Lifecycle Investing - Leveraging when young

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Fri Jul 31, 2020 1:58 pm

redstar wrote:
Mon Jul 27, 2020 10:01 pm
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?
I can do that, but the code is pretty complicated and computationally intensive. If you want a specific utility function calculated, you can always ask me. I think this is a very interesting and under-studied research subject, but it's hard to come up with utility functions that actually reflect actual investor goals. My best guess is that utility is approximately linear to the expected retirement years, that approach results in quite aggressive asset allocations.

I am confident that the desire to retire earlier results in an asset allocation that is more aggressive than lifestyle investing with a fixed retirement date suggests, but I'm not sure how much more aggressive.

Steve Reading wrote:
Mon Jul 27, 2020 10:27 pm
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 :/
I think I know that paper you're talking about. But it's not particularly relevant to this user, as it didn't investigate early retirement motives.

As far as I'm aware of, the topic I linked is the only place on the internet that discusses optimal portfolio models in the context of early retirement goals...
redstar wrote:
Fri Jul 31, 2020 10:36 am
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?
I use 16% for volatility and 5-6% for future ERP. I don't think there are good reasons to use different estimates for different geographic regions. If you want an active sector or geographic region tilt, you can use mean variance optimization to determine the optimal ratio. This is too difficult to do by hand.

IIRC Ayres and Nalebuff use the 10-year t-bill rate for the risk free rate as some sort of compromise. I usually use 1 or 3 month t-bills. I have not read the book so I don't know what the exact definition of samuelson share is, your math looks reasonable.

User avatar
Topic Author
Steve Reading
Posts: 2051
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading » Fri Jul 31, 2020 7:26 pm

redstar wrote:
Fri Jul 31, 2020 10:36 am
For risk/reward inputs into calculation, the authors suggest CAPE and VIX, but this tells me to have a 0% stock allocation?
Yeah that spreadsheet is useless. Just ignore their CAPE timing allocation.
redstar wrote:
Fri Jul 31, 2020 10:36 am
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?
I think those numbers come from simulations at March 31, 2020. So they don't take into account the nearly 35% stock price rise since then. I personally just use the historical ERP of 7.5% and volatility of 19.76% since 1929. If you use the numbers from 1970 onwards, the ERP is reduced to 5.68% but so is the volatility (17.39%) and they actually even out to the point where it doesn't matter much.

The reason I use these numbers is that I don't think I can predict stock returns or T-Bill returns. But the difference between them seems more reasonable. The ERP is simply how much people are willing to pay to avoid market risk and that seems like a more consistent value through time since it comes in large part from human psychology. Just my opinion, feel free to tweak based on your own outlook.
redstar wrote:
Fri Jul 31, 2020 10:36 am
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)
I personally compare it to T-Bills by virtue of using the numbers I showed you before. Because I am leveraged right now, I then further subtract the IBKR margin added cost. If you were in the unleveraged phase and used T-Bills, then if there were savings accounts yielding more, I think it would be fair game to use those savings accounts instead. You'd incorporate that by reducing the ERP by whatever much the savings accounts give you over current T-Bills.
redstar wrote:
Fri Jul 31, 2020 10:36 am
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%
Ok, there's two errors here:
1) Vanguard is providing annualized, compound returns. But the number that you need in the numerator is the arithmetic mean returns. You can add half the variance (volatility squared) to CAGR to get a rough estimate of arithmetic mean since stock yearly returns are roughly gaussian.
2) The ERP is simply pitting your two investment choices. Stocks or paying down margin. If you're unleveraged, the ERP is:
(Mean stock) - T-Bill (0.1%)

Since you're leveraged, the ERP is just:
(Mean stock) - IBKR margin cost (1.59%)

Note that if you're leveraged, it doesn't matter what the T-Bill rate is. As long as your borrowing cost is higher, the borrowing cost is, for all intents and purposes, the risk-free rate available to you.
Also note nowhere in the equation are you putting in that you're 150% leveraged. The Samuelson Share is an equation to figure out how much you'd like to invest in stocks today. It shouldn't depend on your current leverage. It's much more general than that.

I don't separate things by regions. But if I did, I would simply get the weighted average of your stock portfolio returns first, their volatility (which is technically less than their weighted average because of diversification), and use those parameters directly in the Samuelson equation.
"... 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
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Sun Aug 02, 2020 2:43 pm

Steve Reading wrote:
Wed Jul 29, 2020 10:30 am
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


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.
Sorry I thought you meant leveraged ETFs. Do you have any recommendation for solid index ETFs besides the total stock market index? I already hold the total stock market index in my IRA and 401ks so I wouldn't be able to hold it in my brokerage account and also do tax loss harvesting (I would have buys of the total stock market index every month since i'm DCA'ing).

Additionally, besides my HELOC @ 5% as my emergency fund to avoid margin calls I was also able to obtain a $100k personal line of credit @ 3.5% which is interest only for 2 years and then amortizes over the next 13.

Finally, I ran my own simulation of dollar cost averaging monthly into the S&P 500 at 2x leverage over every 10-year period the S&P 500 was in existence with no rebalancing (no selling period only buying). My simulation showed it took nearly 12 years in some instances for the leveraged strategy, after accounting for cumulative margin interest, to beat the unleveraged one, but with some patience it seems the 2x leverage wins out every time. During these stretches there would be at least 2 margin calls if you were required to keep 25%, although it sounds like for some accounts Interactive Brokers allows you to go to as low as 8-10%? Also, since Interactive Brokers allows only 2x leverage for initial margin, is there a way to DCA in at 3x after that or do all initial cash contributions have to be 2x?

User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Sun Aug 02, 2020 4:48 pm

Count of Notre Dame wrote:
Sun Aug 02, 2020 2:43 pm
Sorry I thought you meant leveraged ETFs. Do you have any recommendation for solid index ETFs besides the total stock market index? I already hold the total stock market index in my IRA and 401ks so I wouldn't be able to hold it in my brokerage account and also do tax loss harvesting (I would have buys of the total stock market index every month since i'm DCA'ing).

Additionally, besides my HELOC @ 5% as my emergency fund to avoid margin calls I was also able to obtain a $100k personal line of credit @ 3.5% which is interest only for 2 years and then amortizes over the next 13.

Finally, I ran my own simulation of dollar cost averaging monthly into the S&P 500 at 2x leverage over every 10-year period the S&P 500 was in existence with no rebalancing (no selling period only buying). My simulation showed it took nearly 12 years in some instances for the leveraged strategy, after accounting for cumulative margin interest, to beat the unleveraged one, but with some patience it seems the 2x leverage wins out every time. During these stretches there would be at least 2 margin calls if you were required to keep 25%, although it sounds like for some accounts Interactive Brokers allows you to go to as low as 8-10%? Also, since Interactive Brokers allows only 2x leverage for initial margin, is there a way to DCA in at 3x after that or do all initial cash contributions have to be 2x?
Using high-interest HELOC and personal credit lines to avoid margin calls is a terrible idea. If your risk tolerance supports a maximum leverage of 2, use a maximum leverage of 2. If the market goes down and your effective leverage increases, don't take a loan to prevent a margin call. Rebalance back to 2x leverage (or whatever your maximum leverage is).

2x leverage does not always win out over large periods of time. It may be true in historical data, but it is not guaranteed. Using leverage increases the average outcome, but it also worsens the worst possible outcome. This is not a problem within lifecycle investing because it strategically uses leverage to obtain the a higher expected outcome with the same amount of risk you'd usually take, but this requires quite complicated math to show. A backtest will not be able to give you an accurate overview of the expected outcomes.

With "DCA", I hope that you mean investing income as soon as possible, also known as lump sum investing. Not DCA, spreading out the investment of liquid capital. The latter is irrational.

Count of Notre Dame
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Mon Aug 03, 2020 10:14 am

Uncorrelated wrote:
Sun Aug 02, 2020 4:48 pm
Count of Notre Dame wrote:
Sun Aug 02, 2020 2:43 pm
Sorry I thought you meant leveraged ETFs. Do you have any recommendation for solid index ETFs besides the total stock market index? I already hold the total stock market index in my IRA and 401ks so I wouldn't be able to hold it in my brokerage account and also do tax loss harvesting (I would have buys of the total stock market index every month since i'm DCA'ing).

Additionally, besides my HELOC @ 5% as my emergency fund to avoid margin calls I was also able to obtain a $100k personal line of credit @ 3.5% which is interest only for 2 years and then amortizes over the next 13.

Finally, I ran my own simulation of dollar cost averaging monthly into the S&P 500 at 2x leverage over every 10-year period the S&P 500 was in existence with no rebalancing (no selling period only buying). My simulation showed it took nearly 12 years in some instances for the leveraged strategy, after accounting for cumulative margin interest, to beat the unleveraged one, but with some patience it seems the 2x leverage wins out every time. During these stretches there would be at least 2 margin calls if you were required to keep 25%, although it sounds like for some accounts Interactive Brokers allows you to go to as low as 8-10%? Also, since Interactive Brokers allows only 2x leverage for initial margin, is there a way to DCA in at 3x after that or do all initial cash contributions have to be 2x?
Using high-interest HELOC and personal credit lines to avoid margin calls is a terrible idea. If your risk tolerance supports a maximum leverage of 2, use a maximum leverage of 2. If the market goes down and your effective leverage increases, don't take a loan to prevent a margin call. Rebalance back to 2x leverage (or whatever your maximum leverage is).

2x leverage does not always win out over large periods of time. It may be true in historical data, but it is not guaranteed. Using leverage increases the average outcome, but it also worsens the worst possible outcome. This is not a problem within lifecycle investing because it strategically uses leverage to obtain the a higher expected outcome with the same amount of risk you'd usually take, but this requires quite complicated math to show. A backtest will not be able to give you an accurate overview of the expected outcomes.

With "DCA", I hope that you mean investing income as soon as possible, also known as lump sum investing. Not DCA, spreading out the investment of liquid capital. The latter is irrational.
Why is it a bad idea if my cash flow can support the interest + principal payments (less than 1% of my monthly cash flow) and it would force me to buy low when the market is tanking? My plan is to fund $100k at first for portfolio margin, then $10k per month thereafter. I want to avoid timing the market, especially this year.

I think of this investing strategy as my path to earlier financial independence - before age 60 - and my X factor to take a more aggressive swing for the fences. If it doesn't work out and I trail the market, it won't blowup my financial future. My time horizon is about 15 years. I have $1M in retirement accounts that I am already maxing out each year. I understand I am not applying the concepts of temporal diversification but rather trying to end up with the most money possible.

User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Mon Aug 03, 2020 10:42 am

Count of Notre Dame wrote:
Mon Aug 03, 2020 10:14 am
Uncorrelated wrote:
Sun Aug 02, 2020 4:48 pm
Count of Notre Dame wrote:
Sun Aug 02, 2020 2:43 pm
Sorry I thought you meant leveraged ETFs. Do you have any recommendation for solid index ETFs besides the total stock market index? I already hold the total stock market index in my IRA and 401ks so I wouldn't be able to hold it in my brokerage account and also do tax loss harvesting (I would have buys of the total stock market index every month since i'm DCA'ing).

Additionally, besides my HELOC @ 5% as my emergency fund to avoid margin calls I was also able to obtain a $100k personal line of credit @ 3.5% which is interest only for 2 years and then amortizes over the next 13.

Finally, I ran my own simulation of dollar cost averaging monthly into the S&P 500 at 2x leverage over every 10-year period the S&P 500 was in existence with no rebalancing (no selling period only buying). My simulation showed it took nearly 12 years in some instances for the leveraged strategy, after accounting for cumulative margin interest, to beat the unleveraged one, but with some patience it seems the 2x leverage wins out every time. During these stretches there would be at least 2 margin calls if you were required to keep 25%, although it sounds like for some accounts Interactive Brokers allows you to go to as low as 8-10%? Also, since Interactive Brokers allows only 2x leverage for initial margin, is there a way to DCA in at 3x after that or do all initial cash contributions have to be 2x?
Using high-interest HELOC and personal credit lines to avoid margin calls is a terrible idea. If your risk tolerance supports a maximum leverage of 2, use a maximum leverage of 2. If the market goes down and your effective leverage increases, don't take a loan to prevent a margin call. Rebalance back to 2x leverage (or whatever your maximum leverage is).

2x leverage does not always win out over large periods of time. It may be true in historical data, but it is not guaranteed. Using leverage increases the average outcome, but it also worsens the worst possible outcome. This is not a problem within lifecycle investing because it strategically uses leverage to obtain the a higher expected outcome with the same amount of risk you'd usually take, but this requires quite complicated math to show. A backtest will not be able to give you an accurate overview of the expected outcomes.

With "DCA", I hope that you mean investing income as soon as possible, also known as lump sum investing. Not DCA, spreading out the investment of liquid capital. The latter is irrational.
Why is it a bad idea if my cash flow can support the interest + principal payments (less than 1% of my monthly cash flow) and it would force me to buy low when the market is tanking? My plan is to fund $100k at first for portfolio margin, then $10k per month thereafter. I want to avoid timing the market, especially this year.

I think of this investing strategy as my path to earlier financial independence - before age 60 - and my X factor to take a more aggressive swing for the fences. If it doesn't work out and I trail the market, it won't blowup my financial future. My time horizon is about 15 years. I have $1M in retirement accounts that I am already maxing out each year.
The idea that you can buy low is a form of market timing. You can't buy low, or high. You can only buy at the price that best reflects market expectations of the future. Don't try to time the markets, invest according to the theory of lifecycle investing.

If you hold a constant leverage of 2x during the leverage constrained phase, you will obtain better results than if you switch between 1.5x leverage and 2.5x leverage (average 2x). If you increase your leverage during a downturn, that is suboptimal behavior.
I understand I am not applying the concepts of temporal diversification but rather trying to end up with the most money possible.
Lifecycle investing is the optimal approach to end up with the most money possible (for individuals with a planned retirement date and CRRA). If you would like to end up with even more money, you should work longer or use a lower coefficient of relative risk aversion. If you stray from lifecycle investing, you will take more risk than necessary for a given expected return.

Count of Notre Dame
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Mon Aug 03, 2020 11:14 am

Uncorrelated wrote:
Mon Aug 03, 2020 10:42 am
Count of Notre Dame wrote:
Mon Aug 03, 2020 10:14 am
Uncorrelated wrote:
Sun Aug 02, 2020 4:48 pm
Count of Notre Dame wrote:
Sun Aug 02, 2020 2:43 pm
Sorry I thought you meant leveraged ETFs. Do you have any recommendation for solid index ETFs besides the total stock market index? I already hold the total stock market index in my IRA and 401ks so I wouldn't be able to hold it in my brokerage account and also do tax loss harvesting (I would have buys of the total stock market index every month since i'm DCA'ing).

Additionally, besides my HELOC @ 5% as my emergency fund to avoid margin calls I was also able to obtain a $100k personal line of credit @ 3.5% which is interest only for 2 years and then amortizes over the next 13.

Finally, I ran my own simulation of dollar cost averaging monthly into the S&P 500 at 2x leverage over every 10-year period the S&P 500 was in existence with no rebalancing (no selling period only buying). My simulation showed it took nearly 12 years in some instances for the leveraged strategy, after accounting for cumulative margin interest, to beat the unleveraged one, but with some patience it seems the 2x leverage wins out every time. During these stretches there would be at least 2 margin calls if you were required to keep 25%, although it sounds like for some accounts Interactive Brokers allows you to go to as low as 8-10%? Also, since Interactive Brokers allows only 2x leverage for initial margin, is there a way to DCA in at 3x after that or do all initial cash contributions have to be 2x?
Using high-interest HELOC and personal credit lines to avoid margin calls is a terrible idea. If your risk tolerance supports a maximum leverage of 2, use a maximum leverage of 2. If the market goes down and your effective leverage increases, don't take a loan to prevent a margin call. Rebalance back to 2x leverage (or whatever your maximum leverage is).

2x leverage does not always win out over large periods of time. It may be true in historical data, but it is not guaranteed. Using leverage increases the average outcome, but it also worsens the worst possible outcome. This is not a problem within lifecycle investing because it strategically uses leverage to obtain the a higher expected outcome with the same amount of risk you'd usually take, but this requires quite complicated math to show. A backtest will not be able to give you an accurate overview of the expected outcomes.

With "DCA", I hope that you mean investing income as soon as possible, also known as lump sum investing. Not DCA, spreading out the investment of liquid capital. The latter is irrational.
Why is it a bad idea if my cash flow can support the interest + principal payments (less than 1% of my monthly cash flow) and it would force me to buy low when the market is tanking? My plan is to fund $100k at first for portfolio margin, then $10k per month thereafter. I want to avoid timing the market, especially this year.

I think of this investing strategy as my path to earlier financial independence - before age 60 - and my X factor to take a more aggressive swing for the fences. If it doesn't work out and I trail the market, it won't blowup my financial future. My time horizon is about 15 years. I have $1M in retirement accounts that I am already maxing out each year.
The idea that you can buy low is a form of market timing. You can't buy low, or high. You can only buy at the price that best reflects market expectations of the future. Don't try to time the markets, invest according to the theory of lifecycle investing.

If you hold a constant leverage of 2x during the leverage constrained phase, you will obtain better results than if you switch between 1.5x leverage and 2.5x leverage (average 2x). If you increase your leverage during a downturn, that is suboptimal behavior.
I understand I am not applying the concepts of temporal diversification but rather trying to end up with the most money possible.
Lifecycle investing is the optimal approach to end up with the most money possible (for individuals with a planned retirement date and CRRA). If you would like to end up with even more money, you should work longer or use a lower coefficient of relative risk aversion. If you stray from lifecycle investing, you will take more risk than necessary for a given expected return.
What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.

bumbojumbo
Posts: 18
Joined: Sun Feb 04, 2018 3:25 pm

Re: Lifecycle Investing - Leveraging when young

Post by bumbojumbo » Tue Aug 04, 2020 12:06 am

Steve Reading wrote:
Wed Mar 13, 2019 9:24 pm
I guess just to conclude, here's the plan I settled on:

The one thing I dislike about lifecycle investing is the "buy high, sell low" attitude when leveraging in Phase 1. It adds a feedback mechanism to the strategy that makes you invest more/less based on market conditions (not a fan of this).

So instead, I will opt for a range of leverage allowed (similar to rebalancing bands). My ideal leverage level will be 1.5:1. That way, even if stocks drop a massive 50% and I don't contribute any savings that year, the leverage will only rise to ~3:1 (which I feel comfortable with). I do expect to save significantly though.

This way, I believe I can keep the leverage controlled to levels that I think are very reasonable, purely with savings contributions (without a need to sell during market downturns). I accept this might be less ideal than 2:1 with rebalancing to sell at losses (the true lifecycle investing strategy of the book). I also accept it will take me longer to hit my lifetime stock allocation by targeting 1.5:1 leverage instead. But the upside is that by keeping the leverage much more conservative than 2:1, I have a much wider range of higher leverage such that I don't have to sell during extreme market downturns. Feels like a good blend between lifecycle investing and something I feel comfortable with.

I appreciate the help from everyone here. Perhaps I'll update/bump the thread in the future.
Having just discovered this thread, the above strategy is almost the one I decided on a couple of years ago. Having to perpetually adjust the 2:1 leverage leaves far too much room for emotions to take over. One step further, instead of targeting 1.5:1, I only leverage 1.5:1 initially at the time of contribution and it floats. This seems like the most unemotional way to go about it.

User avatar
Stef
Posts: 998
Joined: Thu Oct 10, 2019 10:13 am

Re: Lifecycle Investing - Leveraging when young

Post by Stef » Tue Aug 04, 2020 12:47 am

So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?

whtmyid99
Posts: 5
Joined: Thu Aug 01, 2019 3:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by whtmyid99 » Tue Aug 04, 2020 1:19 am

Great thread and thank you all for sharing your research into this topic.

For the folks who are using IB to implement this strategy, I am assuming you are either meeting the monthly $10 minimum commission on your IB Pro account or paying the difference to IB.

Is this $120 per year minimum commission considered into your margin rate calculation? The fact that you are paying extra $120 per year to get a better margin rate using pro account, tilt the scale towards using options (with LITE account)?

User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Tue Aug 04, 2020 2:54 am

Count of Notre Dame wrote:
Mon Aug 03, 2020 11:14 am

What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.
There is no good reason to treat "new" money different from old money. Don't "float" your allocation. If your max leverage is 2x, then you should never go above 2x leverage.

Misunderstanding this may result in the loss of your entire brokerage account, that's what happened to Market Timer. Ayres and Nalebuff went through the trouble of calculating what the best approach is, I suggest you follow it to the letter.

User avatar
Topic Author
Steve Reading
Posts: 2051
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading » Tue Aug 04, 2020 8:17 am

Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
I personally don't consider my tax-advantaged space for purposes of leverage since I can't move money between each other. So my overall leverage is a little lower than my ideal leverage target. So be it.
whtmyid99 wrote:
Tue Aug 04, 2020 1:19 am
Great thread and thank you all for sharing your research into this topic.

For the folks who are using IB to implement this strategy, I am assuming you are either meeting the monthly $10 minimum commission on your IB Pro account or paying the difference to IB.

Is this $120 per year minimum commission considered into your margin rate calculation? The fact that you are paying extra $120 per year to get a better margin rate using pro account, tilt the scale towards using options (with LITE account)?
IBKR doesn't charge the $10 monthly fee at all if your account is larger than $100k. That's the case for me so i don't worry about this.
"... 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

whtmyid99
Posts: 5
Joined: Thu Aug 01, 2019 3:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by whtmyid99 » Tue Aug 04, 2020 8:56 am

Steve Reading wrote:
Tue Aug 04, 2020 8:17 am
IBKR doesn't charge the $10 monthly fee at all if your account is larger than $100k. That's the case for me so i don't worry about this.
Awesome. Didn’t know this. Thanks

Count of Notre Dame
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Tue Aug 04, 2020 9:54 am

Uncorrelated wrote:
Tue Aug 04, 2020 2:54 am
Count of Notre Dame wrote:
Mon Aug 03, 2020 11:14 am

What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.
There is no good reason to treat "new" money different from old money. Don't "float" your allocation. If your max leverage is 2x, then you should never go above 2x leverage.

Misunderstanding this may result in the loss of your entire brokerage account, that's what happened to Market Timer. Ayres and Nalebuff went through the trouble of calculating what the best approach is, I suggest you follow it to the letter.
That makes sense. So would the strategy be as the market dips and my equity % is lower, I buy more shares? As the market increases, do I necessarily have to sell to maintain the 2x leverage? Is that what the monthly rebalancing means in portfolio visualizer? There seems to be a dramatic difference in returns when I select monthly rebalancing vs. when I do not.

redstar
Posts: 79
Joined: Thu Jul 13, 2017 11:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by redstar » Tue Aug 04, 2020 2:37 pm

Steve Reading wrote:
Tue Aug 04, 2020 8:17 am
Quick question, are you using the normal Margin account at IB or their Portfolio Margin account? It seems like if you are operating under 2x leverage then the normal account should be fine, right?

Mickelous
Posts: 76
Joined: Mon Apr 20, 2020 11:24 pm

Re: Lifecycle Investing - Leveraging when young

Post by Mickelous » Tue Aug 04, 2020 5:12 pm

Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
You could use Leveraged ETFs like UPRO / TQQQ/ TMF to get the job done.

User avatar
Topic Author
Steve Reading
Posts: 2051
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading » Tue Aug 04, 2020 7:14 pm

redstar wrote:
Tue Aug 04, 2020 2:37 pm
Steve Reading wrote:
Tue Aug 04, 2020 8:17 am
Quick question, are you using the normal Margin account at IB or their Portfolio Margin account? It seems like if you are operating under 2x leverage then the normal account should be fine, right?
Just the normal margin. Portfolio Margin allows more leverage (less equity required) but it's variable and dependent on many complicated factors so just beware if you go that route.
"... 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

User avatar
Topic Author
Steve Reading
Posts: 2051
Joined: Fri Nov 16, 2018 10:20 pm

Re: Lifecycle Investing - Leveraging when young

Post by Steve Reading » Tue Aug 04, 2020 7:51 pm

Steve Reading wrote:
Fri Mar 01, 2019 12:11 am
August 2020
Total Stock Exposure = 540k
Effective Debt = 300k
Equity in the exposure = 241k
Leverage (@ IBKR) = 1.5
Figured I'd give an update. I'll just do these twice a year, there's really nothing exciting about them. Just slowly saving and going through the lifecycle.
"... 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

Impatience
Posts: 58
Joined: Thu Jul 23, 2020 3:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by Impatience » Tue Aug 04, 2020 9:21 pm

Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
Why 125%? Or 175%? You’ve never even used leverage. It seems like everyone immediately leaps to using 20% or 25% leverage and it’s NOT a smart move if you’re doing so on margin.

First of all I’m pretty sure you couldn’t go to 175% exposure (using margin) as Reg T margin is 50% overnight. Even at 150% you would be margin called much sooner than a -57% crash. I’m not sure how you’re getting these numbers.

I recommend you start with 5% leverage on your taxable account. 5% leverage compounded year over year will have a big impact on your gains and you almost certainly won’t get wiped out. It will also give you an opportunity to learn your way around the mechanics and terminology of margin and see how your account reacts to changes in the market.

Crawl before you walk.

Count of Notre Dame
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Tue Aug 04, 2020 10:02 pm

Impatience wrote:
Tue Aug 04, 2020 9:21 pm
Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
Why 125%? Or 175%? You’ve never even used leverage. It seems like everyone immediately leaps to using 20% or 25% leverage and it’s NOT a smart move if you’re doing so on margin.

First of all I’m pretty sure you couldn’t go to 175% exposure (using margin) as Reg T margin is 50% overnight. Even at 150% you would be margin called much sooner than a -57% crash. I’m not sure how you’re getting these numbers.

I recommend you start with 5% leverage on your taxable account. 5% leverage compounded year over year will have a big impact on your gains and you almost certainly won’t get wiped out. It will also give you an opportunity to learn your way around the mechanics and terminology of margin and see how your account reacts to changes in the market.

Crawl before you walk.
Agree with your sentiment but horribly confused by the percentages. Didn't he just mean 1.25x 1.75x without the percentage signs? I'm considering going 2x which would translate to 50%?

sfmurph
Posts: 93
Joined: Mon Aug 12, 2019 8:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by sfmurph » Tue Aug 04, 2020 11:40 pm

Count of Notre Dame wrote:
Tue Aug 04, 2020 10:02 pm
Impatience wrote:
Tue Aug 04, 2020 9:21 pm
Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
Why 125%? Or 175%? You’ve never even used leverage. It seems like everyone immediately leaps to using 20% or 25% leverage and it’s NOT a smart move if you’re doing so on margin.

First of all I’m pretty sure you couldn’t go to 175% exposure (using margin) as Reg T margin is 50% overnight. Even at 150% you would be margin called much sooner than a -57% crash. I’m not sure how you’re getting these numbers.

I recommend you start with 5% leverage on your taxable account. 5% leverage compounded year over year will have a big impact on your gains and you almost certainly won’t get wiped out. It will also give you an opportunity to learn your way around the mechanics and terminology of margin and see how your account reacts to changes in the market.

Crawl before you walk.
Agree with your sentiment but horribly confused by the percentages. Didn't he just mean 1.25x 1.75x without the percentage signs? I'm considering going 2x which would translate to 50%?
Yes, Impatience has something confused. It's like how a 20% down payment means you are 5x leveraged. So to get 1.25x, you need 1/1.25, or 80% "down."

However, using the leveraged ETFs is safer and cheaper. The ER is about 1% vs 3+% for a margin loan, and you can't get margin called for holding UPRO.

In Stef's case, getting to 130% stock and 0% bonds with the account restrictions called out, and given $100,000 in total assets:

In tax-deferred:
VOO: $66,000

In taxable:
VOO: $19,000
UPRO: $15,000

So that would be $85,000 in VOO and $15,000 in UPRO. That's 3x leveraged, so it "counts" as $45,000. Adding that to the total VOO holdings "counts" as $130,000, so 1.3x, with an "excess ER" of 0.89 on the $15,000 for $135. That would compare to a margin loan on $30,000 at 2.6% which would cost $780.
Costs matter ;)

RayKeynes
Posts: 234
Joined: Mon Nov 11, 2019 2:14 am

Re: Lifecycle Investing - Leveraging when young

Post by RayKeynes » Wed Aug 05, 2020 12:21 am

sfmurph wrote:
Tue Aug 04, 2020 11:40 pm
Count of Notre Dame wrote:
Tue Aug 04, 2020 10:02 pm
Impatience wrote:
Tue Aug 04, 2020 9:21 pm
Stef wrote:
Tue Aug 04, 2020 12:47 am
So I just upgraded my IBKR account to margin and thinking about leveraging as I'm only 29 years old. My issue is that 2/3 of my assets are currently in tax-deferred accounts with no option for leveraging up and the other 1/3 on IBKR.

There is no safe way to approach this. If I want 125% overall stock exposure, I'll need to go for 175% in IBKR which could be quite dangerous. A -57% crash would wipe out my taxable account! This is very likely to happen within the next 2 decades.

So should I use leverage in such a situation at all?
Why 125%? Or 175%? You’ve never even used leverage. It seems like everyone immediately leaps to using 20% or 25% leverage and it’s NOT a smart move if you’re doing so on margin.

First of all I’m pretty sure you couldn’t go to 175% exposure (using margin) as Reg T margin is 50% overnight. Even at 150% you would be margin called much sooner than a -57% crash. I’m not sure how you’re getting these numbers.

I recommend you start with 5% leverage on your taxable account. 5% leverage compounded year over year will have a big impact on your gains and you almost certainly won’t get wiped out. It will also give you an opportunity to learn your way around the mechanics and terminology of margin and see how your account reacts to changes in the market.

Crawl before you walk.
Agree with your sentiment but horribly confused by the percentages. Didn't he just mean 1.25x 1.75x without the percentage signs? I'm considering going 2x which would translate to 50%?
That would compare to a margin loan on $30,000 at 2.6% which would cost $780.
Costs matter ;)
IBKR does currently charge 1.6% on a yearly Basis on USD loans ;)

User avatar
Stef
Posts: 998
Joined: Thu Oct 10, 2019 10:13 am

Re: Lifecycle Investing - Leveraging when young

Post by Stef » Wed Aug 05, 2020 12:28 am

sfmurph wrote:
Tue Aug 04, 2020 11:40 pm
Yes, Impatience has something confused. It's like how a 20% down payment means you are 5x leveraged. So to get 1.25x, you need 1/1.25, or 80% "down."

However, using the leveraged ETFs is safer and cheaper. The ER is about 1% vs 3+% for a margin loan, and you can't get margin called for holding UPRO.

In Stef's case, getting to 130% stock and 0% bonds with the account restrictions called out, and given $100,000 in total assets:

In tax-deferred:
VOO: $66,000

In taxable:
VOO: $19,000
UPRO: $15,000

So that would be $85,000 in VOO and $15,000 in UPRO. That's 3x leveraged, so it "counts" as $45,000. Adding that to the total VOO holdings "counts" as $130,000, so 1.3x, with an "excess ER" of 0.89 on the $15,000 for $135. That would compare to a margin loan on $30,000 at 2.6% which would cost $780.
Costs matter ;)
You are right, that's a great idea and you're not risking a margin call. Will look into it, thanks.

User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Wed Aug 05, 2020 3:17 am

Count of Notre Dame wrote:
Tue Aug 04, 2020 9:54 am
Uncorrelated wrote:
Tue Aug 04, 2020 2:54 am
Count of Notre Dame wrote:
Mon Aug 03, 2020 11:14 am

What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.
There is no good reason to treat "new" money different from old money. Don't "float" your allocation. If your max leverage is 2x, then you should never go above 2x leverage.

Misunderstanding this may result in the loss of your entire brokerage account, that's what happened to Market Timer. Ayres and Nalebuff went through the trouble of calculating what the best approach is, I suggest you follow it to the letter.
That makes sense. So would the strategy be as the market dips and my equity % is lower, I buy more shares? As the market increases, do I necessarily have to sell to maintain the 2x leverage? Is that what the monthly rebalancing means in portfolio visualizer? There seems to be a dramatic difference in returns when I select monthly rebalancing vs. when I do not.
Suppose that you have $100k in your brokerage account. Your desired leverage is 2x, so you purchase $200k in equity exposure.

The market drops 25%. Your equity exposure is now $150k and your account is worth $50k. Your effective leverage is 3x, you sell some equity exposure to put the leverage back at 2x.

The market increases 25%. Your equity exposure is now $250k and your account is worth $150k. Your effective leverage is 1.66x, you purchase some equity exposure to put the leverage back at 2x.

If something happens, you rebalance back to 2x leverage. The only hard part is figuring out which rebalancing frequency optimizes tax and transaction costs.

User avatar
Stef
Posts: 998
Joined: Thu Oct 10, 2019 10:13 am

Re: Lifecycle Investing - Leveraging when young

Post by Stef » Wed Aug 05, 2020 5:31 am

Uncorrelated wrote:
Wed Aug 05, 2020 3:17 am
Suppose that you have $100k in your brokerage account. Your desired leverage is 2x, so you purchase $200k in equity exposure.

The market drops 25%. Your equity exposure is now $150k and your account is worth $50k. Your effective leverage is 3x, you sell some equity exposure to put the leverage back at 2x.
What if the market drops 51%? Wiped out.

User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Wed Aug 05, 2020 5:59 am

Stef wrote:
Wed Aug 05, 2020 5:31 am
Uncorrelated wrote:
Wed Aug 05, 2020 3:17 am
Suppose that you have $100k in your brokerage account. Your desired leverage is 2x, so you purchase $200k in equity exposure.

The market drops 25%. Your equity exposure is now $150k and your account is worth $50k. Your effective leverage is 3x, you sell some equity exposure to put the leverage back at 2x.
What if the market drops 51%? Wiped out.
The market doesn't drop 51% in one day. In theory, with the current circuit breakers and if you rebalance every day, it is impossible to get wiped out.

But if you don't rebalance often enough, then you can indeed get wiped out. That's a calculated risk. If you don't want to take that risk, use less leverage.

sfmurph
Posts: 93
Joined: Mon Aug 12, 2019 8:15 pm

Re: Lifecycle Investing - Leveraging when young

Post by sfmurph » Wed Aug 05, 2020 10:56 am

RayKeynes wrote:
Wed Aug 05, 2020 12:21 am
IBKR does currently charge 1.6% on a yearly Basis on USD loans ;)
At the "IBKR Pro" level, yes. At the "Lite" level, it's 2.6%. Both are higher than the ERs in the 3x ETFs, but you do get more flexibility with a margin loan. There's no 3x version of VT, for example.

Count of Notre Dame
Posts: 211
Joined: Fri Oct 11, 2013 1:08 pm

Re: Lifecycle Investing - Leveraging when young

Post by Count of Notre Dame » Wed Aug 05, 2020 11:16 am

Uncorrelated wrote:
Wed Aug 05, 2020 3:17 am
Count of Notre Dame wrote:
Tue Aug 04, 2020 9:54 am
Uncorrelated wrote:
Tue Aug 04, 2020 2:54 am
Count of Notre Dame wrote:
Mon Aug 03, 2020 11:14 am

What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.
There is no good reason to treat "new" money different from old money. Don't "float" your allocation. If your max leverage is 2x, then you should never go above 2x leverage.

Misunderstanding this may result in the loss of your entire brokerage account, that's what happened to Market Timer. Ayres and Nalebuff went through the trouble of calculating what the best approach is, I suggest you follow it to the letter.
That makes sense. So would the strategy be as the market dips and my equity % is lower, I buy more shares? As the market increases, do I necessarily have to sell to maintain the 2x leverage? Is that what the monthly rebalancing means in portfolio visualizer? There seems to be a dramatic difference in returns when I select monthly rebalancing vs. when I do not.
Suppose that you have $100k in your brokerage account. Your desired leverage is 2x, so you purchase $200k in equity exposure.

The market drops 25%. Your equity exposure is now $150k and your account is worth $50k. Your effective leverage is 3x, you sell some equity exposure to put the leverage back at 2x.

The market increases 25%. Your equity exposure is now $250k and your account is worth $150k. Your effective leverage is 1.66x, you purchase some equity exposure to put the leverage back at 2x.

If something happens, you rebalance back to 2x leverage. The only hard part is figuring out which rebalancing frequency optimizes tax and transaction costs.
Why by definition would be buying high, selling low, hoping the leverage overwhelms that effect? I would really hope to avoid maintaining constant leverage, but it seems without rebalancing the results compared to the index aren't as convincing.


User avatar
Uncorrelated
Posts: 815
Joined: Sun Oct 13, 2019 3:16 pm

Re: Lifecycle Investing - Leveraging when young

Post by Uncorrelated » Wed Aug 05, 2020 12:16 pm

Count of Notre Dame wrote:
Wed Aug 05, 2020 11:16 am
Uncorrelated wrote:
Wed Aug 05, 2020 3:17 am
Count of Notre Dame wrote:
Tue Aug 04, 2020 9:54 am
Uncorrelated wrote:
Tue Aug 04, 2020 2:54 am
Count of Notre Dame wrote:
Mon Aug 03, 2020 11:14 am

What I was thinking of doing is always buying in with new purchases at 2x, but otherwise letting the portfolio float unless I reach a level that could trigger a margin call in which I would use the lines of credit as a cash influx to avoid that. The monthly cash influxes would be pushing the portfolio always to 50% equity.
There is no good reason to treat "new" money different from old money. Don't "float" your allocation. If your max leverage is 2x, then you should never go above 2x leverage.

Misunderstanding this may result in the loss of your entire brokerage account, that's what happened to Market Timer. Ayres and Nalebuff went through the trouble of calculating what the best approach is, I suggest you follow it to the letter.
That makes sense. So would the strategy be as the market dips and my equity % is lower, I buy more shares? As the market increases, do I necessarily have to sell to maintain the 2x leverage? Is that what the monthly rebalancing means in portfolio visualizer? There seems to be a dramatic difference in returns when I select monthly rebalancing vs. when I do not.
Suppose that you have $100k in your brokerage account. Your desired leverage is 2x, so you purchase $200k in equity exposure.

The market drops 25%. Your equity exposure is now $150k and your account is worth $50k. Your effective leverage is 3x, you sell some equity exposure to put the leverage back at 2x.

The market increases 25%. Your equity exposure is now $250k and your account is worth $150k. Your effective leverage is 1.66x, you purchase some equity exposure to put the leverage back at 2x.

If something happens, you rebalance back to 2x leverage. The only hard part is figuring out which rebalancing frequency optimizes tax and transaction costs.
Why by definition would be buying high, selling low, hoping the leverage overwhelms that effect? I would really hope to avoid maintaining constant leverage, but it seems without rebalancing the results compared to the index aren't as convincing.
By definition in order to sell "low" more often than you sell "high", you must know when whether the price is going to rise or fall in the near future. But you don't know that. If you did knew that, you would be a day trader not a passive index investor.

If I try your second backtest without contributions, the portfolio goes to zero in 2009. That is the price of not rebalancing. Coincidentally that is exactly what happened to Market Timer.

Using portfoliovisualizer to answer these questions is a terrible idea. Portfoliovisualizer tells you what has happened in the past, but you want to know which method has the best probability distribution of outcomes. Lifecycle investing tells you what method is the best under the specific modeling assumptions they have used. If you disagree with those modeling assumptions, don't use portfolio visualizer, build a better model. (or more probable, spend 5-10 years to become an expert in optimization, and then build a better model).

Post Reply