Lifecycle Investing - Leveraging when young

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mikail15297
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Re: Lifecycle Investing - Leveraging when young

Post by mikail15297 »

sharukh wrote: Tue Apr 12, 2022 8:33 pm
mikail15297 wrote: Tue Apr 12, 2022 7:40 pm Hello, I was hoping to ask for help understanding how leveraging with futures in an IRA would work in practice.

For simplicity, let's say there's $220,000 in an IRA and the current ES price is 4400.

If I understand correctly, with 2x leverage would a 40% decline in ES drop the balance to overnight margin requirements and liquidation? My simple math:

Current ES price: 4400
40% decline price: 2640
Unrealized PnL loss: (4400 - 2640) * $50 per point = $88,000 per contract
2 ES contracts loss: $88,000 * 2 contracts = $176,000
Net balance: $220,000 original balance - $176,000 loss = $44,000
Required overnight margin for 2x contracts = $44,000

Unlike taxable brokerage accounts, IRAs have very low annual contribution limits. Can additional cash, in excess of pretax limits, be deposited into the IRA account during the crash to avoid liquidation, and then withdrawn without penalty when the market recovers?

What do you guys do in practice during a large draw down? Or would 2x in futures IRA not be recommended? Are there other type of tax advantaged accounts where this is more doable?
futures in IRA will have cash drag depending on how much cash reserve you keep
using LEAP is another way to leverage, it will have theta decay
But then what's the reasoning for why OP writes futures are their preferred method in tax-advantaged account?
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

mikail15297 wrote: Wed Apr 13, 2022 8:04 am
sharukh wrote: Tue Apr 12, 2022 8:33 pm
mikail15297 wrote: Tue Apr 12, 2022 7:40 pm Hello, I was hoping to ask for help understanding how leveraging with futures in an IRA would work in practice.

For simplicity, let's say there's $220,000 in an IRA and the current ES price is 4400.

If I understand correctly, with 2x leverage would a 40% decline in ES drop the balance to overnight margin requirements and liquidation? My simple math:

Current ES price: 4400
40% decline price: 2640
Unrealized PnL loss: (4400 - 2640) * $50 per point = $88,000 per contract
2 ES contracts loss: $88,000 * 2 contracts = $176,000
Net balance: $220,000 original balance - $176,000 loss = $44,000
Required overnight margin for 2x contracts = $44,000

Unlike taxable brokerage accounts, IRAs have very low annual contribution limits. Can additional cash, in excess of pretax limits, be deposited into the IRA account during the crash to avoid liquidation, and then withdrawn without penalty when the market recovers?

What do you guys do in practice during a large draw down? Or would 2x in futures IRA not be recommended? Are there other type of tax advantaged accounts where this is more doable?
futures in IRA will have cash drag depending on how much cash reserve you keep
using LEAP is another way to leverage, it will have theta decay
But then what's the reasoning for why OP writes futures are their preferred method in tax-advantaged account?
futures in IRA will have cash drag depending on how much cash reserve you keep
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Fri Apr 08, 2022 2:38 pm One other point, the ER on UPRO is not as bad as it sounds. Per dollar of SPY the ER is 0.3%. Or stated differently you can get a ton of leverage just by owning VOO and a little bit of UPRO.
Just as a reminder, the total implied financing cost using UPRO would be ca. 0.5% (spread of futures financing vs risk-free rate, presumably the same as swaps or whatever they use) + 0.3% = 0.8%.
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hiddenpower
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Re: Lifecycle Investing - Leveraging when young

Post by hiddenpower »

comeinvest wrote: Fri Apr 15, 2022 8:12 pm
skierincolorado wrote: Fri Apr 08, 2022 2:38 pm One other point, the ER on UPRO is not as bad as it sounds. Per dollar of SPY the ER is 0.3%. Or stated differently you can get a ton of leverage just by owning VOO and a little bit of UPRO.
Just as a reminder, the total implied financing cost using UPRO would be ca. 0.5% (spread of futures financing vs risk-free rate, presumably the same as swaps or whatever they use) + 0.3% = 0.8%.
What is the general consensus now on using UPRO (or 3x etfs) as a substitute to using direct margin? Is it appropriate for a long term hold? I can't find many posts on it exactly and obviously many believe it's great with HFEA but I was curious for beyond that.
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

mikail15297 wrote: Tue Apr 12, 2022 7:40 pm Hello, I was hoping to ask for help understanding how leveraging with futures in an IRA would work in practice.

For simplicity, let's say there's $220,000 in an IRA and the current ES price is 4400.

If I understand correctly, with 2x leverage would a 40% decline in ES drop the balance to overnight margin requirements and liquidation? My simple math:

Current ES price: 4400
40% decline price: 2640
Unrealized PnL loss: (4400 - 2640) * $50 per point = $88,000 per contract
2 ES contracts loss: $88,000 * 2 contracts = $176,000
Net balance: $220,000 original balance - $176,000 loss = $44,000
Required overnight margin for 2x contracts = $44,000

Unlike taxable brokerage accounts, IRAs have very low annual contribution limits. Can additional cash, in excess of pretax limits, be deposited into the IRA account during the crash to avoid liquidation, and then withdrawn without penalty when the market recovers?

What do you guys do in practice during a large draw down? Or would 2x in futures IRA not be recommended? Are there other type of tax advantaged accounts where this is more doable?
I think one cannot start with leverage more than 2X in an account like an IRA. There must a better target leverage that can be simulated.

Implement with some combination of ES, MES, VTI, VXUS and short term bonds (VTIP, BSV, SHY etc).

Have some basic rules for rebalancing. min leverage, max leverage, what to do during drawdown.

Post below has some simulation for mHFEA..
bogleheads.org/forum/viewtopic.php?p=6610758#p6610758

Example $100,000 in IRA in IBKR
target leverage 1.6x
4 MES - exposure $85k
100 * VTI - $23k
800 * IXUS - $51k
US/INT - 68/32
$9k excess cash

What do think about this? How would you do this, what leverage would you have?
VTI, VXUS. No individual stocks.
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

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VTI, VXUS. No individual stocks.
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

How's everyone doing with the current market?

At what level above your target leverage do you rebalance?

I inopportunely got into this at the end of March, starting with about 1.6x leverage, and I'm up to 1.95x now, with the intention of 2x being my max leverage.

And then say I get some more money to throw in while I'm still around 2x leverage, do you think I should use it to reduce the leverage back towards 1.6x, or take out more margin to keep the leverage constant and rely on future market gains reduce my leverage back to 1.6x?
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

Lifecycle Investor wrote: Mon Jun 13, 2022 6:05 pm How's everyone doing with the current market?

At what level above your target leverage do you rebalance?

I inopportunely got into this at the end of March, starting with about 1.6x leverage, and I'm up to 1.95x now, with the intention of 2x being my max leverage.

And then say I get some more money to throw in while I'm still around 2x leverage, do you think I should use it to reduce the leverage back towards 1.6x, or take out more margin to keep the leverage constant and rely on future market gains reduce my leverage back to 1.6x?
Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

During this drawdown, replaced few of the SPY Futures to SPY LEAPs in Roth IRA.

Started January with ~1.2X leverage. It has increased, will buy more as stocks more. max 2X while purchasing - letting it float. Not sure if this a good idea - but think it is ok for an early stage investor.
VTI, VXUS. No individual stocks.
gougou
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Re: Lifecycle Investing - Leveraging when young

Post by gougou »

impatientInv wrote: Sun Jun 19, 2022 3:34 pm During this drawdown, replaced few of the SPY Futures to SPY LEAPs in Roth IRA.

Started January with ~1.2X leverage. It has increased, will buy more as stocks more. max 2X while purchasing - letting it float. Not sure if this a good idea - but think it is ok for an early stage investor.
What’s LEAP and where do you buy it? Is that just some long term SPX call options?
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MetaPhysician
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Re: Lifecycle Investing - Leveraging when young

Post by MetaPhysician »

For margin investing, I've been told that it forces one to 'buy high and sell low' in order to keep the desired leverage amount.

Of course, this is the opposite of the golden mantra of 'buy low and sell high.'

I have three questions

1) Therefore, is buying or selling to return to the desired leverage amount merely for risk management?

2) What is the 'ideal' scenario for margin? I imagine taking the most amount of leverage on a lump sum and then seeing it go up. I know that for standard non-margin investing it is 'best' if the market tanks when one is young so they may acquire more assets along the way and then pray that at the end near retirement the asset increases dramatically in value.

3) (The real question) When using margin and if the underlying asset goes down the amount leveraged goes UP, of course. So one could either sell (sell when low) or purchase new assets to lower the leveraged amount. Does the latter replicate the ideal scenario in #2 wherein a young person loads up on assets when they are cheaper?
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
freyj6
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Re: Lifecycle Investing - Leveraging when young

Post by freyj6 »

I'm really interested in levering up a bit if the current decline continues. I read the book twice but after seeing a bunch of threads like this in 2019 and 2021 I became convinced it wasn't the best time to lever up.

I was about 80/20 stocks/cash going into this most recent crash. Now I'm about 93/7. I'd like to lever up to about 1.25x as this continues.

The main barrier for me now is that I don't want to switch everything over to IB for a margin loan and I'm totally unfamiliar with using options or futures. I think what I'll most likely do is begin to buy into UPRO in my tax advantaged accounts if this decline continues a bit further. I'll probably ease in very slowly, but as a young investor with a high risk tolerance, I think a small amount of leverage makes a ton of sense.
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

freyj6 wrote: Mon Jun 20, 2022 12:32 am I'm really interested in levering up a bit if the current decline continues. I read the book twice but after seeing a bunch of threads like this in 2019 and 2021 I became convinced it wasn't the best time to lever up.

I was about 80/20 stocks/cash going into this most recent crash. Now I'm about 93/7. I'd like to lever up to about 1.25x as this continues.

The main barrier for me now is that I don't want to switch everything over to IB for a margin loan and I'm totally unfamiliar with using options or futures. I think what I'll most likely do is begin to buy into UPRO in my tax advantaged accounts if this decline continues a bit further. I'll probably ease in very slowly, but as a young investor with a high risk tolerance, I think a small amount of leverage makes a ton of sense.
“if this decline continues a bit further”, you’ll “ease in very slowly”??

I don’t think you actually have a high risk tolerance if you’re a young investor but were 20% in cash and need more than a 25% decline before you’ll add even a small amount of margin or invest the rest of your cash. The book suggests 2x margin.

Switching over to IB was easy, but you should convert your mutual funds to ETFs before you do (if you’re at Vanguard, you call and they’ll do it for you without tax consequences). Also make sure you sign up with the Nerdwallet link for the margin rate discount. So you should get started now before you miss out on the current stock sale. Especially if you only plan on easing in slowly.
freyj6
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Re: Lifecycle Investing - Leveraging when young

Post by freyj6 »

Lifecycle Investor wrote: Mon Jun 20, 2022 2:06 pm
freyj6 wrote: Mon Jun 20, 2022 12:32 am I'm really interested in levering up a bit if the current decline continues. I read the book twice but after seeing a bunch of threads like this in 2019 and 2021 I became convinced it wasn't the best time to lever up.

I was about 80/20 stocks/cash going into this most recent crash. Now I'm about 93/7. I'd like to lever up to about 1.25x as this continues.

The main barrier for me now is that I don't want to switch everything over to IB for a margin loan and I'm totally unfamiliar with using options or futures. I think what I'll most likely do is begin to buy into UPRO in my tax advantaged accounts if this decline continues a bit further. I'll probably ease in very slowly, but as a young investor with a high risk tolerance, I think a small amount of leverage makes a ton of sense.
“if this decline continues a bit further”, you’ll “ease in very slowly”??

I don’t think you actually have a high risk tolerance if you’re a young investor but were 20% in cash and need more than a 25% decline before you’ll add even a small amount of margin or invest the rest of your cash. The book suggests 2x margin.

Switching over to IB was easy, but you should convert your mutual funds to ETFs before you do (if you’re at Vanguard, you call and they’ll do it for you without tax consequences). Also make sure you sign up with the Nerdwallet link for the margin rate discount. So you should get started now before you miss out on the current stock sale. Especially if you only plan on easing in slowly.
I suppose it depends on your definition of risk tolerance.

I'd say my risk tolerance is high because I generally hold 90-100% stocks and have never been tempted to sell. I have no problem with volatility. If someone offered me a $1 million loan at 1% with no margin calls I'd happily take it and put it all in the market.

My hesitance to jump in at 2x right now isn't really about risk tolerance but more that I think there's a good chance it's a bad idea. It's the same reason I didn't jump into Hedgefundie's strategy a year or two ago, despite it's impressive track record. I was never worried that it would drop 60% and I couldn't handle the volatility. I was worried that bond rates were historically low and stocks were historically high, and that it might be bad timing. Yes yes, that's market timing, the cardinal sin here at Bogleheads, but that's the same dogmatism that led people to take 20 years of duration risk for a few basis points.

It's no secret that this thread was far more popular in 2020 and 2021 than it is now. I think that the fact that I'm becoming more interested in leverage the more the market declines is a better sign of high risk tolerance than being willing to go 2x last summer.

Thanks for all the info though. I'll look into it :)
Dry-Drink
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Re: Lifecycle Investing - Leveraging when young

Post by Dry-Drink »

freyj6 wrote: Mon Jun 20, 2022 3:59 pm It's no secret that this thread was far more popular in 2020 and 2021 than it is now.
Probably because OP wasn't banned back then and they wrote a lot (every other post is theirs). Do you really think it's because leverage interest in a Bogleheads thread signals a market top? Lol.
Also, it was a fantastic idea to leverage back in 2020 so what you're saying doesn't even make sense.
freyj6 wrote: Mon Jun 20, 2022 12:32 am I read the book twice but after seeing a bunch of threads like this in 2019 and 2021 I became convinced it wasn't the best time to lever up.
And you would've been wrong.
From the FAQs:
Steve Reading wrote: Fri Mar 01, 2019 12:11 am I am convinced I want to do this but the market is at an all-time high. Any advice?
viewtopic.php?p=5667471#p5667471
If that poster (they go by username freyj6, ever heard of them?) had leveraged 2-1 back in Dec 2020, they'd be in positive territory today even after this 23% decline :sharebeer
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

freyj6 wrote: Mon Jun 20, 2022 3:59 pm My hesitance to jump in at 2x right now isn't really about risk tolerance but more that I think there's a good chance it's a bad idea.
You're happy to invest 100% in stocks (Though you were 80/20 for some reason? Market timing?), and would take loans at 1% to invest more, because you're highly confident in the market to outperform the alternatives and return more than 1%. If those things are true, why would you not take a margin loan for 1.75% (what mine comes to with IBKR Pro, the Nerdwallet discount, and the different rate tiers), to get more of those returns we're both confident in? Especially at 1.25x, your chances of going above 2x and needing to sell to rebalance would be pretty low. But resetting your leverage each month is taken into account in the strategy and isn't an issue.

If you think it's a bad idea just because you think the market might go down more so it isn't the perfect time to invest, you already said you'd "ease into it", and it'll take a while to transfer the funds. By the time you recognize that the market is recovering and start adding margin, you'll have missed a lot of the recovery; I doubt your average buy will be lower than today's price with that plan.

Also, I don't think it makes sense for any young investors to invest money they're saving for retirement less than 100% in stocks, regardless of their risk tolerance. Since like you, I don't think keeping money in the market over the next 30 years has much risk at all. So investing in stocks now doesn't really mean you have a high risk tolerance.
freyj6
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Re: Lifecycle Investing - Leveraging when young

Post by freyj6 »

You both make good points and they're well taken.

To be honest, I think I'm just cautious after reading through Market Timer's 2008 thread and watching Hedgefundie's strategy become popular right before potentially the worst period for it in almost 50 years. If that means my risk tolerance is low, then so be it.

Anyway, I solute you guys but still don't have the cajones to lever up all the way right now. If we hit bottom in a few months and I'm only up to 1.1x by then, I can live with that.

Looking forward to following your journeys here though :)
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

Fair enough, you do you. The authors specifically address why MT failed though, and if he had been keeping his leverage at 2x, he would’ve been fine. He was going way beyond that, which nobody is advocating for.

I think whenever you start this strategy, you’ll be better off in the long run, so you don’t need to try to time the market. I’d say your fear looking at the current market conditions is exactly what should be signaling to you that it’s a good time to buy.
incognito_man
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Re: Lifecycle Investing - Leveraging when young

Post by incognito_man »

Thought experiment I just had...

What happens if one, on any random date, buys a 2x leveraged s&p 500 fund and takes the following actions:

- any time the levered fund drops to (implying a downward trajectory) "x%" above the regular index return, it is sold for regular index

-any time the levered fund rises to (implying an upward trajectory) "x%" below the regular index return, it is purchased

Essentially, try to capture that x% alpha.

I'm not sure what % of random start days this strategy would work for, or what values of x would be maximal, but it seems like the general theory would be profitable more often than not in a historically upward market.
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

incognito_man wrote: Tue Jun 21, 2022 12:42 pm - any time the levered fund drops to (implying a downward trajectory) "x%" above the regular index return, it is sold for regular index

-any time the levered fund rises to (implying an upward trajectory) "x%" below the regular index return, it is purchased
The regular index return over what time period? I'd guess you'll have way too many situations where you sell on a drop that goes between your bands, but not below the bottom one, and then end up in cash for months waiting for it to drop below the regular index returns and rise again.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

freyj6 wrote: Tue Jun 21, 2022 12:05 am You both make good points and they're well taken.

To be honest, I think I'm just cautious after reading through Market Timer's 2008 thread and watching Hedgefundie's strategy become popular right before potentially the worst period for it in almost 50 years. If that means my risk tolerance is low, then so be it.

Anyway, I solute you guys but still don't have the cajones to lever up all the way right now. If we hit bottom in a few months and I'm only up to 1.1x by then, I can live with that.

Looking forward to following your journeys here though :)
Lifecycle investing should not be confused with hfea. They can be done simultaneously or one or the other and are very distinct. HFEA is fundamentally flawed IMO. The bonds are too long in duration and it is too much bond risk overall.
incognito_man
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Re: Lifecycle Investing - Leveraging when young

Post by incognito_man »

Lifecycle Investor wrote: Tue Jun 21, 2022 3:40 pm
incognito_man wrote: Tue Jun 21, 2022 12:42 pm - any time the levered fund drops to (implying a downward trajectory) "x%" above the regular index return, it is sold for regular index

-any time the levered fund rises to (implying an upward trajectory) "x%" below the regular index return, it is purchased
The regular index return over what time period? I'd guess you'll have way too many situations where you sell on a drop that goes between your bands, but not below the bottom one, and then end up in cash for months waiting for it to drop below the regular index returns and rise again.
From the start of investment period. No cash, ever. Either 100% in 2x levered fund or regular S&P fund. Setup so you'd only move FROM 2x levered TO standard when return since start of investment is above standard return and then FROM standard TO 2x levered only when return since start of investment is below standard return.
freyj6
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Re: Lifecycle Investing - Leveraging when young

Post by freyj6 »

How closely are margin rates tied to the federal rates? And can they change after you've already taken the loan at a specific rate?

Thanks!
Lifecycle Investor
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Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

freyj6 wrote: Wed Jun 22, 2022 6:00 pm How closely are margin rates tied to the federal rates? And can they change after you've already taken the loan at a specific rate?

Thanks!
That's all on IB's margin rates page. Yes, it's pretty closely tied to the federal rates so can change after you've taken the loan.

https://www.interactivebrokers.com/en/t ... -rates.php
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Steve Reading wrote: Mon Mar 04, 2019 9:08 pm
HEDGEFUNDIE wrote: Mon Mar 04, 2019 8:34 pm
megabad wrote: Mon Mar 04, 2019 7:09 pm I love leverage. I hate callable leverage. So I actually agree with levering in as much as I can get low interest, non-callable loans. Turns out, mortgages are one of the only low interest options I have been able to find. I think margin debt is a horrible deal (even at IB). Basically, your lender can call a collateralized debt on a whim anytime they want and I am paying near mortgage rates plus brokerage commissions (sometimes forced). Imagine if banks could just call in huge parts of your mortgage instantly because of one bad appraisal year and then charge you for the privilege of paying that instant call.
The other way to think about it is, you are overpaying for your mortgage because the lender can’t call it. There is no free lunch.
That's a great point.
I have to say I tend to lean towards what megabad says though. Personally speaking, the only reason I'm interested in following this strategy is to temporally diversify my stock risk. Like stock diversification, I believe this gives a free lunch as well. But it hinges on not having to sell during market downturns due to margin. If I'm not forced to sell, I know I should get the risk reduction from temporal diversification. If I am forced to sell, it's not as clear to me anymore.

This is my way of saying that I acknowledge there's a premium (but not a free lunch) in opting for callable debt. That's a premium I'm not interested in pursuing with this particular strategy.
You can make margin debt into non callable if you also buy a put option
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

HEDGEFUNDIE wrote: Mon Mar 04, 2019 8:34 pm
megabad wrote: Mon Mar 04, 2019 7:09 pm I love leverage. I hate callable leverage. So I actually agree with levering in as much as I can get low interest, non-callable loans. Turns out, mortgages are one of the only low interest options I have been able to find. I think margin debt is a horrible deal (even at IB). Basically, your lender can call a collateralized debt on a whim anytime they want and I am paying near mortgage rates plus brokerage commissions (sometimes forced). Imagine if banks could just call in huge parts of your mortgage instantly because of one bad appraisal year and then charge you for the privilege of paying that instant call.
The other way to think about it is, you are overpaying for your mortgage because the lender can’t call it. There is no free lunch.
You can make margin debt into non callable if you also buy a put option. Works Only in portfolio margin account

The cost of the put option is the quantification of cost on non callable ness of the debt and the is the extra price to pay
Laurizas
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Re: Lifecycle Investing - Leveraging when young

Post by Laurizas »

sharukh wrote: Wed Jun 22, 2022 9:12 pm You can make margin debt into non callable if you also buy a put option
Could you provide more details regarding this?
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm
skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Steve Reading wrote: Thu Jun 18, 2020 2:56 pm
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.
I had given a lot of thought for the above 5 step process. Luckily re-reading the book answered this.

"the interest rate on the money you borrow goes up. If you try to gain more leverage via stock index futures, we’ve found that the implied borrowing cost for leverage beyond 2:1 quickly exceeds the expected returns. In other words, more leverage gets expensive quickly."

Steps 1 and 2 are expensive(cost of put) at leverage ratio greater than 2:1. The cost is greater than expected returns, so only lever till 2:1, it is ok to buy puts even during 2:1 to protect, i.e. not get margin calls or not worry from flash crash. The put cost at 2:1 is small, compared to put cost at say 10:1.

Today SPY = ~380
190 strike put of december is $1.11
350 strike put of december is $15.92

Interest rate as of today for december maturing loans is 2.7% per annum. so for half year, it is 1.35%
total cost of borrow:
at 190 strike = 1.11 + 190*1.35/100 = 3.675
at 350 strike = 15.92 + 350*1.35/100 = 20.645

5.6 times more expensive(20.6/3/6) to leverage 1.8 times mores(350/190)

So once you start to leverage more the interest rate is so high and it exceeds the expected return of the stocks.
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Laurizas wrote: Thu Jun 23, 2022 7:18 am
sharukh wrote: Wed Jun 22, 2022 9:12 pm You can make margin debt into non callable if you also buy a put option
Could you provide more details regarding this?
https://www.tdameritrade.com/retail-en_ ... MTD086.pdf
only works in portfolio margin accounts.
See section 8 page 9
Lifecycle Investor
Posts: 8
Joined: Mon Jun 13, 2022 5:49 pm

Re: Lifecycle Investing - Leveraging when young

Post by Lifecycle Investor »

skierincolorado wrote: Thu Jun 23, 2022 9:43 am
Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm
skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
I did look on their website under resources before asking, but there are 5 spreadsheets, none of which seem to deal with managing your leverage, so I was trying to figure out which spreadsheet you meant. Samuelson Share? But that doesn't affect leverage while I'm still below it at 2x.
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Steve Reading wrote: Thu Aug 08, 2019 2:44 pm
Lee_WSP wrote: Thu Aug 08, 2019 1:39 pm
305pelusa wrote: Thu Aug 08, 2019 10:25 am
firebirdparts wrote: Thu Aug 08, 2019 9:51 am I have but one comment on this, and since this thread is still alive I will make it.

I see this as a scheme to protect accumulators from the effect of order-of-returns. Personally it never occurred to me that I should take that seriously. I think it makes some sense, but I would have to do a lot of work to determine whether or not I want protection if I was 25 years old today. I don't think I do. I think I would rather expose myself to the effect of the future order of returns.

Am I nuts?

I don't think much work has been done on order of returns risk and reward to accumulators.
The formal answer is that no one pays you to assume order of returns risk. So diversifying it is a free lunch (I.e. lower risk at the same returns). But you seem to also ask on a more personal level so I'll give you my take.

I'm a fairly risk averse individual. I want to avoid the scenario where the market stays high for the next decade while I accumulate, and then tanks for 2 decades by the time I retire. That could cause some serious damage to my financial goals. OTOH, I'd do very well if the market tanks now and rises later on.

I don't like the uncertainty that things will either be real good or real bad. I'd rather they were just OK in both cases. That's what diversification is; purposefully giving up some of the great results to avoid the bad ones.

It's really comforting to know my results are based on 6 decades on market returns, as opposed to the last 2-3. I sleep BETTER now that I know I'm taking great steps towards protecting against a Great Depression by my retirement.

Posters here don't see that; instead focusing on the NOW and how much I could lose now. But my concern of risk spans multiple decades; not just what the market will do this year.
You keep saying free lunch, but econ 101 is that there is no such thing as a free lunch.

The cost of this particular lunch is the cost of capital.
No, it's not. Think about it. If you don't leverage today, you don't earn any extra from stocks, you don't pay any cost of capital and you don't take any risk.

If you do leverage, you pay the cost of capital. And the equities return two parts; the earnings of capital and the equity risk premium. You also take equity risk. So the cost of capitals offset each other such that you take additional risk with putting no money in and get the returns associated with the equity premium. So you take risk and get rewarded with the risk component of equities accordingly.

The TRUE cost is the difference between the borrowing rate you pay and the earnings of capital. If you can borrow at the risk-free rate (with futures), then there is literally no additional cost to this strategy.


If you borrow at higher rates (like myself), there is a cost. You can quantitatively calculate (and I have) at what point that cost is not worth the additional diversification.
Thanks to Steve Reading and 305pelusa, these are the last few that were needed for me to jump on this strategy.
and an additional one that I found myself: buying a put makes the margin loan non-callable.
So there is a full package now.
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Ben Mathew wrote: Sun Mar 10, 2019 11:32 am Lifecycle investing would have helped in both your friends' cases.
dknightd wrote: Sun Mar 10, 2019 10:54 am A few years ago I was talking with some older friends about retirement savings. Lets pretend it was 2009. I think it was about then.
One was all in the market. He said he was ready to retire, then the market crashed, and he did not have enough money yet.
Lifecycle investing involves reducing stock exposure when you are closer to retirement (because you took more exposure early). So unlike with traditional asset allocation, you are not as susceptible to a few bad years around retirement age when your portfolio is overweight.
dknightd wrote: Sun Mar 10, 2019 10:54 am The other took a very conservative approach, and he did not have enough to retire yet either.
Since lifecycle investing reduces overall lifetime portfolio risk for a given return, you might be able to tolerate more stock exposure over a lifetime --i.e. take some of the benefits of lifecycle investing as higher return instead of lower risk.
dknightd wrote: Sun Mar 10, 2019 10:54 am It sounds like you have family money to support what I would call gambling. You are shooting for the moon. It could work out really well. Or not.
Lifecycle investing is the opposite of gambling. It's more conservative than traditional asset allocation because it's spreading the risks more. If someone bets all their money on one coin toss with a positive expected return, that's a gamble. If they spread their bets across fifty coin tosses, it's less risky.
Very beautifully said. Thanks to dknightd and Ben Mathew for providing case study and how lifecycle strategy would have helped.
skierincolorado
Posts: 1549
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

sharukh wrote: Fri Jun 24, 2022 5:54 am
Steve Reading wrote: Thu Jun 18, 2020 2:56 pm
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.
I had given a lot of thought for the above 5 step process. Luckily re-reading the book answered this.

"the interest rate on the money you borrow goes up. If you try to gain more leverage via stock index futures, we’ve found that the implied borrowing cost for leverage beyond 2:1 quickly exceeds the expected returns. In other words, more leverage gets expensive quickly."

Steps 1 and 2 are expensive(cost of put) at leverage ratio greater than 2:1. The cost is greater than expected returns, so only lever till 2:1, it is ok to buy puts even during 2:1 to protect, i.e. not get margin calls or not worry from flash crash. The put cost at 2:1 is small, compared to put cost at say 10:1.

Today SPY = ~380
190 strike put of december is $1.11
350 strike put of december is $15.92

Interest rate as of today for december maturing loans is 2.7% per annum. so for half year, it is 1.35%
total cost of borrow:
at 190 strike = 1.11 + 190*1.35/100 = 3.675
at 350 strike = 15.92 + 350*1.35/100 = 20.645

5.6 times more expensive(20.6/3/6) to leverage 1.8 times mores(350/190)

So once you start to leverage more the interest rate is so high and it exceeds the expected return of the stocks.
This is incorrect. The cost of a put is not the cost of leverage. And interest is not higher the more that is borrowed. I can buy as many futures contracts as I want up to 10x leverage, all with the same interest rate of 1.5%. The cost of a put is the cost of downside protection. It's the cost of reducing risk. I have no interest in reducing risk. My goal is to increase risk provided the expected return increases proportionally.

The problem with leverage beyond 2x is not that the cost of the leverage increases. It's that the expected return does not increase proportionally. The volatility decay becomes a serious issue. Leveraging to 2.5x or 3x may still be reasonable for very young investors with high savings rates relative to investable assets. Volatility decay isn't an issue because they will be adding large amounts of new funds each quarter.
skierincolorado
Posts: 1549
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

sharukh wrote: Fri Jun 24, 2022 6:19 am
Steve Reading wrote: Thu Aug 08, 2019 2:44 pm
Lee_WSP wrote: Thu Aug 08, 2019 1:39 pm
305pelusa wrote: Thu Aug 08, 2019 10:25 am
firebirdparts wrote: Thu Aug 08, 2019 9:51 am I have but one comment on this, and since this thread is still alive I will make it.

I see this as a scheme to protect accumulators from the effect of order-of-returns. Personally it never occurred to me that I should take that seriously. I think it makes some sense, but I would have to do a lot of work to determine whether or not I want protection if I was 25 years old today. I don't think I do. I think I would rather expose myself to the effect of the future order of returns.

Am I nuts?

I don't think much work has been done on order of returns risk and reward to accumulators.
The formal answer is that no one pays you to assume order of returns risk. So diversifying it is a free lunch (I.e. lower risk at the same returns). But you seem to also ask on a more personal level so I'll give you my take.

I'm a fairly risk averse individual. I want to avoid the scenario where the market stays high for the next decade while I accumulate, and then tanks for 2 decades by the time I retire. That could cause some serious damage to my financial goals. OTOH, I'd do very well if the market tanks now and rises later on.

I don't like the uncertainty that things will either be real good or real bad. I'd rather they were just OK in both cases. That's what diversification is; purposefully giving up some of the great results to avoid the bad ones.

It's really comforting to know my results are based on 6 decades on market returns, as opposed to the last 2-3. I sleep BETTER now that I know I'm taking great steps towards protecting against a Great Depression by my retirement.

Posters here don't see that; instead focusing on the NOW and how much I could lose now. But my concern of risk spans multiple decades; not just what the market will do this year.
You keep saying free lunch, but econ 101 is that there is no such thing as a free lunch.

The cost of this particular lunch is the cost of capital.
No, it's not. Think about it. If you don't leverage today, you don't earn any extra from stocks, you don't pay any cost of capital and you don't take any risk.

If you do leverage, you pay the cost of capital. And the equities return two parts; the earnings of capital and the equity risk premium. You also take equity risk. So the cost of capitals offset each other such that you take additional risk with putting no money in and get the returns associated with the equity premium. So you take risk and get rewarded with the risk component of equities accordingly.

The TRUE cost is the difference between the borrowing rate you pay and the earnings of capital. If you can borrow at the risk-free rate (with futures), then there is literally no additional cost to this strategy.


If you borrow at higher rates (like myself), there is a cost. You can quantitatively calculate (and I have) at what point that cost is not worth the additional diversification.
Thanks to Steve Reading and 305pelusa, these are the last few that were needed for me to jump on this strategy.
and an additional one that I found myself: buying a put makes the margin loan non-callable.
So there is a full package now.
Buying puts is expensive, and very much reduces risk and return. The whole point of this strategy is to take more risk while young to diversify risk taking across time. By reducing risk and return while young you are doing the opposite. Non leveraged investors could also reduce risk by buying puts, but this is not generally recommended. Nor is it recommended when leveraged. You are doing two things directly at odds with each other and thereby adding cost and complexity. The cost of puts is often nearly as large as the entire equity risk premium. Capturing more equity risk premium with leverage is the entire point of the strategy. Buying puts negates much of that benefit even in a purely efficient market. In an inefficient market you have even more costs such as spreads, broker fees, mispricings, etc.

You also can't buy puts in an ira or 401k.
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

skierincolorado wrote: Fri Jun 24, 2022 2:51 pm
sharukh wrote: Fri Jun 24, 2022 5:54 am
Steve Reading wrote: Thu Jun 18, 2020 2:56 pm
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.
I had given a lot of thought for the above 5 step process. Luckily re-reading the book answered this.

"the interest rate on the money you borrow goes up. If you try to gain more leverage via stock index futures, we’ve found that the implied borrowing cost for leverage beyond 2:1 quickly exceeds the expected returns. In other words, more leverage gets expensive quickly."

Steps 1 and 2 are expensive(cost of put) at leverage ratio greater than 2:1. The cost is greater than expected returns, so only lever till 2:1, it is ok to buy puts even during 2:1 to protect, i.e. not get margin calls or not worry from flash crash. The put cost at 2:1 is small, compared to put cost at say 10:1.

Today SPY = ~380
190 strike put of december is $1.11
350 strike put of december is $15.92

Interest rate as of today for december maturing loans is 2.7% per annum. so for half year, it is 1.35%
total cost of borrow:
at 190 strike = 1.11 + 190*1.35/100 = 3.675
at 350 strike = 15.92 + 350*1.35/100 = 20.645

5.6 times more expensive(20.6/3/6) to leverage 1.8 times mores(350/190)

So once you start to leverage more the interest rate is so high and it exceeds the expected return of the stocks.
This is incorrect. The cost of a put is not the cost of leverage. And interest is not higher the more that is borrowed. I can buy as many futures contracts as I want up to 10x leverage, all with the same interest rate of 1.5%. The cost of a put is the cost of downside protection. It's the cost of reducing risk. I have no interest in reducing risk. My goal is to increase risk provided the expected return increases proportionally.

The problem with leverage beyond 2x is not that the cost of the leverage increases. It's that the expected return does not increase proportionally. The volatility decay becomes a serious issue. Leveraging to 2.5x or 3x may still be reasonable for very young investors with high savings rates relative to investable assets. Volatility decay isn't an issue because they will be adding large amounts of new funds each quarter.
Got it, it's the volatility decay. Didn't occur to me to think of volatility decay for cases more than 2x
sharukh
Posts: 447
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

skierincolorado wrote: Fri Jun 24, 2022 3:05 pm
sharukh wrote: Fri Jun 24, 2022 6:19 am
Steve Reading wrote: Thu Aug 08, 2019 2:44 pm
Lee_WSP wrote: Thu Aug 08, 2019 1:39 pm
305pelusa wrote: Thu Aug 08, 2019 10:25 am

The formal answer is that no one pays you to assume order of returns risk. So diversifying it is a free lunch (I.e. lower risk at the same returns). But you seem to also ask on a more personal level so I'll give you my take.

I'm a fairly risk averse individual. I want to avoid the scenario where the market stays high for the next decade while I accumulate, and then tanks for 2 decades by the time I retire. That could cause some serious damage to my financial goals. OTOH, I'd do very well if the market tanks now and rises later on.

I don't like the uncertainty that things will either be real good or real bad. I'd rather they were just OK in both cases. That's what diversification is; purposefully giving up some of the great results to avoid the bad ones.

It's really comforting to know my results are based on 6 decades on market returns, as opposed to the last 2-3. I sleep BETTER now that I know I'm taking great steps towards protecting against a Great Depression by my retirement.

Posters here don't see that; instead focusing on the NOW and how much I could lose now. But my concern of risk spans multiple decades; not just what the market will do this year.
You keep saying free lunch, but econ 101 is that there is no such thing as a free lunch.

The cost of this particular lunch is the cost of capital.
No, it's not. Think about it. If you don't leverage today, you don't earn any extra from stocks, you don't pay any cost of capital and you don't take any risk.

If you do leverage, you pay the cost of capital. And the equities return two parts; the earnings of capital and the equity risk premium. You also take equity risk. So the cost of capitals offset each other such that you take additional risk with putting no money in and get the returns associated with the equity premium. So you take risk and get rewarded with the risk component of equities accordingly.

The TRUE cost is the difference between the borrowing rate you pay and the earnings of capital. If you can borrow at the risk-free rate (with futures), then there is literally no additional cost to this strategy.


If you borrow at higher rates (like myself), there is a cost. You can quantitatively calculate (and I have) at what point that cost is not worth the additional diversification.
Thanks to Steve Reading and 305pelusa, these are the last few that were needed for me to jump on this strategy.
and an additional one that I found myself: buying a put makes the margin loan non-callable.
So there is a full package now.
Buying puts is expensive, and very much reduces risk and return. The whole point of this strategy is to take more risk while young to diversify risk taking across time. By reducing risk and return while young you are doing the opposite. Non leveraged investors could also reduce risk by buying puts, but this is not generally recommended. Nor is it recommended when leveraged. You are doing two things directly at odds with each other and thereby adding cost and complexity. The cost of puts is often nearly as large as the entire equity risk premium. Capturing more equity risk premium with leverage is the entire point of the strategy. Buying puts negates much of that benefit even in a purely efficient market. In an inefficient market you have even more costs such as spreads, broker fees, mispricings, etc.

You also can't buy puts in an ira or 401k.
Leveraged peopled take on the risk of complete wipeout, say market goes down, results in margin call and then goes back up. Leveraged people after margin call dont capture the full up swing. [Those that leverage with Margin or Futures endup empty due to mark to market in realtime] [Leveraging with LEAPS have a builtin put and they dont get margin call]
Non-leveraged people dont have that problem.

So the only (low cost)way a 2:1 leveraged person can protect from margin call is to derisk to 2:1 on monthly basis as said by book ?

yes, puts is expensive near the current stock price, but they seem cheap at 50% down.
i.e. say
2 puts at 200 strike is way less than 1 put at 400 strike.
skierincolorado
Posts: 1549
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

sharukh wrote: Fri Jun 24, 2022 3:49 pm
skierincolorado wrote: Fri Jun 24, 2022 3:05 pm
sharukh wrote: Fri Jun 24, 2022 6:19 am
Steve Reading wrote: Thu Aug 08, 2019 2:44 pm
Lee_WSP wrote: Thu Aug 08, 2019 1:39 pm

You keep saying free lunch, but econ 101 is that there is no such thing as a free lunch.

The cost of this particular lunch is the cost of capital.
No, it's not. Think about it. If you don't leverage today, you don't earn any extra from stocks, you don't pay any cost of capital and you don't take any risk.

If you do leverage, you pay the cost of capital. And the equities return two parts; the earnings of capital and the equity risk premium. You also take equity risk. So the cost of capitals offset each other such that you take additional risk with putting no money in and get the returns associated with the equity premium. So you take risk and get rewarded with the risk component of equities accordingly.

The TRUE cost is the difference between the borrowing rate you pay and the earnings of capital. If you can borrow at the risk-free rate (with futures), then there is literally no additional cost to this strategy.


If you borrow at higher rates (like myself), there is a cost. You can quantitatively calculate (and I have) at what point that cost is not worth the additional diversification.
Thanks to Steve Reading and 305pelusa, these are the last few that were needed for me to jump on this strategy.
and an additional one that I found myself: buying a put makes the margin loan non-callable.
So there is a full package now.
Buying puts is expensive, and very much reduces risk and return. The whole point of this strategy is to take more risk while young to diversify risk taking across time. By reducing risk and return while young you are doing the opposite. Non leveraged investors could also reduce risk by buying puts, but this is not generally recommended. Nor is it recommended when leveraged. You are doing two things directly at odds with each other and thereby adding cost and complexity. The cost of puts is often nearly as large as the entire equity risk premium. Capturing more equity risk premium with leverage is the entire point of the strategy. Buying puts negates much of that benefit even in a purely efficient market. In an inefficient market you have even more costs such as spreads, broker fees, mispricings, etc.

You also can't buy puts in an ira or 401k.
Leveraged peopled take on the risk of complete wipeout, say market goes down, results in margin call and then goes back up. Leveraged people after margin call dont capture the full up swing. [Those that leverage with Margin or Futures endup empty due to mark to market in realtime] [Leveraging with LEAPS have a builtin put and they dont get margin call]
Non-leveraged people dont have that problem.

So the only (low cost)way a 2:1 leveraged person can protect from margin call is to derisk to 2:1 on monthly basis as said by book ?

yes, puts is expensive near the current stock price, but they seem cheap at 50% down.
i.e. say
2 puts at 200 strike is way less than 1 put at 400 strike.
If you rebalance to target 2x frequently there is no chance of margin call. There is some volatility decay, but also possibility of low volatility boost. HIstorically daily rebal at 2x leverage has returns roughly 2x unleveraged (more than 2x in some decades, less in others). And contributions reduce volatility decay even further.

I own a leap. I think some downside protection is fine. But it is expensive and is not my main source of leverage. When I have looked, it costs roughly 2.5%. With borrowing costs of 3, the total cost is 5.5% which is roughly what I expect equity returns to be. Therefore the expected return is near zero. I have not checked cost of LEAPS recently so maybe it is less now.

Efficient investor has a strategy to try to recover some of the downside protection by staying theta neutral. You can search for it.
unemployed_pysicist
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Re: Lifecycle Investing - Leveraging when young

Post by unemployed_pysicist »

skierincolorado wrote: Fri Jun 24, 2022 3:05 pm You also can't buy puts in an ira or 401k.
What do you mean? I buy and sell puts in my IRA all the time.
couldn't afford the h
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Thu Jun 23, 2022 9:43 am
Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm
skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
"If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures" - that's what I thought, until I started mHFEA with 1.4 leverage with respect to equities, which became 2.8 before I knew it (with respect to equities, not to mention the bond risk), due to both stocks and bonds falling in lockstep since the beginning of this year. (I know you referred to an equities only portfolio.)

If pure equity index lifecycle investing recommends max 2x leverage in phase 2, I'm still a bit unsure how that limit would translate to lifecycle investing with mHFEA. Adding treasuries usually reduces total portfolio risk, except during inflationary periods where it increases risk, like this year. So would I want to have a leverage ratio limit >2, =2, or <2 with respect to my equities allocation (assuming 2 is a consensus and validated optimal limit for equities-only lifecycle investing in phase 2).
Last edited by comeinvest on Sun Jun 26, 2022 8:26 am, edited 7 times in total.
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Fri Jun 24, 2022 4:47 pm
sharukh wrote: Fri Jun 24, 2022 3:49 pm
skierincolorado wrote: Fri Jun 24, 2022 3:05 pm
sharukh wrote: Fri Jun 24, 2022 6:19 am
Steve Reading wrote: Thu Aug 08, 2019 2:44 pm

No, it's not. Think about it. If you don't leverage today, you don't earn any extra from stocks, you don't pay any cost of capital and you don't take any risk.

If you do leverage, you pay the cost of capital. And the equities return two parts; the earnings of capital and the equity risk premium. You also take equity risk. So the cost of capitals offset each other such that you take additional risk with putting no money in and get the returns associated with the equity premium. So you take risk and get rewarded with the risk component of equities accordingly.

The TRUE cost is the difference between the borrowing rate you pay and the earnings of capital. If you can borrow at the risk-free rate (with futures), then there is literally no additional cost to this strategy.


If you borrow at higher rates (like myself), there is a cost. You can quantitatively calculate (and I have) at what point that cost is not worth the additional diversification.
Thanks to Steve Reading and 305pelusa, these are the last few that were needed for me to jump on this strategy.
and an additional one that I found myself: buying a put makes the margin loan non-callable.
So there is a full package now.
Buying puts is expensive, and very much reduces risk and return. The whole point of this strategy is to take more risk while young to diversify risk taking across time. By reducing risk and return while young you are doing the opposite. Non leveraged investors could also reduce risk by buying puts, but this is not generally recommended. Nor is it recommended when leveraged. You are doing two things directly at odds with each other and thereby adding cost and complexity. The cost of puts is often nearly as large as the entire equity risk premium. Capturing more equity risk premium with leverage is the entire point of the strategy. Buying puts negates much of that benefit even in a purely efficient market. In an inefficient market you have even more costs such as spreads, broker fees, mispricings, etc.

You also can't buy puts in an ira or 401k.
Leveraged peopled take on the risk of complete wipeout, say market goes down, results in margin call and then goes back up. Leveraged people after margin call dont capture the full up swing. [Those that leverage with Margin or Futures endup empty due to mark to market in realtime] [Leveraging with LEAPS have a builtin put and they dont get margin call]
Non-leveraged people dont have that problem.

So the only (low cost)way a 2:1 leveraged person can protect from margin call is to derisk to 2:1 on monthly basis as said by book ?

yes, puts is expensive near the current stock price, but they seem cheap at 50% down.
i.e. say
2 puts at 200 strike is way less than 1 put at 400 strike.
If you rebalance to target 2x frequently there is no chance of margin call. There is some volatility decay, but also possibility of low volatility boost. HIstorically daily rebal at 2x leverage has returns roughly 2x unleveraged (more than 2x in some decades, less in others). And contributions reduce volatility decay even further.
...
"There is some volatility decay, but also possibility of low volatility boost" - Yes, it's kind of symmetrical, but then again asymmetrical. In a more general context, I understand that the (in a mathematical sense) expected final portfolio value of leveraged, rebalanced portfolios is not affected by the leverage ratio; only the distribution of final values gets more skewed, until the singular scenarios where you would greatly outperform the expected return become more and more unlikely, all the while your probability of underperforming the expected return to a degree becomes more and more likely.
... which also brings us back to the question that we discussed in the mHFEA thread, if it is better to let the leverage ratio "float" within a range (e.g. from 1.4x up to 2x), or to strictly rebalance periodically to the target; as well as to the question of how frequently to rebalance. I have a feeling (no proof) that it doesn't matter a lot if at all, as the expected return won't change depending on any of that. Less frequent rebalancing probably has the same effect as a slightly higher leverage ratio with more frequent rebalancing. Either earlier deleveraging, or reducing the leverage ratio, both have the effect of reducing the risk of more aggressive deleveraging later on closer to market lows, and/or letting the leverage ratio get high enough where volatility decay shows. The important thing is to be consistent, and to keep the leverage ratio under a certain value where the volatility decay becomes noticeable, i.e. where the singular, rare scenarios of sequence of returns with a very high final value are unlikely to happen throughout the investment horizon, while the probabilities of the scenarios that underperform will dominate.
For the same reason, leveraging with call options might not be as bad, maybe on par with futures and options boxes, if we assume that the options market is efficient in that sense. Yes your "visible" cost of leverage is higher, but yes you never have to worry about deleveraging, plus you are protected from potential market downturns in the future that we have not seen in the past or that don't show in statistics (tail risks). You can probably dial up your effective leverage ratio a tad, if you use call options. The problem is I have not seen any real life simulations, probably for lack of easily accessible historical data.

"HIstorically daily rebal at 2x leverage has returns roughly 2x unleveraged" - This is only true after subtracting the financing cost. I think you forgot to mention that. You meant that the effect of the volatility decay is likely small. But do you have a reference showing the effect by leverage ratio (and possibly by rebal frequency)? I know it greatly increases between 2x and 3x.
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

comeinvest wrote: Sun Jun 26, 2022 7:06 am
skierincolorado wrote: Thu Jun 23, 2022 9:43 am
Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm
skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
"If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures" - that's what I thought, until I started mHFEA with 1.4 leverage with respect to equities, which became 2.8 before I knew it (with respect to equities, not to mention the bond risk), due to both stocks and bonds falling in lockstep since the beginning of this year. (I know you referred to an equities only portfolio.)

If pure equity index lifecycle investing recommends max 2x leverage in phase 2, I'm still a bit unsure how that limit would translate to lifecycle investing with mHFEA. Adding treasuries usually reduces total portfolio risk, except during inflationary periods where it increases risk, like this year. So would I want to have a leverage ratio limit >2, =2, or <2 with respect to my equities allocation (assuming 2 is a consensus and validated optimal limit for equities-only lifecycle investing in phase 2).
Yes that definitely only applies to an equity only portfolio. 1.4x equities can endure ~50% before needing to rebalance leverage if your cap is 2.3x. Or 43% if cap is 2.0x. We certainly haven't seen a 50% drop so far, so it's the bonds that are breaking it.

I personally think if starting at 2x, adding bonds would require lowering the equity leverage a bit.

But starting at 1.4x, I think adding bonds probably doesn't change the amount of equity, since I view an equity crash of 50% simultaneously with a bond crash as very unlikely. The distribution of returns shows that losses for bonds and equities can occur simultaneously, but large losses in both at the same time are very rare. But if you're in Phase I with 2x leverage, you can't endure large losses in equities anyways, and adding bonds easily has the potential to worsen volatility decay (unless very early in phase I where contributions will outweigh all).
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Sun Jun 26, 2022 7:35 pm
comeinvest wrote: Sun Jun 26, 2022 7:06 am
skierincolorado wrote: Thu Jun 23, 2022 9:43 am
Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm
skierincolorado wrote: Sun Jun 19, 2022 11:38 am Letting the leverage float is generally more consistent with lifecycle investing. Getting more money (like from an inheritance) would generally be used to reduce leverage (unless in phase I where staying at 2x). If you already have the money, like sitting in a checking account, it should already be used to calculate leverage.

There's a spreadsheet on the book's website that deals with this.
Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
"If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures" - that's what I thought, until I started mHFEA with 1.4 leverage with respect to equities, which became 2.8 before I knew it (with respect to equities, not to mention the bond risk), due to both stocks and bonds falling in lockstep since the beginning of this year. (I know you referred to an equities only portfolio.)

If pure equity index lifecycle investing recommends max 2x leverage in phase 2, I'm still a bit unsure how that limit would translate to lifecycle investing with mHFEA. Adding treasuries usually reduces total portfolio risk, except during inflationary periods where it increases risk, like this year. So would I want to have a leverage ratio limit >2, =2, or <2 with respect to my equities allocation (assuming 2 is a consensus and validated optimal limit for equities-only lifecycle investing in phase 2).
Yes that definitely only applies to an equity only portfolio. 1.4x equities can endure ~50% before needing to rebalance leverage if your cap is 2.3x. Or 43% if cap is 2.0x. We certainly haven't seen a 50% drop so far, so it's the bonds that are breaking it.

I personally think if starting at 2x, adding bonds would require lowering the equity leverage a bit.

But starting at 1.4x, I think adding bonds probably doesn't change the amount of equity, since I view an equity crash of 50% simultaneously with a bond crash as very unlikely. The distribution of returns shows that losses for bonds and equities can occur simultaneously, but large losses in both at the same time are very rare. But if you're in Phase I with 2x leverage, you can't endure large losses in equities anyways, and adding bonds easily has the potential to worsen volatility decay (unless very early in phase I where contributions will outweigh all).
I'm in phase 2 with little expected future contributions compared to the amount of existing assets, and my target was 140% equities. Agree with your statement regarding phase 1 and avoiding volatility decay under all circumstances.
Also agree that I never thought that I would reduce my 140% equities because of adding treasuries. Given zero or negative term premia from treasuries, I probably would have had a hard time justifying that.
But unfortunately I'm now overleveraged before I knew it, and I was not prepared to have a solid plan for that scenario. Both equities and treasuries returns seem to be controlled by inflation numbers and subsequent upward rates adjustments, not to mention sky high valuations from the beginning and global crises. The current situation for mHFEA from the start of the year is equivalent to a ca. 50% equities crash, and I'm not sure if I should rely on what you say that both fall further is unlikely. Fed rates could go to 5% or higher instead of the current 3.75% target, and equities fall further accordingly. The fed expressed that a recession not necessarily justifies stopping rate hikes, if needed to curb inflation.
So my question is really regarding the upper limit to the leverage ratio (with respect to the equities allocation) for mHFEA, not the starting or target leverage ratio. I'm now questioning if I should have deleveraged before reaching the 2.0 ratio because as you say, the volatility decay probably shows earlier if equities and treasuries are correlated.
I'm also more and more questioning floating leverage with range limits. Somehow this seems to inevitably introduce a hard to justify lookback element (dependency on past trajectory) into the otherwise strictly memoryless decision process. Have we ever shown any benefit of floating within limits for the leverage ratio, vs. fixed percentage ratios of NAV e.g. every quarter at the same time when I do the rebalancing between asset classes, and call it a day? I understand the overarching goal is to avoid deleveraging i.e. volatility decay altogether; but it appears we cannot achieve that even with relatively moderate leverage ratios like 1.4 for mHFEA. And if we cannot achieve that, then it's just a decision between small pain earlier / more frequently vs. big pain later / more rarely.
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Sun Jun 26, 2022 7:35 pm But starting at 1.4x, I think adding bonds probably doesn't change the amount of equity, since I view an equity crash of 50% simultaneously with a bond crash as very unlikely.
I think you also mentioned a while earlier in the other thread that you would kind of view the equities allocation independent of the treasuries, for leveraging and deleveraging purposes. But that doesn't really work. Even if you don't reduce the target allocation to equities when adding treasuries, a drawdown of treasuries may force you to deleverage your equities when otherwise you wouldn't.
I'm still trying to wrap my head around all the scenarios. I'm realizing more than ever before that it's important to have an accurate investment plan *before* things happen, not after.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

comeinvest wrote: Sun Jun 26, 2022 9:21 pm
skierincolorado wrote: Sun Jun 26, 2022 7:35 pm But starting at 1.4x, I think adding bonds probably doesn't change the amount of equity, since I view an equity crash of 50% simultaneously with a bond crash as very unlikely.
I think you also mentioned a while earlier in the other thread that you would kind of view the equities allocation independent of the treasuries, for leveraging and deleveraging purposes. But that doesn't really work. Even if you don't reduce the target allocation to equities when adding treasuries, a drawdown of treasuries may force you to deleverage your equities when otherwise you wouldn't.
I'm still trying to wrap my head around all the scenarios. I'm realizing more than ever before that it's important to have an accurate investment plan *before* things happen, not after.
I don't think it would force reduction in allocation to equities if starting at 1.4x, unless one had a ton of treasuries. For example, I have not come close to needing to reduce my allocation to equities or treasuries, despite the significant drawdown in both. The leverage has gone up some and 6 months of contributions have helped a little bit. I've actually done the opposite of selling to pay off debt, instead I'm borrowing more money today than I was 6 months ago.
Last edited by skierincolorado on Mon Jun 27, 2022 2:20 pm, edited 4 times in total.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

comeinvest wrote: Sun Jun 26, 2022 8:18 pm
skierincolorado wrote: Sun Jun 26, 2022 7:35 pm
comeinvest wrote: Sun Jun 26, 2022 7:06 am
skierincolorado wrote: Thu Jun 23, 2022 9:43 am
Lifecycle Investor wrote: Sun Jun 19, 2022 7:16 pm

Which spreadsheet are you referring to?

In the book, I saw they said you should rebalance monthly, but could rebalance after large swings as well. And then it said it's alright not to rebalance when it'd be too much of a hassle because you're using futures for leverage or something, and your leverage is close to your target anyway, like 1.9-2.1.
The one on their website under resources. Definitely recommend using it.

If you use futures and start at 2x... you will have to rebalance.. leverage will easily become mush higher or lower.

If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures. When you have less money relative to future income, you should be more leveraged. So when the market goes down, leverage should increase. But in phase 1 its just fixed at 2x ( I think there is some argument for 2.5x early in phase 1).
"If you ate in phase 2 and at 1.5x leverage you may not need to rebalance with futures" - that's what I thought, until I started mHFEA with 1.4 leverage with respect to equities, which became 2.8 before I knew it (with respect to equities, not to mention the bond risk), due to both stocks and bonds falling in lockstep since the beginning of this year. (I know you referred to an equities only portfolio.)

If pure equity index lifecycle investing recommends max 2x leverage in phase 2, I'm still a bit unsure how that limit would translate to lifecycle investing with mHFEA. Adding treasuries usually reduces total portfolio risk, except during inflationary periods where it increases risk, like this year. So would I want to have a leverage ratio limit >2, =2, or <2 with respect to my equities allocation (assuming 2 is a consensus and validated optimal limit for equities-only lifecycle investing in phase 2).
Yes that definitely only applies to an equity only portfolio. 1.4x equities can endure ~50% before needing to rebalance leverage if your cap is 2.3x. Or 43% if cap is 2.0x. We certainly haven't seen a 50% drop so far, so it's the bonds that are breaking it.

I personally think if starting at 2x, adding bonds would require lowering the equity leverage a bit.

But starting at 1.4x, I think adding bonds probably doesn't change the amount of equity, since I view an equity crash of 50% simultaneously with a bond crash as very unlikely. The distribution of returns shows that losses for bonds and equities can occur simultaneously, but large losses in both at the same time are very rare. But if you're in Phase I with 2x leverage, you can't endure large losses in equities anyways, and adding bonds easily has the potential to worsen volatility decay (unless very early in phase I where contributions will outweigh all).
I'm in phase 2 with little expected future contributions compared to the amount of existing assets, and my target was 140% equities. Agree with your statement regarding phase 1 and avoiding volatility decay under all circumstances.
Also agree that I never thought that I would reduce my 140% equities because of adding treasuries. Given zero or negative term premia from treasuries, I probably would have had a hard time justifying that.
But unfortunately I'm now overleveraged before I knew it, and I was not prepared to have a solid plan for that scenario. Both equities and treasuries returns seem to be controlled by inflation numbers and subsequent upward rates adjustments, not to mention sky high valuations from the beginning and global crises. The current situation for mHFEA from the start of the year is equivalent to a ca. 50% equities crash, and I'm not sure if I should rely on what you say that both fall further is unlikely. Fed rates could go to 5% or higher instead of the current 3.75% target, and equities fall further accordingly. The fed expressed that a recession not necessarily justifies stopping rate hikes, if needed to curb inflation.
So my question is really regarding the upper limit to the leverage ratio (with respect to the equities allocation) for mHFEA, not the starting or target leverage ratio. I'm now questioning if I should have deleveraged before reaching the 2.0 ratio because as you say, the volatility decay probably shows earlier if equities and treasuries are correlated.
I'm also more and more questioning floating leverage with range limits. Somehow this seems to inevitably introduce a hard to justify lookback element (dependency on past trajectory) into the otherwise strictly memoryless decision process. Have we ever shown any benefit of floating within limits for the leverage ratio, vs. fixed percentage ratios of NAV e.g. every quarter at the same time when I do the rebalancing between asset classes, and call it a day? I understand the overarching goal is to avoid deleveraging i.e. volatility decay altogether; but it appears we cannot achieve that even with relatively moderate leverage ratios like 1.4 for mHFEA. And if we cannot achieve that, then it's just a decision between small pain earlier / more frequently vs. big pain later / more rarely.
I would not say further fall in equities and bonds is very unlikely. Equities are only down 19% from peak. I do think at a certain point it becomes deflationary and unlikely to both fall further from a macro and historical perspective, but we're not there yet thus far.. maybe this quarter we see something change, or not. Another 19% drop in equities and 8% drop in 5 year bonds is certainly possible.. it just happened once, why not again. That would put us down 36% and 15% respectively for both assets. For equities to fall 50% total, they would have to fall 38% from here and I personally think it would be very unlikely for bonds to fall significantly in such a scenario, and much more likely to rise as the stock fall deepened and became deflationary.

I think the biggest justification for the floating leverage is lifecycle investing and the fact that as net worth falls it also becomes smaller relative to future earnings and contributions. If it weren't for that fact, I don't think it would be particularly justified and would basically be market timing. It would have the benefit of capturing the market return without volatility decay, but is also a lot riskier and/or requires less initial leverage.
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

skierincolorado wrote: Sun Jun 26, 2022 11:44 pm I would not say further fall in equities and bonds is very unlikely. Equities are only down 19% from peak. I do think at a certain point it becomes deflationary and unlikely to both fall further from a macro and historical perspective, but we're not there yet thus far.. maybe this quarter we see something change, or not. Another 19% drop in equities and 8% drop in 5 year bonds is certainly possible.. it just happened once, why not again. That would put us down 36% and 15% respectively for both assets. For equities to fall 50% total, they would have to fall 38% from here and I personally think it would be very unlikely for bonds to fall significantly in such a scenario, and much more likely to rise as the stock fall deepened and became deflationary.
You're right, my math was off. I used 140% mostly European equities, which returned -21.5% in USD terms vs. -19.5 for U.S., and started with 200% ITT measured at 5.5 years duration (approx. that of the VGIT ETF which returned -8.5% this year) if I remember right. My performance assuming no deleveraging this year, should have been -21.5 * 1.4 - 8.5 * 2 = -47.1%, and accordingly my equities should now be leveraged at (1.4 * (1 - 0.195)) / (1 - 0.471) = 2.13% if my math is right. (I had some additional, supposedly uncorrelated strategies unrelated to lifecycle or mHFEA, that all of a sudden became correlated. A typical mistake made by hedge funds, lol.)
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