Applying a bit of Leverage in Roth IRA as an early accumulator

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
w3ldon
Posts: 45
Joined: Thu Jul 09, 2020 9:06 am

Applying a bit of Leverage in Roth IRA as an early accumulator

Post by w3ldon »

I understand that many bogleheads frown on the idea of trying to get out more than the "market gives you." But on the other hand, I have been convinced by arguments for lifecycle investing that make a good point -- why have so much equity exposure later in your investing timeline than earlier. This is balanced out by the practicalities of applying leverage, and of course the risk of total loss.

viewtopic.php?t=274390

from this thread, I've seen the following criteria proposed:
bobcat2 wrote: Sat Mar 02, 2019 8:46 pm
Lifecycle investing does call for a high percentage of investible assets be invested in risky assets for young investors no older than their early thirties, because so much of their wealth is in relatively safe human capital rather than financial capital. But their financial wealth wouldn’t be leveraged or even 100% because they need some safe assets to deal with bad financial states such as unemployment and bad health. For a young person to reasonably leverage their assets would require that she has no student debt, no credit card or other consumer debt such as car loan or lease, very stable employment such as tenured professor, physician, or law partner, employment not correlated with financial markets, and that she be very knowledgeable about financial markets and investing. The percentage of young investors that fit that leverage profile would appear to be less than 1% of the population of adults no older than their early thirties.

BobK
1. Early thirties or younger [x]
2. Safe human capital [x]
3. No debt of any kind [x] (including no mortgage)
4. Stable employment, not correlated with financial markets [x]
5. Knowledgeable about investing [ ] ? Improving hopefully. I have read two books about futures in general and other online education.

I would like to apply some leverage in my Roth IRA.

I'd rather keep this more theoretical and not go into my exact account balances, but to give some context:

Overall, I have around 100k invested, 95% equities, 5% cash. 80/20 split on total stock market or S&P 500 and international.

The Roth IRA I have has 34k currently and is currently 80/20% ITOT ( iShares Core S&P Total US Stock Market ETF) and IXUS (iShares Core MSCI Total International Stock ETF).

I wanted to start off targeting 1.5x leverage (in this account only), and adding some EDV for negative correlation.

Proposed allocation in Roth IRA:
1x Micro E-Mini S&P 500 futures contract : 5 x $3400 = $17,000
Margin for contract (1,200 required, but keep more for safety) = $3,000
EDV (Vanguard Extended Duration ETF) = $3,400 (10%)
ITOT = $13,800 (40.5%)
IXUS = $13,800 (40.5%)

Overall equity leverage would therefore be:
($17,000 (micro E mini) + $13,800+ $13,800) / ($13,800 + $13,800 + $3,000 + $3,400) = 131% equities + 10% EDV + 9% cash margin = 150% total

The plan would then be to roll over the futures contracts quarterly and potentially add a new contract every year with the $6,000 contribution (perhaps until I have a mortgage again and have leverage through that). If there is a large dip / margin call, I liquidate some of the (hopefully) excess EDV percentage over 10% and if above that, the equity ETFs to maintain the buy and hold strategy.

Thoughts on my calculations or the overall strategy in my position?
Rlew
Posts: 15
Joined: Mon Mar 18, 2019 8:32 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Rlew »

I don't think it is crazy to apply a modest amount of leverage early in life, especially in a Roth. That's essentially what a mortgage is, as you don't have one. Having said that, I would ask yourself if you really need to take on the extra risk to meet your financial goals. There a chance this strategy might sound really smart until it doesn't ... Go back and look at the thread from market timer about life cycle investing through the great recession.

If you are going to apply some leverage, I think it would be easier to look into PSLDX (leveraged fund with risk parity approach)... Also a long and interesting thread about that on here recently. PIMCO also has an international fund with the same concept. Or really roll the dice and jump onto HEDGEFUNDIE'S great adventure... Again, not an endorsement for this strategy, but something to consider if you are bent on leverage
"When there are multiple solutions to a problem, choose the simplest one" Jack Bogle
PluckyDucky
Posts: 269
Joined: Tue Jan 15, 2019 8:29 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by PluckyDucky »

My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
Last edited by PluckyDucky on Tue Oct 06, 2020 11:22 am, edited 2 times in total.
refinedchain
Posts: 27
Joined: Tue Feb 17, 2015 10:32 am

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by refinedchain »

Someone must be doing some marketing somewhere because this is also on my brain and I also read that thread. Maybe that alone should be a warning sign to us?

Things you may have missed:
  • Your Roth IRA likely has higher margin requirements than the futures contract states. At Interactive Brokers it is 300%, for example.
  • Why do you have both ITOT and futures? It seems like you could ditch ITOT and replace it with another futures contract + more bonds for increased safety.
  • What happens when you back-test this portfolio against March's sudden drop?
  • How much must the market fall to wipe you out? What are you going to do about that?
User avatar
Steve Reading
Posts: 2518
Joined: Fri Nov 16, 2018 10:20 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Steve Reading »

w3ldon wrote: Tue Oct 06, 2020 10:17 am I understand that many bogleheads frown on the idea of trying to get out more than the "market gives you." But on the other hand, I have been convinced by arguments for lifecycle investing that make a good point -- why have so much equity exposure later in your investing timeline than earlier. This is balanced out by the practicalities of applying leverage, and of course the risk of total loss.

viewtopic.php?t=274390

from this thread, I've seen the following criteria proposed:
bobcat2 wrote: Sat Mar 02, 2019 8:46 pm
Lifecycle investing does call for a high percentage of investible assets be invested in risky assets for young investors no older than their early thirties, because so much of their wealth is in relatively safe human capital rather than financial capital. But their financial wealth wouldn’t be leveraged or even 100% because they need some safe assets to deal with bad financial states such as unemployment and bad health. For a young person to reasonably leverage their assets would require that she has no student debt, no credit card or other consumer debt such as car loan or lease, very stable employment such as tenured professor, physician, or law partner, employment not correlated with financial markets, and that she be very knowledgeable about financial markets and investing. The percentage of young investors that fit that leverage profile would appear to be less than 1% of the population of adults no older than their early thirties.

BobK
1. Early thirties or younger [x]
2. Safe human capital [x]
3. No debt of any kind [x] (including no mortgage)
4. Stable employment, not correlated with financial markets [x]
5. Knowledgeable about investing [ ] ? Improving hopefully. I have read two books about futures in general and other online education.

I would like to apply some leverage in my Roth IRA.

I'd rather keep this more theoretical and not go into my exact account balances, but to give some context:

Overall, I have around 100k invested, 95% equities, 5% cash. 80/20 split on total stock market or S&P 500 and international.

The Roth IRA I have has 34k currently and is currently 80/20% ITOT ( iShares Core S&P Total US Stock Market ETF) and IXUS (iShares Core MSCI Total International Stock ETF).

I wanted to start off targeting 1.5x leverage (in this account only), and adding some EDV for negative correlation.

Proposed allocation in Roth IRA:
1x Micro E-Mini S&P 500 futures contract : 5 x $3400 = $17,000
Margin for contract (1,200 required, but keep more for safety) = $3,000
EDV (Vanguard Extended Duration ETF) = $3,400 (10%)
ITOT = $13,800 (40.5%)
IXUS = $13,800 (40.5%)

Overall equity leverage would therefore be:
($17,000 (micro E mini) + $13,800+ $13,800) / ($13,800 + $13,800 + $3,000 + $3,400) = 131% equities + 10% EDV + 9% cash margin = 150% total

The plan would then be to roll over the futures contracts quarterly and potentially add a new contract every year with the $6,000 contribution (perhaps until I have a mortgage again and have leverage through that). If there is a large dip / margin call, I liquidate some of the (hopefully) excess EDV percentage over 10% and if above that, the equity ETFs to maintain the buy and hold strategy.

Thoughts on my calculations or the overall strategy in my position?
1) Are you willing to rebalance leverage when it gets too out of wack? Yes, that means selling stocks if markets drop enough.
2) You can lose a lot of money with these strategies. I lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis. And it happened in 3 weeks. Are you psychologically prepared for that kind of scenario?
refinedchain wrote: Tue Oct 06, 2020 11:17 am [*]What happens when you back-test this portfolio against March's sudden drop?
You lose a large chunk of your financial net worth.
refinedchain wrote: Tue Oct 06, 2020 11:17 am Someone must be doing some marketing somewhere because this is also on my brain and I also read that thread. Maybe that alone should be a warning sign to us?
I'm not selling anyone, anything haha. Just trying to show BHs that Lifecycle Investing can be done done prudently.
refinedchain wrote: Tue Oct 06, 2020 11:17 am [*]Why do you have both ITOT and futures? It seems like you could ditch ITOT and replace it with another futures contract + more bonds for increased safety.
Something to keep in mind is that equity futures don't quite borrow at the risk-free rate (probably closer to 0.3-0.5%). So in general, it's best to have as much of the equity exposure through regular, low-cost ETFs, and only supplement with futures to the extent you need.
"... 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
djeayzonne
Posts: 101
Joined: Wed Dec 06, 2017 2:14 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by djeayzonne »

The PSLDX and NTSX are great suggestions. I have both of these funds in my portfolio. However, neither gives leverage to equities.

I wouldn't use Roth space for NTSX either.

I think your proposal is good if looking at only the one account. As you are only planning to do 1.5x in one small account, I don't see any reason to decrease leverage further when you get a mortgage.

If your total portfolio is 100k, then the one MES contact gets you only to about 1.15x equity exposure at current notional value.

If lifecycle investing is really something you believe in, and you are willing to put in the effort to manage it and accept the risk, why implement only a 1.15x strategy?
Tingting1013
Posts: 488
Joined: Mon Aug 24, 2020 5:44 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Tingting1013 »

Steve Reading wrote: Tue Oct 06, 2020 2:01 pmI lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis.
-55% is actually exactly how much the S&P 500 fell top to bottom during the GFC
User avatar
Steve Reading
Posts: 2518
Joined: Fri Nov 16, 2018 10:20 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Steve Reading »

Tingting1013 wrote: Tue Oct 06, 2020 2:35 pm
Steve Reading wrote: Tue Oct 06, 2020 2:01 pmI lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis.
-55% is actually exactly how much the S&P 500 fell top to bottom during the GFC
Yes, but dividends cushioned it a little bit (-4% cushion). And many investors in 100% stocks are accumulators so by the end of the GFC, they wouldn't have seen a net worth that dropped 50% from the start to the end due to their cash contributions. So if they started with 100k, they never would've seen it drop below 50k for instance.

When you leverage, the above can, has, and probably will occur. This is why William Bernstein writes "there is no sentient being in this galaxy that can tolerate a Lifecycle Investing portfolio". While maybe a bit dramatic, he isn't that off either.
"... 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
Tingting1013
Posts: 488
Joined: Mon Aug 24, 2020 5:44 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Tingting1013 »

Steve Reading wrote: Tue Oct 06, 2020 2:51 pm
Tingting1013 wrote: Tue Oct 06, 2020 2:35 pm
Steve Reading wrote: Tue Oct 06, 2020 2:01 pmI lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis.
-55% is actually exactly how much the S&P 500 fell top to bottom during the GFC
Yes, but dividends cushioned it a little bit (-4% cushion). And many investors in 100% stocks are accumulators so by the end of the GFC, they wouldn't have seen a net worth that dropped 50% from the start to the end due to their cash contributions. So if they started with 100k, they never would've seen it drop below 50k for instance.
No the -55% drawdown included dividends.

Check out the 2007 high and 2009 low on the S&P 500 TR index.
User avatar
Steve Reading
Posts: 2518
Joined: Fri Nov 16, 2018 10:20 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Steve Reading »

Tingting1013 wrote: Tue Oct 06, 2020 2:56 pm
Steve Reading wrote: Tue Oct 06, 2020 2:51 pm
Tingting1013 wrote: Tue Oct 06, 2020 2:35 pm
Steve Reading wrote: Tue Oct 06, 2020 2:01 pmI lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis.
-55% is actually exactly how much the S&P 500 fell top to bottom during the GFC
Yes, but dividends cushioned it a little bit (-4% cushion). And many investors in 100% stocks are accumulators so by the end of the GFC, they wouldn't have seen a net worth that dropped 50% from the start to the end due to their cash contributions. So if they started with 100k, they never would've seen it drop below 50k for instance.
No the -55% drawdown included dividends.

Check out the 2007 high and 2009 low on the S&P 500 TR index.
I see a drop of 56% in SPY’s price. That’s why I assumed what you said didn’t include dividends. Perhaps dividends were cut more than I thought they had.

Cheers mate.
"... 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
Topic Author
w3ldon
Posts: 45
Joined: Thu Jul 09, 2020 9:06 am

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by w3ldon »

Steve Reading wrote: Tue Oct 06, 2020 2:51 pm
Tingting1013 wrote: Tue Oct 06, 2020 2:35 pm
Steve Reading wrote: Tue Oct 06, 2020 2:01 pmI lost ~55% of my net worth back in March. That's more than even the most aggressive 100% stock BHs lost during the Great Financial Crisis.
-55% is actually exactly how much the S&P 500 fell top to bottom during the GFC
Yes, but dividends cushioned it a little bit (-4% cushion). And many investors in 100% stocks are accumulators so by the end of the GFC, they wouldn't have seen a net worth that dropped 50% from the start to the end due to their cash contributions. So if they started with 100k, they never would've seen it drop below 50k for instance.

When you leverage, the above can, has, and probably will occur. This is why William Bernstein writes "there is no sentient being in this galaxy that can tolerate a Lifecycle Investing portfolio". While maybe a bit dramatic, he isn't that off either.
Thank you everyone for the helpful comments.

In response to NTSX and PSLDX - while potentially safer, I'm not sure they fit into my overall goal of having higher equity exposure now (and less later to follow Lifecycle Investing).

In response to comments about why stop at 1.15x for the total portfolio, there are some practicalities. First, I don't want to start too ambitiously; while I have been comfortable at 95% equities even through March (my only real test at this point), while I learn the rebalancing that Steve Reading mentioned and the workflow of rolling futures contracts, I don't have to be too heavily leveraged at first. Also, while my DW is also comfortable with 100% equities, I think it would be a step beyond to ask that she transfer her assets to a different broker to permit more leverage. That would leave me with taking a very high degree of leverage in the Roth account that could definitely wipe it out.

Steve, in response to your comment about the 55% drawdown -- I saw you're still updating the original thread -- do you still feel that the leverage was worth it (stress wise, time requirement wise) during the drawdown? If you hadn't rebalanced on the way down to deleverage would you have been wiped out?

If I only have 1 Micro E Mini contract to start, I would just be decreasing equity exposure by converting it to cash or EDV to rebalance when there's a large enough correction if I'm understanding correctly.

The backtesting shows a larger drawdown that S&P 500, but it started a bit higher if you begin the portfolio at Jan 2019:
https://www.portfoliovisualizer.com/bac ... ion6_1=-50

If I end this at April 2020, it is showing a max drawdown of 25% (SD 26.9) vs 19.6% (SD 21.5) for the S&P 500, which shouldn't wipe out the portfolio.
User avatar
Steve Reading
Posts: 2518
Joined: Fri Nov 16, 2018 10:20 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Steve Reading »

w3ldon wrote: Tue Oct 06, 2020 4:38 pm Steve, in response to your comment about the 55% drawdown -- I saw you're still updating the original thread -- do you still feel that the leverage was worth it (stress wise, time requirement wise) during the drawdown? If you hadn't rebalanced on the way down to deleverage would you have been wiped out?
I am as much of an ardent supporter for Lifecycle Investing then as I am now. The diversification benefits are truly remarkable, far higher than whatever bonds, commodities, etc offer. I continue to use it. And the time requirements are minimal. I am just realistic that most people probably would do more harm than good using it.

I didn't rebalance on the way down. You need about a 56% drop to force a liquidation when you start at 1.5:1 leverage (and that's what I used back then).

The academically correct way would be to rebalance and sell stocks once leverage gets higher (just like you rebalance a portfolio once the weights are off, say, by 5-10%). I didn't do this for personal reasons (you can read them in my thread) but if I recommended the strategy to anyone, it would be to use 1.5:1 leverage (2:1 historically hasn't actually been better... 1.5:1 seems to be a sweet spot), and to rebalance once the allocation gets reasonably off (say, 1.6:1).

EDIT: BTW, you don't have to sell the contract to reduce leverage. You can also convert the stock ETFs to cash. Result is the same.
"... 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
refinedchain
Posts: 27
Joined: Tue Feb 17, 2015 10:32 am

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by refinedchain »

w3ldon wrote: Tue Oct 06, 2020 4:38 pm
The backtesting shows a larger drawdown that S&P 500, but it started a bit higher if you begin the portfolio at Jan 2019:
https://www.portfoliovisualizer.com/bac ... ion6_1=-50

If I end this at April 2020, it is showing a max drawdown of 25% (SD 26.9) vs 19.6% (SD 21.5) for the S&P 500, which shouldn't wipe out the portfolio.
One more calculation to ponder: this backtest doesn't show the part where you meet the futures margin call by selling your EDV. I might try to bust out the thinkOrSwim backtester and see if I can simulate the margin call. But it will take some doing to set up.
manlymatt83
Posts: 200
Joined: Tue Jan 30, 2018 8:23 am

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by manlymatt83 »

PluckyDucky wrote: Tue Oct 06, 2020 11:16 am My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
Why no PSLDX?
PluckyDucky
Posts: 269
Joined: Tue Jan 15, 2019 8:29 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by PluckyDucky »

manlymatt83 wrote: Wed Oct 07, 2020 4:29 pm
PluckyDucky wrote: Tue Oct 06, 2020 11:16 am My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
Why no PSLDX?
I don't remember the specific reasons, but if I remember correctly, it is 2x and implemented in a way I did not like. Also an issue with buying it because not offered everywhere for free commission. ER is also 1.01%.

Any specific leverage between 1x to 3x can easily be achieved and managed using a balance of no leverage and 3x leverage funds and M1Finance. Those funds usually have ER around 1% though.

One could use the Kelly Criterion to try to maintain the optimal leverage given recent past conditions if they really wanted. But I chose NTSX as a simple set it and forget method.
Last edited by PluckyDucky on Wed Oct 07, 2020 4:55 pm, edited 2 times in total.
Impatience
Posts: 201
Joined: Thu Jul 23, 2020 3:15 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by Impatience »

PluckyDucky wrote: Tue Oct 06, 2020 11:16 am My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
That’s an extremely negligible amount of leverage. If you’re looking to hit the gas on your accumulation you’ll need over 100% equities.
Topic Author
w3ldon
Posts: 45
Joined: Thu Jul 09, 2020 9:06 am

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by w3ldon »

Impatience wrote: Wed Oct 07, 2020 4:54 pm
PluckyDucky wrote: Tue Oct 06, 2020 11:16 am My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
That’s an extremely negligible amount of leverage. If you’re looking to hit the gas on your accumulation you’ll need over 100% equities.
I agree -- while the 90/60 is leveraged, it is less than 100% equity, so it falls short of the goal of increasing equity exposure for an accumulator. Hence, it seemed to me like futures contracts (since Micro E Mini is a palatable contract size) were the lowest cost/least complicated way to increase equity exposure. It doesn't seem like they are great from a tax standpoint and impose the need for relatively frequent rebalancing in the account, so that's why I was thinking IRA space is the best place to implement. Perhaps with more money to invest I would get a better rate to invest on margin, but at the rates I'm currently seeing for that small account, it doesn't seem beneficial.
PluckyDucky
Posts: 269
Joined: Tue Jan 15, 2019 8:29 pm

Re: Applying a bit of Leverage in Roth IRA as an early accumulator

Post by PluckyDucky »

w3ldon wrote: Thu Oct 08, 2020 7:05 am
Impatience wrote: Wed Oct 07, 2020 4:54 pm
PluckyDucky wrote: Tue Oct 06, 2020 11:16 am My IRA account is 100% NTSX. Set it and forget it. Much simpler than what you're trying to do, and it is 1.5x (90/60) with only a 0.20 % ER.

I have other stuff in taxable and my 401k doesn't have NTSX available.
That’s an extremely negligible amount of leverage. If you’re looking to hit the gas on your accumulation you’ll need over 100% equities.
I agree -- while the 90/60 is leveraged, it is less than 100% equity, so it falls short of the goal of increasing equity exposure for an accumulator. Hence, it seemed to me like futures contracts (since Micro E Mini is a palatable contract size) were the lowest cost/least complicated way to increase equity exposure. It doesn't seem like they are great from a tax standpoint and impose the need for relatively frequent rebalancing in the account, so that's why I was thinking IRA space is the best place to implement. Perhaps with more money to invest I would get a better rate to invest on margin, but at the rates I'm currently seeing for that small account, it doesn't seem beneficial.
There is a simpler way to add leverage than rolling futures yourself. Just mix unleveraged and leveraged ETFs. For example, 50% 1x SP500 (SPY) + 50% 3x SP500 (UPRO) is 2x SP500. The combined expense ratio for this combo would be 0.5125%, which isn't too bad. Of course it changes with the amount of each you have. You can use M1Finance IRA account to easily keep a certain balance of leverage or adjust leverage balance using something like Kelly Criterion.

It is more simple than rolling your own futures, but you might not like how the 3x and 2x leveraged ETFs work or it sounds like you want to avoid the expense ratios. How much is your time worth?
Post Reply