Investing - Leveraging when young

Post by langlands »

White Oak wrote: Sat Jul 04, 2020 4:18 pm Hi Callisto,

It sounds like we are following a similar approach. I have most of my long-term savings at 50/50 UPRO/TMF (now also some TQQQ because of TLH, see below). Currently I have about 400k in that allocation, and another 100k in various other index funds (for example, in my 401k where I can't buy UPRO or TMF). Once we get to 3M total exposure, I'll start deleveraging. Hopefully that will be in 3-6 years.
You plan on going from 400K to 3M in 3-6 years? Is this coming primarily from additional contributions or the gains from your portfolio?
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Re: Lifecycle Investing - Leveraging when young

Post by White Oak »

langlands wrote: Sun Jul 05, 2020 3:40 pm You plan on going from 400K to 3M in 3-6 years? Is this coming primarily from additional contributions or the gains from your portfolio?
Yeah, that would be pretty nice, wouldn't it?

No, the Monte Carlo simulator that I ran suggested that I would hit $1M of assets in 3-6 years, based on that current balance and continued contributions (roughly 50k/year). But most of the assets are in 3x LETFs, so the total exposure at that point would be 3M. 3M is my savings goal, so I would start deleveraging once I hit 1M in 3x LETFs or 3M in total exposure.
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Re: Lifecycle Investing - Leveraging when young

Post by langlands »

White Oak wrote: Sun Jul 05, 2020 4:14 pm
langlands wrote: Sun Jul 05, 2020 3:40 pm You plan on going from 400K to 3M in 3-6 years? Is this coming primarily from additional contributions or the gains from your portfolio?
Yeah, that would be pretty nice, wouldn't it?

No, the Monte Carlo simulator that I ran suggested that I would hit $1M of assets in 3-6 years, based on that current balance and continued contributions (roughly 50k/year). But most of the assets are in 3x LETFs, so the total exposure at that point would be 3M. 3M is my savings goal, so I would start deleveraging once I hit 1M in 3x LETFs or 3M in total exposure.
I see, that makes sense. Good luck!
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Re: Lifecycle Investing - Leveraging when young

Post by Callisto »

White Oak wrote: Sun Jul 05, 2020 2:38 pm
Callisto wrote: Sun Jul 05, 2020 10:21 am
I guess for me it comes down to my previous point, where I'm just afraid of employing the strategy across my entire portfolio. I also think that the strategy described in this thread is fundamentally different from Hedgefundie's, even though I'm using LETFs for both.
That makes sense -- not putting all your eggs in one basket.

One other question that's been on my mind: what is your strategy for deleveraging in taxable? You mentioned only cashing out enough to hit the 0% LTCG tax bracket each year. I'm guessing that gradually selling like that will eventually leave you with a higher leverage ratio than you'd want.

This would be a good problem to have, and it is still several years in the future for me, but I've been thinking about what the best approach would be.
I'm planning on buying 1x S&P to reduce leverage, as I approach my target exposure. That way, I won't be 100% in SSO by the time I call it quits. I think that technically, according to this strategy, I'll be overlevered still, but it won't be 2x. I'll then prioritize selling SSO to further reduce my leverage over time.

Of course, if things go my way and I end up with a very high leverage ratio, I'll rebalance. But, like you said, that'll be a good problem to have.
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Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated »

White Oak wrote: Sun Jul 05, 2020 4:14 pm
langlands wrote: Sun Jul 05, 2020 3:40 pm You plan on going from 400K to 3M in 3-6 years? Is this coming primarily from additional contributions or the gains from your portfolio?
Yeah, that would be pretty nice, wouldn't it?

No, the Monte Carlo simulator that I ran suggested that I would hit $1M of assets in 3-6 years, based on that current balance and continued contributions (roughly 50k/year). But most of the assets are in 3x LETFs, so the total exposure at that point would be 3M. 3M is my savings goal, so I would start deleveraging once I hit 1M in 3x LETFs or 3M in total exposure.
The point at which you deleverage should be determined by the ratio between current net worth and remaining human capital, not your savings goal. If you have an actual savings goal instead of a CRRA, you should follow a different asset allocation scheme. For example, the one discussed here: viewtopic.php?f=10&t=293469#p4812570
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Re: Lifecycle Investing - Leveraging when young

Post by White Oak »

Uncorrelated wrote: Mon Jul 06, 2020 3:29 am The point at which you deleverage should be determined by the ratio between current net worth and remaining human capital, not your savings goal. If you have an actual savings goal instead of a CRRA, you should follow a different asset allocation scheme. For example, the one discussed here: viewtopic.php?f=10&t=293469#p4812570
Thanks for your comment. Some of us did have this discussion earlier in the thread.

You are correct that I am deviating from the Lifecycle book by using a savings goal rather than my total expected savings. (I'm also deviating by leveraging a balanced portfolio rather than only stocks, a conversation we've already had.) In my case, the savings goal isn't all that different from my expected savings (counting in some investment growth). But if my goal was significantly lower than my total expected savings, I would probably still use the savings goal as an additional conservatism. Steve argued that I should instead adjust my final stock fraction downward instead of artificially capping the target number, but I didn't find this a compelling argument.

I glanced at the post you linked. It looks like you didn't consider a leverage ratio greater than one there, so I'm not sure how to translate that to this discussion.

While these are interesting conversations to have, I do think the benefit from leveraging early in the accumulation phase is a first-order effect, while most of these details are second order.


Edit: changed total expected earnings to savings
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Re: Lifecycle Investing - Leveraging when young

Post by UberGrub »

So your reply on another thread and wanted to know how this "experiment" was going??
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Re: Lifecycle Investing - Leveraging when young

Post by rkhusky »

UberGrub wrote: Sun Jul 19, 2020 9:45 pm So your reply on another thread and wanted to know how this "experiment" was going??
OP is updating first post.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

UberGrub wrote: Sun Jul 19, 2020 9:45 pm So your reply on another thread and wanted to know how this "experiment" was going??
Doing fine, thanks for asking. Still buying with margin. Will post an update soon.
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Last edited by hdas on Mon Aug 10, 2020 5:42 pm, edited 1 time in total.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

hdas wrote: Mon Jul 20, 2020 5:33 pm
Steve Reading wrote: Mon Jul 20, 2020 4:56 pm Still buying with margin
Is it cheaper than futures?........could you show your calculations (if it's not too much to ask). H
Last time I checked, futures were cheaper (but not by much, maybe 0.5%-0.8% or thereabouts) but the tax savings alone more than makes up for it. Realizing gains at 60/40 yearly is a big drag vs just buying ETFs and holding for decades (at least for my circumstances).

Also, I get to leverage the exact ETFs I want, so a bit of a bonus. And don't have to worry about a cash drag (with rates this low, this isn't a big concern any more but it used to be a year ago if you recall).

How are you btw?
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by djeayzonne »

Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

djeayzonne wrote: Tue Jul 21, 2020 6:14 pm Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
Margin is just cheaper for me once you account for taxes. I had very slight gains on the options so I just sold them and re-established exposure with margin. Same exposure, but will pay less money for it over the upcoming years.

Had good timing since stocks have gone up quite a bit and switching at this time would create serious gains. I'm much happier paying a ~1% interest rate on my loan and knowing these gains probably won't get realized for decades to come.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by djeayzonne »

I see.

The reason I ask is because I am thinking of doing the same, except I had the absolute worst luck by establishing my first LEAP synthetic long position LITERALLY at the peak one day before things started crashing, so my position is still quite in the red.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

djeayzonne wrote: Tue Jul 21, 2020 7:02 pm I see.

The reason I ask is because I am thinking of doing the same, except I had the absolute worst luck by establishing my first LEAP synthetic long position LITERALLY at the peak one day before things started crashing, so my position is still quite in the red.
That's no cause to be concerned. This is what leverage is for. If markets drop, now you lose more money, but you also get to buy equities at much cheaper prices (hopefully you did that). And if the market rises a lot, causing you to accumulate at expensive prices, well, at least you'll have some gains from leverage.

I also made the switch to margin because I liked it before, but was concerned about the variable rate (what if it went up?). But the Fed has given guidance that short-term rates will stay near zero for the next couple of years at least, so I decided it was a good time to take the plunge.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by RocketShipTech »

Steve Reading wrote: Tue Jul 21, 2020 6:57 pm
djeayzonne wrote: Tue Jul 21, 2020 6:14 pm Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
Margin is just cheaper for me once you account for taxes. I had very slight gains on the options so I just sold them and re-established exposure with margin. Same exposure, but will pay less money for it over the upcoming years.

Had good timing since stocks have gone up quite a bit and switching at this time would create serious gains. I'm much happier paying a ~1% interest rate on my loan and knowing these gains probably won't get realized for decades to come.
Question for you about the deductibility of investment interest.

My understanding is that it can only be deducted against non-preferential investment income, like ordinary dividends and treasury or corporate bond interest.

Which essentially means you need to have bond holdings in taxable to take advantage of the tax deduction (given that most stock funds pay almost entirely QDI).

Is this correct?
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

RocketShipTech wrote: Tue Jul 21, 2020 8:47 pm
Steve Reading wrote: Tue Jul 21, 2020 6:57 pm
djeayzonne wrote: Tue Jul 21, 2020 6:14 pm Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
Margin is just cheaper for me once you account for taxes. I had very slight gains on the options so I just sold them and re-established exposure with margin. Same exposure, but will pay less money for it over the upcoming years.

Had good timing since stocks have gone up quite a bit and switching at this time would create serious gains. I'm much happier paying a ~1% interest rate on my loan and knowing these gains probably won't get realized for decades to come.
Question for you about the deductibility of investment interest.

My understanding is that it can only be deducted against non-preferential investment income, like ordinary dividends and treasury or corporate bond interest.

Which essentially means you need to have bond holdings in taxable to take advantage of the tax deduction (given that most stock funds pay almost entirely QDI).

Is this correct?
I believe that's right. I don't itemize so I haven't thought about it that much.
"... 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" - Paul Samuelson
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Re: Lifecycle Investing - Leveraging when young

Post by ChrisBenn »

Steve Reading wrote: Tue Jul 21, 2020 9:00 pm
RocketShipTech wrote: Tue Jul 21, 2020 8:47 pm
Steve Reading wrote: Tue Jul 21, 2020 6:57 pm
djeayzonne wrote: Tue Jul 21, 2020 6:14 pm Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
Margin is just cheaper for me once you account for taxes. I had very slight gains on the options so I just sold them and re-established exposure with margin. Same exposure, but will pay less money for it over the upcoming years.

Had good timing since stocks have gone up quite a bit and switching at this time would create serious gains. I'm much happier paying a ~1% interest rate on my loan and knowing these gains probably won't get realized for decades to come.
Question for you about the deductibility of investment interest.

My understanding is that it can only be deducted against non-preferential investment income, like ordinary dividends and treasury or corporate bond interest.

Which essentially means you need to have bond holdings in taxable to take advantage of the tax deduction (given that most stock funds pay almost entirely QDI).

Is this correct?
I believe that's right. I don't itemize so I haven't thought about it that much.
It is correct - per: https://www.irs.gov/pub/irs-pdf/f4952.pdf
(Technically you can elect to have qualified dividends taxed at the ordinary income rate, which does make them eligible for deduction, but I can't imagine with interest rates as low as they are that would be advantageous; it's a per year election)
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Re: Lifecycle Investing - Leveraging when young

Post by jarjarM »

RocketShipTech wrote: Tue Jul 21, 2020 8:47 pm
Steve Reading wrote: Tue Jul 21, 2020 6:57 pm
djeayzonne wrote: Tue Jul 21, 2020 6:14 pm Steve,

I was re-reading some of this thread and noticed that you sold the options to use margin at IB.
Sorry if the answer is obvious, but why didn't you just move the options over as well and build on top of that instead of kinda starting over?
Margin is just cheaper for me once you account for taxes. I had very slight gains on the options so I just sold them and re-established exposure with margin. Same exposure, but will pay less money for it over the upcoming years.

Had good timing since stocks have gone up quite a bit and switching at this time would create serious gains. I'm much happier paying a ~1% interest rate on my loan and knowing these gains probably won't get realized for decades to come.
Question for you about the deductibility of investment interest.

My understanding is that it can only be deducted against non-preferential investment income, like ordinary dividends and treasury or corporate bond interest.

Which essentially means you need to have bond holdings in taxable to take advantage of the tax deduction (given that most stock funds pay almost entirely QDI).

Is this correct?
FYI, for those who are in the highest marginal tax bracket (54.1% Fed+CA+NIIT), here's a way that some propose to reclaim some of the 750k+ mortgage interest deductibility.

https://www.svb.com/blogs/mary-toomey/m ... st-expense
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Re: Lifecycle Investing - Leveraging when young

Post by redstar »

Hi all, thank you for this topic and other writing you've done on this forum. I've been generally interested in using leverage while young for a few years now, but other than owning a bit of PSLDX, I haven't taken the full plunge. I've read the Lifecycle Investing book, and I think one of my issues is that the concept is not very user-friendly, compared to the work that has gone into making the Three-Fund Portfolio easy for new investors to set up. I'll give some examples of my struggles with Lifecycle Investing:

First, I need to compute my future savings, which is one of the hardest steps I think. As a young person, I am still early in my career and don't know what the future holds in terms of 1) future earnings, 2) future expenses (and therefore savings), and 3) how many years I will work. It seems like the book authors assume someone would retire at 65 (at least using their spreadsheets on the website), but I think if my retirement accounts hit some amount (maybe 25x expenses?) after de-levering, I might choose to retire early. But this ruins all of the math to get to this point! Is there a way to account for career uncertainty and not set a defined amount of working years to arrive at this number?

Second, you need to compute the present value of the future savings. Maybe I'm just completely incorrect in this, but doesn't this really depend on the risk free rate over the next few decades? I suppose I can just plug in ~1% for now, but is it fine to assume that going forward?

Third, I need to estimate a few other things about future savings. One is Social Security, which again relies on income and number of working years to compute. Another is how much of my future income is bond-like. I'm not sure how to answer this, as I don't know what jobs I may work in the future. The book seems to default to bond-like for income, is there any rule of thumb for people who work in specific sectors to figure out how correlated to the market they are?

Fourth, I need the Samuelson share, which relies heavily on how you compute the RRA, as well as the other inputs. I've found that I have trouble giving consistent answers to the New Job question, which varies the resulting Samuelson Share. Is there a way to compute RRA that has better test-retest reliability?

It seems to me that arriving to your desired amount of equity exposure really depends on having some clarity on the future of your career earnings, expenses (family situation, location, etc), and risk aversion (hard to compute). As this strategy is most useful to young investors, those aspects are really making is difficult to get started! Could we reformulate some of this to be more user-friendly?

My guess is that none of these calculations really matter for young investors (like myself) because the desired amount of equity exposure will be high enough to warrant going up to whatever their leverage cap is. So to get started, just invest it all at the capped leverage amount. But at some point you have to know when start deleveraging, which is where these all need to be solidified.
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

redstar wrote: Sat Jul 25, 2020 10:14 pm First, I need to compute my future savings, which is one of the hardest steps I think. As a young person, I am still early in my career and don't know what the future holds in terms of 1) future earnings, 2) future expenses (and therefore savings), and 3) how many years I will work. It seems like the book authors assume someone would retire at 65 (at least using their spreadsheets on the website), but I think if my retirement accounts hit some amount (maybe 25x expenses?) after de-levering, I might choose to retire early. But this ruins all of the math to get to this point! Is there a way to account for career uncertainty and not set a defined amount of working years to arrive at this number?
A simple way is to just answer "what nest egg would I need today, to retire at the standard of living I want, today?". Say that's 1M. Provided you have a Samuelson Share of 50%, then you need to hit 500K in stocks today. It's as easy as that.

Why can you simplify like that? Because you don't know what income/savings/number of years of work lie in your future. But you do know you will work until you hit a given nest egg size, regardless of how long it takes. So the present value of all of your future savings contributions are just equal to that. That's what your human capital is worth today because your human capital will produce the necessary nest egg to give you that living standard.

This isn't exactly what the book does, and there technically are more correct portfolio design methods for people who have a specific nest egg target, but IMO is close enough here. You probably will have to leverage for many years (maybe decades) before you even hit Phase 2. At that point, you could revisit the exact book methodology and will hopefully have a better idea of your future. For now, this is a good, first, initial target.
redstar wrote: Sat Jul 25, 2020 10:14 pm Second, you need to compute the present value of the future savings. Maybe I'm just completely incorrect in this, but doesn't this really depend on the risk free rate over the next few decades? I suppose I can just plug in ~1% for now, but is it fine to assume that going forward?
Yeah, there's no easy answer here. The theory assumes rates don't change. I personally just use the current interest rate and if it changes, I change it in my calculations. Just getting close is what matters in the end. Doesn't matter at all if you use the "nest egg" approach from above.
redstar wrote: Sat Jul 25, 2020 10:14 pm Third, I need to estimate a few other things about future savings. One is Social Security, which again relies on income and number of working years to compute. Another is how much of my future income is bond-like. I'm not sure how to answer this, as I don't know what jobs I may work in the future. The book seems to default to bond-like for income, is there any rule of thumb for people who work in specific sectors to figure out how correlated to the market they are?
As for SS, you could consider only considering it once you'd get to Phase 2 based on the "nest egg" question above. That might be many years from today and you might have a better idea of what SS might look like. So then you'd add that in your analysis and continue Phase 1 as needed.

The nature of your job is a good question. You'll have to look at your profession and make a reasonable estimate. Most people's jobs are uncorrelated with the market, so they don't have to think much about this. Even if it had some correlation, the reality is that you probably will work more, work longer, or save more, as needed to hit your required nest egg. In that sense, your human capital is actually completely safe and riskless.
redstar wrote: Sat Jul 25, 2020 10:14 pm Fourth, I need the Samuelson share, which relies heavily on how you compute the RRA, as well as the other inputs. I've found that I have trouble giving consistent answers to the New Job question, which varies the resulting Samuelson Share. Is there a way to compute RRA that has better test-retest reliability?
I haven't found one. It's a tough question. But again, a very worthwhile one because it truly is looking for what matters (risk aversion) instead of using rules of thumbs like "age in bonds".

One thing I like to do is look at what RRAs lead to what portfolios. For instance, an RRA of 3.0 for me is about right, but would result in a 70/30 retirement portfolio (once I take SS into account, I would be 100% stocks during retirement). That seems a bit high, so I have tweaked my RRA accordingly based on what makes sense. So that's one way to sort of tweak your RRA until it's logical and reasonable to you.
redstar wrote: Sat Jul 25, 2020 10:14 pm It seems to me that arriving to your desired amount of equity exposure really depends on having some clarity on the future of your career earnings, expenses (family situation, location, etc), and risk aversion (hard to compute). As this strategy is most useful to young investors, those aspects are really making is difficult to get started! Could we reformulate some of this to be more user-friendly?
Yes, it is tough. I'd say the risk aversion is the hardest. I personally struggled trying to get to a number I liked.

I wouldn't sweat the details about careers, expenses, etc. Getting close is what matters. For now, you're almost certainly going to have to leverage and stay in Phase 1 for quite some time. All you need is a rough, crude target as to when you might transition to Phase 2. Once you get there, you can sit down, go through some of these details again, and include SS. You'll continue on Phase 1 for quite some time after (SS is a fairly big bond to many), but will hopefully have a better idea about all of this once you get there.
redstar wrote: Sat Jul 25, 2020 10:14 pm My guess is that none of these calculations really matter for young investors (like myself) because the desired amount of equity exposure will be high enough to warrant going up to whatever their leverage cap is. So to get started, just invest it all at the capped leverage amount. But at some point you have to know when start deleveraging, which is where these all need to be solidified.
That's right :)
"... 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" - Paul Samuelson
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Uncorrelated
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Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated »

redstar wrote: Sat Jul 25, 2020 10:14 pm First, I need to compute my future savings, which is one of the hardest steps I think. As a young person, I am still early in my career and don't know what the future holds in terms of 1) future earnings, 2) future expenses (and therefore savings), and 3) how many years I will work. It seems like the book authors assume someone would retire at 65 (at least using their spreadsheets on the website), but I think if my retirement accounts hit some amount (maybe 25x expenses?) after de-levering, I might choose to retire early. But this ruins all of the math to get to this point! Is there a way to account for career uncertainty and not set a defined amount of working years to arrive at this number?
Lifecycle investing is based on the assumption that you have a CRRA and know your future human capital. If you plan to retire when you hit 25x expenses, you do not have a CRRA and there is no way to estimate your human capital. In that case lifecycle investing is not the appropriate model to use.

I have attempted to calculate optimal asset allocations for different utility functions. I tried optimizing for the fastest (on average) way to reach a certain number, or maximize the number of retirement years. You can view it in this topic. I don't know how well this utility function matches your goals, but the point is that a different utility function results in very different asset allocations. These scenario's were calculated without leverage.

Steve Reading wrote: Sat Jul 25, 2020 10:48 pm Yeah, there's no easy answer here. The theory assumes rates don't change. I personally just use the current interest rate and if it changes, I change it in my calculations. Just getting close is what matters in the end. Doesn't matter at all if you use the "nest egg" approach from above.
They don't assume rates don't change. They assume your human capital grows at the risk free rate. With a CRRA, the current risk free rate or future risk free rate does not affect the asset allocation. Only the equity risk premium affects the asset allocation, but the equity risk premium is assumed to be a constant.

Again this assumes a CRRA. If your utility function is "reach 25x expenses", it's pretty obvious that the risk free rate does matter since the real risk free rate influences how fast you reach your goal, and therefore indirectly affects how much human capital you have remaining.
redstar
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Re: Lifecycle Investing - Leveraging when young

Post by redstar »

Steve Reading wrote: Sat Jul 25, 2020 10:48 pm
A simple way is to just answer "what nest egg would I need today, to retire at the standard of living I want, today?". Say that's 1M. Provided you have a Samuelson Share of 50%, then you need to hit 500K in stocks today. It's as easy as that.
Thanks for the response! That's a great simplification that will help me (and hopefully others) get started,
Steve Reading wrote: Sat Jul 25, 2020 10:48 pm
This isn't exactly what the book does, and there technically are more correct portfolio design methods for people who have a specific nest egg target, but IMO is close enough here.
For the sake of completeness, and because I find this topic fun, what would a better design method be? Would it be similar to Uncorrelated's approach in their linked thread?
Steve Reading wrote: Sat Jul 25, 2020 10:48 pm
I wouldn't sweat the details about careers, expenses, etc. Getting close is what matters. For now, you're almost certainly going to have to leverage and stay in Phase 1 for quite some time. All you need is a rough, crude target as to when you might transition to Phase 2. Once you get there, you can sit down, go through some of these details again, and include SS. You'll continue on Phase 1 for quite some time after (SS is a fairly big bond to many), but will hopefully have a better idea about all of this once you get there.
Great, I'm going to give it a shot! I moved my positions over to IB. Would you still recommend margin as the implementation method for taxable accounts? I've looked a bit into options/futures but honestly margin seems a bit easier (and has the tax benefits you mentioned previously).
redstar
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Re: Lifecycle Investing - Leveraging when young

Post by redstar »

Uncorrelated wrote: Sun Jul 26, 2020 12:30 am I have attempted to calculate optimal asset allocations for different utility functions. I tried optimizing for the fastest (on average) way to reach a certain number, or maximize the number of retirement years. You can view it in this topic. I don't know how well this utility function matches your goals, but the point is that a different utility function results in very different asset allocations. These scenario's were calculated without leverage.
This thread was very informative and interesting, thank you. I think my utility function is not well defined, and I probably should spend some time thinking about what an appropriate one is. I really enjoyed the AA charts you generated. Would you be willing to share any of that code to mess with other possible scenarios?
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Steve Reading
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

redstar wrote: Mon Jul 27, 2020 9:59 pm For the sake of completeness, and because I find this topic fun, what would a better design method be? Would it be similar to Uncorrelated's approach in their linked thread?
Uncorrelated will answer that better, he showed me once a paper that used a specific strategy to target a specific nest egg. It still uses leverage and everything but ramps down differently. That might be a better fit for you. I seem to recall it was complex, not as simple as just an equation you plug into at any time, regardless of time horizon or current assets.

I only brought up a nest egg target as a rough estimate as to when you might be done with Phase 1 and then could sit down and actually factor in SS, future wages, etc. But the above strategy might ramp you down before so if that's what you prefer and ultimately want to use, I would use that strategy since the beginning.

Hopefully he'll link the paper, I never saved it :/
redstar wrote: Mon Jul 27, 2020 9:59 pm Great, I'm going to give it a shot! I moved my positions over to IB. Would you still recommend margin as the implementation method for taxable accounts? I've looked a bit into options/futures but honestly margin seems a bit easier (and has the tax benefits you mentioned previously).
I'm happy with margin because I get to:
1) Buy the exact ETFs I want (International, Emerging, small-cap value, etc).
2) It's the most tax efficient for me. In costs, it comes out way ahead.
3) Little work involved (similar to an options synthetic long). No need to add or take out cash (like futures), you just leave it there, adding money on every paycheck and buying from time to time when your leverage starts to dip a bit.

My only concern with margin was short term rate increases but the Fed has given guidance for rates to stay at zero for the next 1-2 years, so I feel more comfortable now. You could always short a 10Y treasury future to hedge the margin variable rate if you want to be sure but I haven't gone that far.

Last thing I'd say is to just leverage conservatively. If you go 2-1, be prepared to sell on down markets potentially. You probably would have during March since the market dropped past 33%. That would be when you'd be forced to sell with 2-1 leverage. Ideally, you'd sell a little earlier in such a case. I've gone with 1.5-1 leverage. Historically, it seems to have been just about as good, capturing lots of the temporal diversification benefits. And it would require a 55% market decline, which is a better psychological buffer. I feel reasonably capable of stabilizing my account with paychecks and 1.5-1 leverage. For various reasons, i'd rather I wasn't forced to sell so I am OK leveraging less than the theoretically ideal solutions for that peace of mind. Your mileage will vary.
"... 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" - Paul Samuelson
RayKeynes
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Re: Lifecycle Investing - Leveraging when young

Post by RayKeynes »

I am also leveraging using both Margin and Leveraged ETFs, my current ratios are:

Current Leverage
Asset Leverage: 138% (by Margin @ 1.6%)
Return Leverage: 166.4% (by Leveraged ETFs, SSO & UPRO)
Total Leverage: 229.6% (Combined), Invested in VTI, VEA, VWO, VIOV + Leveraged ETFs (SSO + UPRO)

Additional Safety Measures - Implemening SMA230
1) I have implemented the SMA 230 (SP500) as a risk-adjusting factor. Thus, if SP500 closes below SMA230, I will decrease Return Leverage to 100% immediately (thus selling UPRO & SSO). Thus, as a result, total leverage will decrease significantly to around 100-110%.
2) If the SP500 falls below the SMA 230, I will consider releveraging, if:
a) SP500 hits a drawdown of -20% -> Invest 20% of sold UPRO & SSO
b) SP500 hits a drawdown of -25% -> Invest additional 15% of sold UPRO & SSO
c) SP500 hits a drawdown of -30% -> Invest additional 12.5% of sold UPRO & SSO
d) SP500 hits a drawdown of -35% -> Invest additional 10% of sold UPRO & SSO
e) SP500 hits a drawdown of -40% -> Invest additional 10% of sold UPRO & SSO
...

"Flash Crashes"
I have myself, never experienced a so-called flash crash when invested via Leverage. Certain ETFs did drop to 1 Cent for a few seconds. My questions here is - does anyone have experience with that and how this is handled margin-wise? I cannot stand the thought of loosing all my shares just because the price drops to a certain level for 1 second.

I am asking myself if this approach is still save. I can withstand an immediate 1-Day Drawdown of -36% in the SP500 as well as a 3-month Drawdown (including allocating more cash reserves on my bank account) up to -54.5% (SP500 theoretical, assuming return leverage remains constant), thus SP500 falling to around 1'480 within 3 months is my maximum (from 3'200). However, as I will be decreasing return leverage if SP500 falls below its SMA 230 - the strategy seems quite "risk-free"

What kind of risk-based approach do you guys take? What is the maximum amount one should consider save?
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Steve Reading
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

RayKeynes wrote: Tue Jul 28, 2020 7:30 am My questions here is - does anyone have experience with that and how this is handled margin-wise?
I asked about this a few posts before (or last page). I don't have any experience but maybe there's some info there that helps you.
RayKeynes wrote: Tue Jul 28, 2020 7:30 am What kind of risk-based approach do you guys take? What is the maximum amount one should consider save?
I don't use technical analysis to invest so my only "risk-based" approach is to leverage only to the extent I feel comfortable stabilizing via future contributions.
I don't understand the second question.
"... 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" - Paul Samuelson
Count of Notre Dame
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Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame »

Steve Reading wrote: Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote: Mon Mar 04, 2019 10:03 am @OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
If I face a margin call, I have a HELOC for ~$200k interest only for 10 years available to use. I of course would need to transfer money a few days before if the margin % was getting close to the callable territory. I suppose a 90% flash crash in one day could trigger automatic portfolio sell offs, but have we ever had that large of a drop in one day?
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

Count of Notre Dame wrote: Tue Jul 28, 2020 12:38 pm
Steve Reading wrote: Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote: Mon Mar 04, 2019 10:03 am @OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
If I face a margin call, I have a HELOC for ~$200k interest only for 10 years available to use. I of course would need to transfer money a few days before if the margin % was getting close to the callable territory. I suppose a 90% flash crash in one day could trigger automatic portfolio sell offs, but have we ever had that large of a drop in one day?
Absolutely, we have. VTI traded for 15 cents during the 2010 Flash Crash, losing 99%+ of its value in seconds. A lot of trades below specific values were canceled retrospectively but I don't know to what extent.

At the time, we didn't have circuit breakers for specific ETFs. Only for futures (instituted due to 1987's Black Monday). Now exchanges do have circuit breakers for ETFs. It's a dicey situation and I honestly don't know how effective such circuit breakers could be. Personally, I'm hoping that circuit breakers for my ETFs, combined with exchanges willing to cancel trades below the breakers (provided the breakers don't kick in), will be enough to deal with any potential future Flash Crashes. But I'm not a huge fan of the situation.
"... 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" - Paul Samuelson
Count of Notre Dame
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Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame »

Steve Reading wrote: Tue Jul 28, 2020 12:57 pm
Count of Notre Dame wrote: Tue Jul 28, 2020 12:38 pm
Steve Reading wrote: Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote: Mon Mar 04, 2019 10:03 am @OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
If I face a margin call, I have a HELOC for ~$200k interest only for 10 years available to use. I of course would need to transfer money a few days before if the margin % was getting close to the callable territory. I suppose a 90% flash crash in one day could trigger automatic portfolio sell offs, but have we ever had that large of a drop in one day?
Absolutely, we have. VTI traded for 15 cents during the 2010 Flash Crash, losing 99%+ of its value in seconds. A lot of trades below specific values were canceled retrospectively but I don't know to what extent.

At the time, we didn't have circuit breakers for specific ETFs. Only for futures (instituted due to 1987's Black Monday). Now exchanges do have circuit breakers for ETFs. It's a dicey situation and I honestly don't know how effective such circuit breakers could be. Personally, I'm hoping that circuit breakers for my ETFs, combined with exchanges willing to cancel trades below the breakers (provided the breakers don't kick in), will be enough to deal with any potential future Flash Crashes. But I'm not a huge fan of the situation.
I'm not a fan of ETFs and was planning on investing in mutual funds. Did that flash crash end the day down 99% or 9%? There's a pretty big difference there:

"Stock indices, such as the S&P 500, Dow Jones Industrial Average and Nasdaq Composite, collapsed and rebounded very rapidly.[5] The Dow Jones Industrial Average had its second biggest intraday point decline (from the opening) up to that point,[5] plunging 998.5 points (about 9%), most within minutes, only to recover a large part of the loss.[6][7] It was also the second-largest intraday point swing (difference between intraday high and intraday low) up to that point, at 1,010.14 points.[5][6][8][9] The prices of stocks, stock index futures, options and exchange-traded funds (ETFs) were volatile, thus trading volume spiked.[5]:3 A CFTC 2014 report described it as one of the most turbulent periods in the history of financial markets.[5]:1"
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Steve Reading
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Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading »

Count of Notre Dame wrote: Wed Jul 29, 2020 9:58 am
Steve Reading wrote: Tue Jul 28, 2020 12:57 pm
Count of Notre Dame wrote: Tue Jul 28, 2020 12:38 pm
Steve Reading wrote: Mon Mar 04, 2019 10:23 am
gmaynardkrebs wrote: Mon Mar 04, 2019 10:03 am @OP -- what is your plan if the market tanks in the first years of leverage and you are wiped out? Maybe you answered this, but I didn't see it.
My debt is not callable so there is no wipe-out, no liquidation. I just pay the interest (like a mortgage). My plan is the same as every Boglehead. I buy and I hold through the downturns. I can leverage all I want (say 5:1) and there's no issues on that front. It's basically a mortgage except the money bought stocks instead of real estate.
If I face a margin call, I have a HELOC for ~$200k interest only for 10 years available to use. I of course would need to transfer money a few days before if the margin % was getting close to the callable territory. I suppose a 90% flash crash in one day could trigger automatic portfolio sell offs, but have we ever had that large of a drop in one day?
Absolutely, we have. VTI traded for 15 cents during the 2010 Flash Crash, losing 99%+ of its value in seconds. A lot of trades below specific values were canceled retrospectively but I don't know to what extent.

At the time, we didn't have circuit breakers for specific ETFs. Only for futures (instituted due to 1987's Black Monday). Now exchanges do have circuit breakers for ETFs. It's a dicey situation and I honestly don't know how effective such circuit breakers could be. Personally, I'm hoping that circuit breakers for my ETFs, combined with exchanges willing to cancel trades below the breakers (provided the breakers don't kick in), will be enough to deal with any potential future Flash Crashes. But I'm not a huge fan of the situation.
I'm not a fan of ETFs and was planning on investing in mutual funds. Did that flash crash end the day down 99% or 9%? There's a pretty big difference there:

"Stock indices, such as the S&P 500, Dow Jones Industrial Average and Nasdaq Composite, collapsed and rebounded very rapidly.[5] The Dow Jones Industrial Average had its second biggest intraday point decline (from the opening) up to that point,[5] plunging 998.5 points (about 9%), most within minutes, only to recover a large part of the loss.[6][7] It was also the second-largest intraday point swing (difference between intraday high and intraday low) up to that point, at 1,010.14 points.[5][6][8][9] The prices of stocks, stock index futures, options and exchange-traded funds (ETFs) were volatile, thus trading volume spiked.[5]:3 A CFTC 2014 report described it as one of the most turbulent periods in the history of financial markets.[5]:1"
I'm confused, I thought you were asking about using margin? Mutual funds cannot be purchased on margin.
"... 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" - Paul Samuelson
redstar
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Re: Lifecycle Investing - Leveraging when young

Post by redstar »

Would anyone be able to check my math on computing the Samuelson Share? I'm looking for a 55% US / 45% Intl. weight of equity (close to market weight). My initial guess at an RRA is 3.

For risk/reward inputs into calculation, the authors suggest CAPE and VIX, but this tells me to have a 0% stock allocation? So I looked at Vanguard's August 2020 estimates for equity returns and volatility instead. Are these reasonable to use or are there better numbers here?

US Stock Return: 4% - 6% (I'll use 5%)
US Stock Volatility: 16.4%
Intl. Stock Return: 7% - 9% (I'll use 8%)
Intl. Stock Volatility: 18.3%

So now I need the equity risk premium for each asset class. What should I be comparing to? The t-bill rate is 0.10%, I can earn 1% in the savings account I have, or should I be comparing to bonds in general? (I'll use 1% below for now)

Leverage Amount: 150%
Borrowing Cost above 100% at IB: 1.59%

Effective US ERP after borrowing = (5%+(5%-1.59%)*(50%))/150% - 1% = 3.47%
Effective Intl. ERP after borrowing = (8%+(8%-1.59%)*(50%))/150% - 1% = 6.47%

US Samuelson Share = 3.47% / ((16.4% ^ 2)*3) * 55% US equity ratio = 23.65%
Intl. Samuelson Share = 6.47% / ((18.3% ^ 2)*3) * 45% Intl equity ratio = 28.98%
Total Samuelson Share (all equity) = 52.63%

I think I'm failing to account for expense ratios and stuff here, but overall does this look right for factoring in multiple equity types, borrowing cost, and some risk-free rate?
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