Ayres and Nalebuff: Young people should buy stocks on margin

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OkieIndexer
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Ayres and Nalebuff: Young people should buy stocks on margin

Post by OkieIndexer » Fri Apr 16, 2010 11:03 pm

[restarted old thread - check post dates before replying]

What do you think about this? Seems like a possible sign of nearing a market top to me. You know, the "magazine indicator." :lol: This seems like the opposite of the famous "Death of Equities" magazine cover from the late 70s.

Have they forgotten that a 57% bear market happened with the S&P 500 just a little over a year ago? That would have resulted in a total loss for a 2x margined retirement account that was entirely in stocks, because you will get a margin call as your account is reduced to zero equity. In other words, a 50% drop in the market = a 100% loss in a 2x margined account. Also, most young people do not have cash reserves to meet margin calls.

Also, I really think they are severely overestimating most peoples' risk tolerance. I don't care if you're young, sitting through a 70-100% drop in a big chunk of your life savings is PAINFUL for the vast majority of people, and that kind of loss can easily happen with a margined account. It's happened twice in the last 10 years.

http://www.time.com/time/business/artic ... -1,00.html
Last edited by OkieIndexer on Mon Jul 26, 2010 2:11 pm, edited 11 times in total.
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Post by Grt2bOutdoors » Fri Apr 16, 2010 11:06 pm

To the professors I say: You first.

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Post by dmcmahon » Fri Apr 16, 2010 11:11 pm


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Post by sscritic » Fri Apr 16, 2010 11:39 pm

Did you try and think it through?

You are investing for 30 years. After the first year, you lose 100% of your investment on January 1. You then save for 29 years without another loss.

You are investing for 30 years. After 29 years without a loss, you lose 100% of your investment on January 1.

Who is better off?

Losing 100% at the end of year 1 is much less damaging to your retirement than losing 50% at the end of year 29.

It is easier to recover from early losses than from late losses since 1) the amount of money involved is much smaller; 2) you have more time to replenish your savings with your human capital.

So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?

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Post by CodeMaster » Fri Apr 16, 2010 11:42 pm

GRT2BOUTDOORS wrote:To the professors I say: You first.
no kidding!

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Post by OkieIndexer » Fri Apr 16, 2010 11:54 pm

sscritic wrote: So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?
The large risk bets may occur during a long period (20+ years) where the market goes sideways or down and experiences two or three 50% losses, and your margined strategy would get destroyed during that period. By the time you are older and need to take less risk, you would likely end up not having enough money to retire on schedule, possibly FAR less than enough.

You might say, "well then, if it didn't work out when you were young then you need to take more risk when you're older." Certainly no guarantee this margin strategy will be any better when you're older and within 10-20 years of retirement, and the risks of not retiring on schedule are higher.

Also, this "strategy" completely ignores the risk tolerance issue.

I find it amusing that this article is being published on the back of a 75% rise in the Dow and at a time when valuations aren't exactly cheap. Where was Time magazine with this article in March 2009? Hmm? :lol:
Last edited by OkieIndexer on Sat Apr 17, 2010 12:09 am, edited 1 time in total.
"In bull markets, people say 'The more risk I take, the greater my return.' But when people aren't afraid of risk, they'll accept risk without being compensated." -Howard Marks, Oaktree Capital

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Post by Erwin » Sat Apr 17, 2010 12:07 am

Read this for a critical view:
http://seekingalpha.com/article/199216- ... nt-account
I can never be amazed by our short memory. 2008 was not that long ago!
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Post by Tuxx » Sat Apr 17, 2010 12:26 am

A hindsight market top story. Groovy.

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Post by dumbmoney » Sat Apr 17, 2010 12:27 am

Suppose the market drops 50% overnight due to some scary news, then immediately recovers. A non-margin investor loses nothing. A 2x margin investor loses 100%.
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

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Post by Jacobkg » Sat Apr 17, 2010 12:48 am

One of the first pieces of advice my father gave me was: " Never buy on margin"

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Post by xerty24 » Sat Apr 17, 2010 1:27 am

This article is an interesting combination of reasonably good insights and weird contradictions.

For example, if stocks go up over the long term and either 1) you rebalance regularly, or 2) they never go down by more than ~50%, you will do better on margin than not, on average, just because the market usually goes up. This is just the fact that stocks go up on average more than your borrowing costs.

However, they go on to say that 2:1 is good, but don't do 3:1 or 4:1 since it's too expensive. I don't get this, since I don't know of anywhere that charges you for margin at a higher rate based on your leverage - often it's a poor rate and often it's capped at 2:1, but I don't know anywhere that's like 3% for 2:1, but 10% for 4:1. Margin is "too expensive" at almost all retail brokerages, although their suggestion of Interactive Brokers is an exception.

One conclusion they don't really draw but is strongly suggested by their logic is that you should have a very high equity allocation. Suppose your AA called for 50-50 stocks/bonds, but you decide you want your stocks at 2:1. Since your bond returns are lower than your margin cost, you should probably "finance" your 2:1 leverage yourself by just holding 100% stocks instead of holding lower yielding fixed income simultaneously with higher cost debt. Mind you I don't think this is such a great idea, but it would seem to be a logical conclusion.

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Post by mlebuf » Sat Apr 17, 2010 2:13 am

Buy on margin? Isn't that what caused the Great Depression? I agree that an article like that could be a good bear market forecaster. I don't care what university they come from or what their credentials are. Trying to get emotional beings to invest for 30 years without taking emotion into account, is a stupid, stupid idea.
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Post by G-Money » Sat Apr 17, 2010 5:52 am

sscritic wrote:So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?
"Age in bonds" achieves that goal without the possibility of getting completely wiped out.
dmcmahon wrote:The professors need to read this:

http://www.bogleheads.org/foru....php?t=5934
They know all about it. See market timer's post on 1/11/10 in that thread:
People who've enjoyed following this discussion should know that a book is on its way, due out in hardcover May 4th in time for Cinco de Mayo:

http://www.amazon.com/Lifecycl....amp;sr=8-3

Professors Ayres and Nalebuff explain -- or did, at least, in the version I read last summer -- what went wrong with my implementation of Mortgage Your Retirement. Those who contributed to this thread back in October 2008 might recall there was some question about whether the authors in their Forbes article recommended 2x initial leverage without rebalancing or a maximum of 2x leverage. Their book clarifies that leverage should be rebalanced monthly to a level of 2x, similar in mechanics to a leveraged fund.

I expect their book will be quite popular, especially given the recent strength in equities. After suggesting some factual corrections to the section about this thread, I recommended framing my story as a warning of the behavioral complications leveraged investors may experience in turbulent markets, instead of focusing as much on the legitimate flaws in my design.

If you buy a copy, please support the forum by clicking through the Bogleheads home page.

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Post by Snowjob » Sat Apr 17, 2010 6:36 am

There are ways to accomplish this with less risk than they propose. I have been borrowing on private loans, credit cards and margin since summer of 2008 and it has worked out quite well for me.

Main take aways -
-Borrowings costs were / are extreemly low
-Invested in individual securities, not index funds and NOT 100% stock.
-Keep the amount of margin at a respectable ratio to disposable CF
-Don't reach for results. I've kept a very high allocation to bond proxies for most of this time and while I've had very good returns its certainly not the 300%+ that well timed risky bets would have gotten me. Yet this kept me solvent.

This can be done under the right circumstances, (cheap borrowing costs and cheap securities) as prices normalize this becomes far less attractive. Everything needs to be evaluated in the context of valuation.

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Post by nisiprius » Sat Apr 17, 2010 6:43 am

Obscene. Reckless. Irresponsible.

Yale? Perhaps they have heard of the late Yale Professor Irving Fisher, a genuinely brilliant economist who lost most of his personal money in the stock market and would literally have lost his home if a benevolent Yale had not purchased it and rented it back to him. Perhaps Ayres and Nalebuff are confident that Yale will do the same for them should need arise, but Yale is not going to help any readers who take their advice should it blow up. In some six-sigma event that could never have been foreseen (the invariable excuse of the risk-taker who cannot face the fact that they took the risk).
The antileverage impulse is so strong. I was taught in high school that leverage caused the Great Depression and that only speculators buy stock on margin.
(Begin irony) Oh, those silly-billies who lived through the Depression and passed those little Glass-Steagal acts. What did they know? Nowadays we can do sophisticated calculations and we understand that the Depression was a six-sigma event, so unlikely that it shouldn't really have happened and therefore shouldn't count.(end irony)
We have to overcome this psychology.
Why? Why? Why? Why is it important to overcome this psychology? What, exactly, is this imperative to buy stocks that has been in the air for decades? The best thing about this statement is that it confirms my impression that they are speaking to persuade, not to inform.
We don't demonize leveraged purchases of education...
Education is a different kind of goal from "retiring 60% richer." Even though education debt may be necessary, my personal observation is that education debt weighs heavily on the shoulders of those who bear it, a little black cloud drizzling on the early part of their careers.
...and leveraged purchases of homes.
A mortgage is not a leveraged purchase of an investment property, because a home is not an investment, it's shelter. You get the loan because you want/need to live in a house. Most people do not buy and sell their homes frequently as part of a strategy to managed a real estate slice of their portfolio. They buy the house, they pay it off, the value of the house is only really important when it's time to move to another house.
We're trying to open people's minds to the idea that to buy stock on margin in a disciplined way to reduce and control risk is prudent and the way of the future.
That is pure doublespeak. Buying stock on margin increases risk. It is typical of the sales pitches used by merchants of risk.

They could argue that it is a calculated risk or a worthwhile risk or that the risk of 100% stocks is so small that 150% stocks is arguable but when to say that it is a way to "reduce risk" certifies that they are intellectually dishonest people. It confirms that they are speaking to persuade rather than to inform.
it helps people better diversify risk across time.
Anyone who takes about diversification across time is obliged to mention a 1974 paper by Merton and Samuelson and explain why it is wrong: "Fallacy of the log-normal approximation to optimal portfolio decision-making over many periods." I can't understand this paper myself--I ought to take another whack at it--but John Norstad explains it in a presentation I do understand, at The Fallacy of Time Diversification Maybe Merton and Samuelson were wrong. But they need to be answered.

This country has been drunk on debt for decades. If recent events haven't taught us that the pendulum swung too far in that direction, I don't know what would. Even if we grant that mortgage debt is a necessary evil, and education debt is a necessary evil, the last thing that is needed is to add a third chunk of debt on top of that, debt which is not necessary in any sense of the word "necessary" and is not directed toward any identifiable life goal other than the undifferentiated greedy pursuit of "more."

Some readers know what's coming. The man who had this boulder carved, Roger Babson, may have had a bee or two in his bonnet, but unlike Professor Fisher he survived the Depression financially and I believe he died wealthy.
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Post by sscritic » Sat Apr 17, 2010 6:46 am

G-Money wrote:
sscritic wrote:So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?
"Age in bonds" achieves that goal without the possibility of getting completely wiped out.
Thank you.

We agree a common strategy is to start with higher risk (low bonds) early and lower risk (high bonds) late. In fact, many people "leverage" this by borrowing money to buy a house and invest in stocks for retirement at the same time. Assuming you start at age 25, you can save $25,000 a year for 10 years and put nothing into retirement. Then at 35, you buy your house for cash and start your retirement investing, putting 35% into bonds. Most people however, use "negative bonds" so they can start investing for retirement earlier and own a house at the same time. (They also have read the stories about investing from 25 to 35 and stopping gets you more at age 65 than investing from 35 to 65.) By borrowing money, their bond allocation can go from -200% to 65% from age 25 to age 65.

But going "negative" bond is leveraging your stock investments. Unless you pay 100% cash for your home, you borrow money during your investing life. So the question shouldn't be if you should borrow, it is what type of borrowing. What is the best way to borrow so you can invest in stocks while young?
a) credit cards balance
b) home mortgage
c) margin

I think arguments can be made that borrowing against your house is better than using margin, but since a majority of people do borrow at some time in some form during the time they are saving for retirement, you can't really say that no one should borrow ever. Or perhaps you can, but I haven't seen that argument.

Note that the authors did not suggest 2x leverage for 20 years, but declining leverage as you age. When you take a mortgage so you can afford to have that house and save for retirement at the same time, you also have a declining balance as you pay the mortgage off (I am referring here to sane people who don't commit heloc abuse with serial refinancings at higher and higher balances).

So borrow when you are young to invest in stocks and reduce your borrowing as you age and simultaneously increase your bond allocation. Is that really such bad advice? Many people do it and retire comfortably.

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Post by Snowjob » Sat Apr 17, 2010 7:07 am

I think you and I are on an Island on this one SS

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Post by Tramper Al » Sat Apr 17, 2010 7:19 am

Snowjob wrote:I think you and I are on an Island on this one SS
No, I agree as well. Borrow cheaply and prudently while young, I mean. It's just not worth saying so here.

I have a mortgage rate of 5.75%, a margin rate of 1.25%, and can purchase an I-Bond with fixed rate 0.3%. I could discharge all debt with liquid assets tomorrow - I just do feel like paying LTCG taxes to do so. So where should I apply my next paycheck?
Last edited by Tramper Al on Sat Apr 17, 2010 7:32 am, edited 2 times in total.

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Post by jeffyscott » Sat Apr 17, 2010 7:26 am

When I was 26, I borrowed $45,000 at 9.5% interest in order to buy a house. The monthly payments of PITI were the same as the monthly rent payments on a similar home would be.

In order to have invested in the stock market, I would have had to borrow more. If I did not borrow to buy the home, I would have been spending the same amount on rent each month as I did spend on the mortgage, etc. It really was not an option to pay cash for the house and borrow in order to buy stocks on margin, instead.

Should I have rented and borrowed to buy stocks instead? Perhaps I should have, given what happened in the stock market in the 80s and 90s.
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Post by Snowjob » Sat Apr 17, 2010 7:31 am

Tramper Al wrote:
Snowjob wrote:I think you and I are on an Island on this one SS
No, I agree as well. Borrow cheaply and prudently while young, I mean. It's just not worth saying so here.

I have a mortgage rate of 5.75%, a margin rate of 1.25%, and can purchase an I-Bond with fixed rate 0.3%. So where should I apply my next paycheck?
Depends on your age and level of debt, but I would suggest its either invest in more stocks & bonds or pay down the mortgage. .3% interest on Ibond is aweful in its own right especailly if you are paying higher interest elsewhere.

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Post by jeffyscott » Sat Apr 17, 2010 7:32 am

nisiprius wrote:
...and leveraged purchases of homes.
A mortgage is not a leveraged purchase of an investment property, because a home is not an investment, it's shelter. You get the loan because you want/need to live in a house.
In addition, it seems to me that some of the leveraged purchasing of homes that was done as an investment (or largely as investments and secondarily as shelter) did not work out too well for some who did so at prices that they later found out were too high.
Time is your friend; impulse is your enemy. - John C. Bogle

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Post by Tramper Al » Sat Apr 17, 2010 7:37 am

Snowjob wrote:
Tramper Al wrote:
Snowjob wrote:I think you and I are on an Island on this one SS
No, I agree as well. Borrow cheaply and prudently while young, I mean. It's just not worth saying so here.

I have a mortgage rate of 5.75%, a margin rate of 1.25%, and can purchase an I-Bond with fixed rate 0.3%. So where should I apply my next paycheck?
Depends on your age and level of debt, but I would suggest its either invest in more stocks & bonds or pay down the mortgage. .3% interest on Ibond is aweful in its own right especailly if you are paying higher interest elsewhere.
Sorry, that was essentially a rhetorical question.

Obviously a loan on an investment (however modest or cheap) is very very wrong, while a loan on a house is fine and dandy. Does the money really know where it is owed, or merely its interest rate cost?

Oh, and as awful as a 0.3% I-Bond sounds, with a little inflation it actually does come out ahead of a tax-deductible borrowing cost of 1.25%, strangely enough.

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Post by Snowjob » Sat Apr 17, 2010 7:51 am

Tramper Al wrote: Obviously a loan on an investment (however modest or cheap) is very very wrong, while a loan on a house is fine and dandy. Does the money really know where it is owed, or merely its interest rate cost?

Oh, and as awful as a 0.3% I-Bond sounds, with a little inflation it actually does come out ahead of a tax-deductible borrowing cost of 1.25%, strangely enough.
Just a cost..

re- I bonds. I bonds wouldn't be held in a brokerage account so they would be increasing your margin equity ratio much more than if you bought a stock/etf/mutual fund. Additionally I dont think you can deduct the margin cost of buying an I-bond (need to check) I know you cant deduct the cost of tax exempt items.[/quote]

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Post by ResNullius » Sat Apr 17, 2010 9:04 am

Buying on margin is about the same as playing poker, and I gather that's a major passtime of the younger generation these days. Too bad their professors have bought into this stupidity. I worked far to hard for the money I earned during my decades in the rat race to gamble it away is such a frivolous manner.

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Professors behaving badly

Post by bobcat2 » Sat Apr 17, 2010 9:08 am

I notice at the Amazon preview of their book, Lifecycle Investing, Ayres and Nalebuff dedicate the book "to their teacher Paul Samuelson" and claim their book is a straightforward application of research done by Samuelson.

In October of 2008 Paul Samuelson attended an economics conference on lifecycle investing. I believe it was the last economics conference Samuelson attended. Here is what Paul Samuelson said about the investing strategy of Ayres and Nalebuff at that conference.
Many analysts argue that when you average over many investment periods, so favorable are the long-run returns of stocks that while you are still young, you should borrow substantially to hold large positions in stocks and you should do so because some kind of “stochastic dominance” is supposed to justify it.

Now, when I read such things, my eyebrows arch upwards. I think I have written 27 articles rebutting this idea—with at least one article completely in one syllable words, except for the word “syllable” itself. It smacks of what I call the “Milton Friedman fallacy.” When that sage was a TIAA trustee before me, he believed that investing for a large number of future periods did, by some law of large numbers, mandate becoming more risk tolerant. The Milton Friedman fallacy is a simple one. Also called the Kelly criterion, it leads to the conclusion that, in contrast to utility theory, one should always maximize the geometric mean. It is the same as the 1738 Daniel Bernoulli conjecture that if you have a duel with your brother-in-law and you are faced with a stationary probability process—stationary through time—going to the geometric mean is the way to win. Being second in investing, unlike being second in dueling, is good, however, and very few attain it.

The ideas that I have been criticizing do not shrivel up and die. They always come back.... Recently I received an abstract for a paper in which a Yale economist and a Yale law school professor advise the world that when you are young and you have many years ahead of you, you should borrow heavily, invest in stocks on margin, and make a lot of money. I want to remind them, with a well-chosen counterexample: I always quote from Warren Buffett (that wise, wise man from Nebraska) that in order to succeed, you must first survive. People who leverage heavily when they are very young do not realize that the sky is the limit of what they could lose and from that point on, they would be knocked out of the game.

So once Samuelson dies a year later Ayres and Nalebuff dedicate a book to Samuelson on an investment strategy Samuelson and his research had roundly rejected, while he was alive and able to defend his rejection of their strategy.

Shame on them. Shame.

BobK

PS - Link to conference proceedings that includes Samuelson quote.
http://www.cfainstitute.org/memresource ... cle_4.html
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Post by peter71 » Sat Apr 17, 2010 9:55 am

People have made some good arguments in defense of leverage but I do think there's a practical distinction between the familiar procedure of taking out a mortgage in order to achieve a life goal one can't easily achieve without that leverage and the more demanding procedure of doing due diligence on Interactive Brokers (and whatever one uses the account to invest in ) in order to achieve a life goal (comfortable retirement) that a smart and responsible young person can easily achieve without the leverage, One could, for example, pour a mere 100% of their money into stocks when valuations are historically high, and provided the data cited holds up one will do great anyway . . . :D

All best,
Pete

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Post by nisiprius » Sat Apr 17, 2010 11:12 am

I've decided to change with the times.

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Post by TheEternalVortex » Sat Apr 17, 2010 11:38 am

sscritic wrote:Did you try and think it through?

You are investing for 30 years. After the first year, you lose 100% of your investment on January 1. You then save for 29 years without another loss.

You are investing for 30 years. After 29 years without a loss, you lose 100% of your investment on January 1.

Who is better off?

Losing 100% at the end of year 1 is much less damaging to your retirement than losing 50% at the end of year 29.

It is easier to recover from early losses than from late losses since 1) the amount of money involved is much smaller; 2) you have more time to replenish your savings with your human capital.

So what is wrong with a strategy of large risk bets with smaller amounts early and small risk bets with large amounts later?
I've posted this so many times I should just copy & paste it, but the arguments for making your allocation more conservative over time are entirely unconvincing. This applies just as much to the strategy discussed in the OP.

I'll summarize again:
Having a riskier allocation when you are younger is only reasonable if your future retirement savings (i.e., from your wages) are fairly riskless. But that's simply NOT the case for most people.

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Post by Lbill » Sat Apr 17, 2010 12:00 pm

I always quote from Warren Buffett (that wise, wise man from Nebraska) that in order to succeed, you must first survive.
Thank you, BobK for your post regarding Samuelson's comments. I think that says it all. In their book "Spend 'til the End," Burns & Kotlikoff take a view similar to Buffett's. As does Samuelson, they explicitly reject the notion of "time diversification of risk" as a justification for being heavily invested in stocks when younger. They actually suggest that young investors should have a relatively low allocation to stocks. It's important, they believe, to first accumulate an investment stake before taking on high equity risk. They take into account the capacity to take financial risk in terms of the value and predictability of "human capital," which is needed to replace loss in financial capital. Human capital depends on skills, but more importantly on experience and being more established in one's career. Earlier in one's career, human capital does not diversify financial capital as well, since both may be vulnerable to the same economic risks. They suggest that allocation to equities should probably be highest for most people in mid-career when they have a more established and secure career, and then be reduced as one approaches retirement. The only other economist I follow who might advise high stock allocation at a young age is Milevsky, but even he wouldn't advise this unless one's human capital is very "bond-like"; i.e., very stable and secure.

The advice from the Yale professors reminded me of a family story. My uncle moved from the midwest to Las Vegas when he was in is early 20s, and Las Vegas was just a few casinos and a couple stop lights. He and a partner opened a small lunchroom restaurant called the Ready Room at the small Las Vegas airport. Soon they were unable to meet expenses. They decided in desperation to take all the money they could borrow and otherwise scrape together and put it all on one spin of the roulette wheel at a casino - nothing to lose at that point they reckoned. In this case, they had the need to take risk and were able to take the risk "on margin." Despite the odds, they won and kept the Ready Room open. It was the one and only time my uncle ever placed a bet in a Vegas casino. He didn't believe in gambling, just hard work and smarts. A few years later when Las Vegas grew and the airport expanded he employed over 200 people at the Ready Room and they had the contract to provide food service for TWA and other airlines. They sold the Ready Room for millions and retired in their 40s. It worked for my uncle, but I really don't think it makes any sense at all for most people to use the "Ready Room" investment strategy that the Yale professors advocate -- unless you really need to.
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Post by UrbanMedic » Sat Apr 17, 2010 12:08 pm

Jacobkg wrote:One of the first pieces of advice my father gave me was: " Never buy on margin"
I liked the "diversify across time" thing. We need to work on wormholes and time travel. Problem solved.

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Post by jeffyscott » Sat Apr 17, 2010 12:12 pm

TheEternalVortex wrote:the arguments for making your allocation more conservative over time are entirely unconvincing.
But also unconvincing is the argument that the percentages determine how risky/conservative your portfolio is. A 25 year old with $50,000 in stocks, representing 100% of assets is taking on much less risk* than a 60 year old with 50% of his $1 million portfolio in stocks.

*Where "risk" is not defined as the standard deviation :!:
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Post by LadyGeek » Sat Apr 17, 2010 12:21 pm

I updated the wiki page to include this thread.

Please see Leverage on the Bogleheads Wiki.
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DRiP Guy
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Post by DRiP Guy » Sat Apr 17, 2010 12:30 pm

Barbara Kiviat’s Education
* Columbia University - Graduate School of Journalism
MA , business and economics journalism , 2005 — 2006

* The Johns Hopkins University
BA , Writing Seminars, psychology , 1997 — 2001
http://www.linkedin.com/pub/barbara-kiviat/4/696/B43


She is a writer, with an undergrad in psych.

She knows what makes for drawing eyeballs.

I would not put much stock in her economic ability, however.

To the whole concept of levering to try to get a head start: Thanks, but no thanks. It's bad on every level, not the least of which is the moral and precedent setting effect on the investor.

We need to build a national psychology towards SAVING, not BORROWING if we hope to end up as anything less than a third world nation over the next forty years or so.


Reading her latest scheme, you'd almost have a hard time believing she is the same author who wrote this just a couple of years ago:
Call it the international house of pancaked leverage, built on the proliferation of subprime and exotic mortgages that did away with many of the safeguards built into the classic 30-year fixed rate with a 20% down payment. Riskier loans originally designed for a narrow band of home buyers--interest only, adjustable rate, balloon payment, no documentation (of income, that is)--took off broadly in the last rising market, and Denver was one of the many areas where they were hot.

The demand was coming not so much from borrowers as from Wall Street, which packaged the loans into securities to sell to investors looking to pile into "low risk" real estate. So mortgage brokers found ways to squeeze buyers into first and second mortgages even when their finances were questionable.
http://www.time.com/time/magazine/artic ... -1,00.html

That is, if you did not stop to think of what her trade is, and how she gets rewarded. After you do that, it all makes sense.

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Post by DRiP Guy » Sat Apr 17, 2010 12:37 pm

About Barbara Kiviat

Barbara Kiviat recently celebrated her 6-year anniversary covering business and economics for TIME magazine. Over the years, she's written stories about Ben Bernanke, Starbucks, Atlantic City, the zany worlds of real estate, private equity and hedge funds, ING Direct, J. Crew, the people who are buying up our public roads, how Verizon really got her angry by asking for her Social Security number, and why you shouldn't go shopping when you're sad. It's a pretty good gig.
http://curiouscapitalist.blogs.time.com/author/bkiviat/

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Re: Professors behaving badly

Post by Murray Boyd » Sat Apr 17, 2010 12:38 pm

bobcat2 wrote: So once Samuelson dies a year later Ayres and Nalebuff dedicate a book to Samuelson on an investment strategy Samuelson and his research had roundly rejected, while he was alive and able to defend his rejection of their strategy.
Creeps!

This thread reminded me of when I got the first inkling that there was more to investing than asset allocation, this old discussion about about what mortgages meant to a portfolio: Home equity vs small caps.

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Post by ensign_lee » Sat Apr 17, 2010 12:44 pm

Isn't this what Market Timer did? And aren't those *the same* Yale Professors that he was talking about?

Haven't they done enough damage? I mean, poor market timer. Ooof, can't believe this got published in TIME...

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Re: Creeps!

Post by bobcat2 » Sat Apr 17, 2010 1:35 pm

Hi Murray,

Good to see you posting again. :)
You wrote.
Creeps!
I couldn't agree more. What the Yale guys did to Samuelson has a creepy Orwellian feel about it. Maybe they should angle for positions in the Ministry of Truth with an area of special expertise in Doublethink. :lol:

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Post by baw703916 » Sat Apr 17, 2010 1:41 pm

There's a big difference between taking out a mortgage so you can invest and actually investing on margin.

On margin, the broker is watching the value of your portfolio, and if it goes down too much, will make you a forced seller at the worst possible moment, when it's time to be buying.

If you have a mortgage, the lender isn't going to care unless you stop making the payments. Even if the house gets underwater, as long as you keep paying, the lender is more than happy to look the other way.

Brad
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Post by Jacobkg » Sat Apr 17, 2010 1:53 pm

What I don't understand is if this strategy is so good, why would anyone loan you the money at such a low rate? If all you are going to do is buy stocks with it, the loaners could easily cut you out and spend all their extra capital on stocks directly.

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Post by ResNullius » Sat Apr 17, 2010 1:57 pm

Jacobkg wrote:What I don't understand is if this strategy is so good, why would anyone loan you the money at such a low rate? If all you are going to do is buy stocks with it, the loaners could easily cut you out and spend all their extra capital on stocks directly.
Money is why people will loan you money. There's a sucker born every day, or so they say.

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Post by sscritic » Sat Apr 17, 2010 2:02 pm

baw703916 wrote:There's a big difference between taking out a mortgage so you can invest and actually investing on margin.

On margin, the broker is watching the value of your portfolio, and if it goes down too much, will make you a forced seller at the worst possible moment, when it's time to be buying.
No, you will get a margin call. No one is going to force you to sell your stocks. You will sell some of your bonds and pay the broker what is required. The result is the same as if you sold bonds to rebalance and to buy more stocks when stocks fall. Either way, you sell bonds when stocks fall.

The thing about borrowing money is that you have to be prepared to pay it back. If you aren't, don't borrow. It's true for stocks and it's true for houses. Don't borrow $600,000 with zero down and interest only for 2 years if you aren't prepared for what is going to happen when those 2 years are up. You might not be able to sell your house at a profit then (and you might not be able to sell your stocks at a profit then either).

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Post by sscritic » Sat Apr 17, 2010 2:06 pm

Jacobkg wrote:What I don't understand is if this strategy is so good, why would anyone loan you the money at such a low rate? If all you are going to do is buy stocks with it, the loaners could easily cut you out and spend all their extra capital on stocks directly.
Risk transfer. The lender can get a guaranteed (low) rate of return and let you bet the farm (take the risk). That is why people put money in CDs instead of going 100% or higher in stocks.

In case you missed it, a lot of banks and lenders got caught taking too much risk a couple of years ago. Perhaps slow and steady has more appeal now for lenders.

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Post by nisiprius » Sat Apr 17, 2010 2:09 pm

DRiP Guy wrote:
Barbara Kiviat’s Education
She is a writer, with an undergrad in psych.
She's a journalist. She's not espousing the theory, she's reporting on it. A journalist can do a good job of reporting on something she's not an expert in... as the Terry Gross book title says, All I Did Was Ask. In this case, she asks intelligent questions, very much the question I would have liked to have someone ask. She either gets succinct, concise answers or has edited them well. It doesn't read like a puff piece. It doesn't read like a hatchet job. The only issue is whether the quotes are a fair representation of Ayres and Nalebuff's point of view.

Ayres and Nalebuff are promoting their book. I think it's distinctly cheesy of them to be giving out little sound bites when the book itself is not out yet and not available for review.

The full title of the book is Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio The dictionary definition of audacious is
The Free Dictionary Online wrote:recklessly bold or daring; fearless
Merriiam-Webster online wrote:a. intrepidly daring : adventurous <an> b : recklessly bold
American Heritage dictionary, 3rd edition wrote:fearlessly, often recklessly daring; bold
So they are convicted of recklessness by their own book title. How something that is recklessly daring can also be "safe" is a little puzzling.

The question I wish she had asked is what the investor following their advice is expected to do when they get a margin call. From the article, it appears they are suggesting a "2-to-1" so a margin call during the recent downturn would have been a distinct possibility. Presumably they have a strategy for dealing with this, but if you keep a cash reserve to meet a margin call it would seem that you're canceling out your leverage. I guess. Since I don't do margin and don't do leverage I have no idea how it works. Perhaps Market Timer can enlighten me.
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Post by matt » Sat Apr 17, 2010 2:17 pm

sscritic wrote:
You are investing for 30 years. After the first year, you lose 100% of your investment on January 1. You then save for 29 years without another loss.
How many investors will stick with this strategy after losing 100% of their money? Most investors can't even stick with an un-levered 100% equity portfolio, much less 200%. Even if the theory is great (it's not), the practice is the hard part. This is true even for Bogleheads just managing a passive portfolio.

Practical example other than Market Timer's blowup: Rydex Nova (RYNVX) has a 1.5x exposure to the S&P 500. The fund has underperformed the S&P 500 by more than 2% per year over the past 15 years. Do you know any investors in the real world that would keep funneling money into this strategy ever year when it hasn't worked in the past decade?

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Post by OkieIndexer » Sat Apr 17, 2010 2:21 pm

This strategy isn't really practical for retirement accounts because brokers don't allow margin investing in IRA accounts, and margin investing isn't available in 401k, 403b, 457, etc. accounts.

One of the Yale profs says that if your employer matches in your 401k, you should invest in the 401k and avoid the margin strategy. I guess he would recommend that if your employer doesn't match, you should avoid the 401k entirely and put your money in a taxable margin account at a broker? Really?

I highly doubt that their margin strategy would make it worthwhile to give up the tax benefits of a Roth IRA, and probably the 401k, even if your employer doesn't match the 401k.
"In bull markets, people say 'The more risk I take, the greater my return.' But when people aren't afraid of risk, they'll accept risk without being compensated." -Howard Marks, Oaktree Capital

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Post by DRiP Guy » Sat Apr 17, 2010 2:24 pm

nisiprius wrote:She's a journalist. She's not espousing the theory, she's reporting on it.... she asks intelligent questions... She either gets succinct, concise answers or has edited them well. It doesn't read like a puff piece. It doesn't read like a hatchet job.

Ayres and Nalebuff are promoting their book.
What if someday they gave a book and nobody came....
:lol:
(but your points were all well taken, other than the fact she is at minimum a collaborator in their hyping it. ) If only her piece had not been titled:
Why Young People Should Buy Stocks on Margin
By Barbara Kiviat Friday, Apr. 16, 2010
but:
An interview with authors promoting a book that claims Young People Should Buy Stocks on Margin
By Barbara Kiviat Friday, Apr. 16, 2010
Last edited by DRiP Guy on Sat Apr 17, 2010 2:29 pm, edited 1 time in total.

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Post by market timer » Sat Apr 17, 2010 2:28 pm

nisiprius wrote:The question I wish she had asked is what the investor following their advice is expected to do when they get a margin call. From the article, it appears they are suggesting a "2-to-1" so a margin call during the recent downturn would have been a distinct possibility. Presumably they have a strategy for dealing with this, but if you keep a cash reserve to meet a margin call it would seem that you're canceling out your leverage. I guess. Since I don't do margin and don't do leverage I have no idea how it works. Perhaps Market Timer can enlighten me.
They recommend buying LEAPS, which insulate the investor from margin calls at a cost. LEAPS were how I originally planned to implement the MYR strategy, before deciding they were not very tax efficient. See this post for an example: http://www.bogleheads.org/forum/viewtop ... 3329#73329

Check out chapter 6 of the book on Amazon's "search inside this book" feature. The professors point out some of my strategy's major flaws, including the use of CC debt, being overleveraged, and investing in single name financials. I'm glad to see they also cautioned investors about the difficulty staying the course with MYR, quoting several excerpts from my thread.

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Post by DRiP Guy » Sat Apr 17, 2010 2:33 pm

market timer wrote:They recommend buying LEAPS, which insulate the investor from margin calls at a cost... The professors point out some of my strategy's major flaws, including the use of CC debt, being overleveraged, and investing in single name financials. I'm glad to see they also cautioned investors about the difficulty staying the course with MYR, quoting several excerpts from my thread.
I don't know how else to ask this without seeming rude, so I guess I'll just come out and ask it:

"Were you compensated for your part in the book?"

I recall when you first came on the scene, many people were struck by your scheme and figured it was a 'stunt' of some sort. Again, without being personally disparaging, if it turns out you were compensated for your activities here, towards getting good material for the book, then I'd have to conclude it was indeed a stunt; whether entertaining and informative for Boglehead board readers or not.

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Post by market timer » Sat Apr 17, 2010 2:43 pm

DRiP Guy wrote:"Were you compensated for your part in the book?"
No, I've never even met the authors.

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Post by Rodc » Sat Apr 17, 2010 2:45 pm

market timer wrote:
nisiprius wrote:The question I wish she had asked is what the investor following their advice is expected to do when they get a margin call. From the article, it appears they are suggesting a "2-to-1" so a margin call during the recent downturn would have been a distinct possibility. Presumably they have a strategy for dealing with this, but if you keep a cash reserve to meet a margin call it would seem that you're canceling out your leverage. I guess. Since I don't do margin and don't do leverage I have no idea how it works. Perhaps Market Timer can enlighten me.
They recommend buying LEAPS, which insulate the investor from margin calls at a cost. LEAPS were how I originally planned to implement the MYR strategy, before deciding they were not very tax efficient. See this post for an example: http://www.bogleheads.org/forum/viewtop ... 3329#73329

Check out chapter 6 of the book on Amazon's "search inside this book" feature. The professors point out some of my strategy's major flaws, including the use of CC debt, being overleveraged, and investing in single name financials. I'm glad to see they also cautioned investors about the difficulty staying the course with MYR, quoting several excerpts from my thread.
I imagine if I really tried I could figure out LEAPS, but given that the average American has trouble adding fractions, this can't possibly be a workable strategy for more than a very tiny subset of people investing for retirement.

Given the panic we saw here, in the land of Stay the Course!, from people who at some level knew better, and had basic stock AND BOND portfolios, this can't possibly be a workable strategy for more than a fraction of that tiny fraction of people investing for retirement.

If indeed it makes sense for anyone.
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