Lifecycle Investing - Leveraging when young

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skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

daze wrote: Thu Sep 30, 2021 8:25 pm
skierincolorado wrote: Wed Aug 18, 2021 5:37 pm .
Not sure if it's a dumb idea.

Considering the idea of liabilities matching with lifecycle investing, would it be better to get a debt with duration similar to your income flow?
If you are going to retire in 30 years, and the income of later years would be greater than young ages, the duration of your income flow would be 15 or 20 years?
Mortgage would have a duration of years, but futures/margin loan/LETFs has a duration essentially zero. If using futures/margin loan/LETFs to get leverage, should we short treasuries to adjust the duration?
Liability matching has never made sense to me. The return from investing comes from taking risk. If we have so little tolerance for risk then the only thing we can invest in is unleveraged LTT. Liability matching also fails to define risk correctly. Yes I can *guarantee* that I can meet my future liabilities by investing in a 30 year bond. But the return of stocks over a 30 year period has always been greater, so is it really a greater risk? Likewise, the return from investing and rolling leveraged ITT has always been greater than investing in LTT for 30 years, so is it really a greater risk? Even if it is a greater risk, are we really so risk averse that we would pass up a 99% chance of being wealthier because of a 1% chance we are not? Are our liabilities really so set in stone?
daze
Posts: 59
Joined: Fri Mar 08, 2019 12:09 am

Re: Lifecycle Investing - Leveraging when young

Post by daze »

skierincolorado wrote: Fri Oct 01, 2021 10:10 am
daze wrote: Thu Sep 30, 2021 8:25 pm Not sure if it's a dumb idea.

Considering the idea of liabilities matching with lifecycle investing, would it be better to get a debt with duration similar to your income flow?
If you are going to retire in 30 years, and the income of later years would be greater than young ages, the duration of your income flow would be 15 or 20 years?
Mortgage would have a duration of years, but futures/margin loan/LETFs has a duration essentially zero. If using futures/margin loan/LETFs to get leverage, should we short treasuries to adjust the duration?
Liability matching has never made sense to me. The return from investing comes from taking risk. If we have so little tolerance for risk then the only thing we can invest in is unleveraged LTT. Liability matching also fails to define risk correctly. Yes I can *guarantee* that I can meet my future liabilities by investing in a 30 year bond. But the return of stocks over a 30 year period has always been greater, so is it really a greater risk? Likewise, the return from investing and rolling leveraged ITT has always been greater than investing in LTT for 30 years, so is it really a greater risk? Even if it is a greater risk, are we really so risk averse that we would pass up a 99% chance of being wealthier because of a 1% chance we are not? Are our liabilities really so set in stone?
I don't mean matching future spending with bond. I mean matching debt with future income.

For example, if your income is in EUR, taking EUR debt has lower currency risk than taking USD debt. You could still take USD debt if you want to make active speculation bet, but borrowing in EUR should be the baseline status.

Similarly, if you will get a lump sum income 3 years from now, matching it with a 3 year duration no coupon loan would be risk-free. Taking a loan benchmarked to SOFR is taking duration risk exposure implicitly. The 3 year loan is the baseline, then you could decide how much duration risk you want to take.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

daze wrote: Fri Oct 01, 2021 10:38 pm
skierincolorado wrote: Fri Oct 01, 2021 10:10 am
daze wrote: Thu Sep 30, 2021 8:25 pm Not sure if it's a dumb idea.

Considering the idea of liabilities matching with lifecycle investing, would it be better to get a debt with duration similar to your income flow?
If you are going to retire in 30 years, and the income of later years would be greater than young ages, the duration of your income flow would be 15 or 20 years?
Mortgage would have a duration of years, but futures/margin loan/LETFs has a duration essentially zero. If using futures/margin loan/LETFs to get leverage, should we short treasuries to adjust the duration?
Liability matching has never made sense to me. The return from investing comes from taking risk. If we have so little tolerance for risk then the only thing we can invest in is unleveraged LTT. Liability matching also fails to define risk correctly. Yes I can *guarantee* that I can meet my future liabilities by investing in a 30 year bond. But the return of stocks over a 30 year period has always been greater, so is it really a greater risk? Likewise, the return from investing and rolling leveraged ITT has always been greater than investing in LTT for 30 years, so is it really a greater risk? Even if it is a greater risk, are we really so risk averse that we would pass up a 99% chance of being wealthier because of a 1% chance we are not? Are our liabilities really so set in stone?
I don't mean matching future spending with bond. I mean matching debt with future income.

For example, if your income is in EUR, taking EUR debt has lower currency risk than taking USD debt. You could still take USD debt if you want to make active speculation bet, but borrowing in EUR should be the baseline status.

Similarly, if you will get a lump sum income 3 years from now, matching it with a 3 year duration no coupon loan would be risk-free. Taking a loan benchmarked to SOFR is taking duration risk exposure implicitly. The 3 year loan is the baseline, then you could decide how much duration risk you want to take.
Since a young person can reasonably expect to have a 30+ year career, by this argument they should borrow at 30 year interest rates. This is true whether they are borrowing to invest in bonds, or to invest in stocks. The authors of Lifecycle Investing certainly did not endorse such a position. And it doesn't make sense. Yes, this is the riskless way to borrow money for 30 years. However,

1. Investing is about taking risk. There is a high probability that borrowing at short term rates for 30 years will cost less than borrowing at the 30 year rate. This has been true historically and it is true theoretically because of the term premium. Only in an environment of rising rates would borrowing at the 30 year win.

2. Both your investments and your income are interest rate sensitive. As interest rates rise, so to should expectations of future investment growth and income growth. Increased returns from investments and increased income will more than offset borrowing costs. Borrowing at the short-term rate is the rate-neutral riskless position. We can see this work empirically as well. An young investor in 1972 when rates were low that borrowed at the short-term rate should be *happy* that interest rates increaseed. These rate increases, preceded astounding returns on their investments, economic growth, and likely income growth. Even if we go back to the start of the rate increase cycle in 1963, an investor borrowing at short-term rates should have been happy that rates increased. Over a 50 or 60 year investment horizon, with accumulation occurring in the 60s 70s and 80s, they did phenomenally - better than they could possibly have hoped for in 1963.

A young investor in 1990, retiring today, should be disappointed by falling rates over the first 30 years of their investing career. Wage growth has been slower since 2000. And the expected future returns of both stocks and bonds are very low. But at least by borrowing at the short end and investing in stocks and longer duration bonds they will have profitted and built a nice cushion for the lower expected returns for the next 30 years. Borrowing large sums at the 30-yr rate in 1990 could have been disastrous for this investor. Borrowing at the short-term rate has acted as a hedge in the scenario that interest rates and future expected returns decrease.
Kal1981
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Location: Berkeley, CA

Re: Lifecycle Investing - Leveraging when young

Post by Kal1981 »

Learning about lifecycle using leverage. Os the goal to buy LEAPS and continue renewing? Can someone share an example on what it may look like? Thanks.
markfaix wrote: Wed Jun 03, 2020 2:19 pm
Steve Reading wrote: Tue Jun 02, 2020 8:13 am
Ciel wrote: Tue Jun 02, 2020 3:32 am I don't invest taxable but max my tax advantaged space. LEAPS in an IRA is a possibility for leverage, but it seems like it's impossible to get permission from a brokerage to trade options without prior experience doing so (without lying on the application, which is a route I don't want to go down).
Oh that's a shame. Getting permission to buy call options is typically level 1 for brokers. Since it carries no margin risk, you can generally obtain it without prior options experience. It's where most of us start. What broker are you using? I wouldn't lie on the application; I got approved for call options years ago and I told them I had zero experience. I used Merrill back then.
Ciel wrote: Tue Jun 02, 2020 3:32 am So, I mainly find the book relevant for the very few individuals in their twenties who have plenty to invest in a taxable account (on margin through interactive brokers) after maxing out their tax advantaged space. That's a very small group of individuals.
I think the book is relevant to many others. Mainly:
- Individuals of any age (20s, 30s, 40s, etc) who are saving enough to fill up their tax-advantaged but not much else. They would use LEAPs in their IRAs as per the book. In fact, this is the demographic they simulate most (I believe each person saves like 5k a year).
- Individuals of any age (20s, 30s, 40s and 50s) who have saved more than their tax-advantaged and also have a taxable account. Those individuals might use LEAPs or margin outside, in the taxable account. You might only need like 15k to buy a LEAP or use margin so it seems accessible to most individuals, especially later in life.
- Individuals later in life (50s, 60s, etc) that still have an income will still use these concepts. They might not need to leverage (or like Ian, they might only need a little leverage). If you take Social Security into account, this is especially relevant. As they show, even starting late has benefits!
- Individuals who have kids. They show some recommendations as to how to save for them to set them up for their lifecycle investing journey.
- Even institutions, endowment funds, etc will want to take heed. They probably already do though.

Just my 2 cents.
I have read the book and this entire thread. I'm nearly 50 years old with 15 years of work left. How I wish I could have read this book and implemented it when I was younger! The idea of time diversification makes complete sense. But better late than never...

A few questions about implementation in my season of life:
1. We own our house outright but will be purchasing a second home, which we plan to sell in 10 years. How would you count the equity being accumulated in the second house toward this asset allocation? I wouldn't count the equity in the first house since we have to live there, but presumably we'll get the equity in the second home back when we sell (minus expenses).

Example:
Current assets 750k
First house 350k (own outright)
Second house 500k (mortgage 300k, equity 200k)
PV of future earnings 450k
PV of future mortgage payments ~70k (I just added up 10 yrs of payments toward principal in the amortization table)
desired ratio 50/50
So total PV of investable assets with this method = 750k + 200k -300k + 450k + 70k ??

2. How did you decide on your Samuelson ratio? I tried the risk calculators in the book and on their website. Got very different numbers, from 40% stock to >70%. I have high willingness to take risk, and a high desire to maximize chances to retire sooner, but my human capital is getting smaller and smaller.
skierincolorado
Posts: 2377
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

Kal1981 wrote: Mon Oct 11, 2021 10:55 pm Learning about lifecycle using leverage. Os the goal to buy LEAPS and continue renewing? Can someone share an example on what it may look like? Thanks.
markfaix wrote: Wed Jun 03, 2020 2:19 pm
Steve Reading wrote: Tue Jun 02, 2020 8:13 am
Ciel wrote: Tue Jun 02, 2020 3:32 am I don't invest taxable but max my tax advantaged space. LEAPS in an IRA is a possibility for leverage, but it seems like it's impossible to get permission from a brokerage to trade options without prior experience doing so (without lying on the application, which is a route I don't want to go down).
Oh that's a shame. Getting permission to buy call options is typically level 1 for brokers. Since it carries no margin risk, you can generally obtain it without prior options experience. It's where most of us start. What broker are you using? I wouldn't lie on the application; I got approved for call options years ago and I told them I had zero experience. I used Merrill back then.
Ciel wrote: Tue Jun 02, 2020 3:32 am So, I mainly find the book relevant for the very few individuals in their twenties who have plenty to invest in a taxable account (on margin through interactive brokers) after maxing out their tax advantaged space. That's a very small group of individuals.
I think the book is relevant to many others. Mainly:
- Individuals of any age (20s, 30s, 40s, etc) who are saving enough to fill up their tax-advantaged but not much else. They would use LEAPs in their IRAs as per the book. In fact, this is the demographic they simulate most (I believe each person saves like 5k a year).
- Individuals of any age (20s, 30s, 40s and 50s) who have saved more than their tax-advantaged and also have a taxable account. Those individuals might use LEAPs or margin outside, in the taxable account. You might only need like 15k to buy a LEAP or use margin so it seems accessible to most individuals, especially later in life.
- Individuals later in life (50s, 60s, etc) that still have an income will still use these concepts. They might not need to leverage (or like Ian, they might only need a little leverage). If you take Social Security into account, this is especially relevant. As they show, even starting late has benefits!
- Individuals who have kids. They show some recommendations as to how to save for them to set them up for their lifecycle investing journey.
- Even institutions, endowment funds, etc will want to take heed. They probably already do though.

Just my 2 cents.
I have read the book and this entire thread. I'm nearly 50 years old with 15 years of work left. How I wish I could have read this book and implemented it when I was younger! The idea of time diversification makes complete sense. But better late than never...

A few questions about implementation in my season of life:
1. We own our house outright but will be purchasing a second home, which we plan to sell in 10 years. How would you count the equity being accumulated in the second house toward this asset allocation? I wouldn't count the equity in the first house since we have to live there, but presumably we'll get the equity in the second home back when we sell (minus expenses).

Example:
Current assets 750k
First house 350k (own outright)
Second house 500k (mortgage 300k, equity 200k)
PV of future earnings 450k
PV of future mortgage payments ~70k (I just added up 10 yrs of payments toward principal in the amortization table)
desired ratio 50/50
So total PV of investable assets with this method = 750k + 200k -300k + 450k + 70k ??

2. How did you decide on your Samuelson ratio? I tried the risk calculators in the book and on their website. Got very different numbers, from 40% stock to >70%. I have high willingness to take risk, and a high desire to maximize chances to retire sooner, but my human capital is getting smaller and smaller.
Did you read the original post? LEAPs aren't really the optimal strategy. Margin loans, box spreads, and futures contracts are best. I'd recommend skimming most of the thread. Good to listen to the audiobook too.

Also this thread has more:
viewtopic.php?f=10&t=357281
skierincolorado
Posts: 2377
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

Kal1981 wrote: Mon Oct 11, 2021 10:55 pm Learning about lifecycle using leverage. Os the goal to buy LEAPS and continue renewing? Can someone share an example on what it may look like? Thanks.

Did you read the original post? LEAPs aren't really the optimal strategy. Margin loans, box spreads, and futures contracts are best. Leveraged ETFs like UPRO and TYD are ok too but less optimal. I'd recommend skimming most of this thread. Good to listen to the audiobook too.

Also this thread has more:
viewtopic.php?f=10&t=357281

A basic implementation could be to buy 10k SPY and 10k UPRO.

Or to buy 40k VTI with a 20k margin loan from Interactive Brokers at 1.5%. Optionally the loan could be refinanced to a .7% loan with a box sread.
purg
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Re: Lifecycle Investing - Leveraging when young

Post by purg »

Thanks to Steve Reading and all the others in this thread for the great discussion!

I initially posted in this thread a little under a year ago after reading the Ayres & Nalebuff book for the first time. I was intrigued by the idea, but after seeing that the implied rates on calls, and especially non-US calls, were much higher than I had expected, probably because of the value of the downside protection, I was afraid that I didn’t understand the assumptions involved well enough and decided to follow an unlevered version of this strategy. I have since been at 100% stocks.

Now that the mega backdoor Roth 401(k) is (probably) closing, I’ve decided to reconsider using this strategy. Here are my thoughts after spending a week of my life rereading the book and papers and replicating the authors’ results:

Implementation

Because I don’t trust my intuition, I decided to use Vanguard’s expected return and volatility projections as the basis for my Samuelson share. If I’m to believe those projections, the expected risk-adjusted returns are larger for a globally weighted equity index than for a US one. Therefore, I should be far more willing to leverage a globally weighted portfolio than a US one. As such, I don’t think it makes sense to buy call options or futures on the S&P 500 when globally weighted alternatives are available.

I also found that, when margin rates are higher, my Samuelson share (while leveraged) should be lower. Consistent with this thread, I found that even the SPY LEAP with the lowest implied interest rate has a much higher rate than the available alternatives (1.58% vs 3.71%). Therefore, I really don’t think it makes sense to buy call options for leverage. In addition, SPY LEAPs and S&P 500 micro E-mini futures are currently sold in denominations of $22k+, which means they’re impossible to use in small portfolios and make non-US exposure difficult to maintain. They are also not tax-efficient, so I wouldn’t use them in a taxable account.

Therefore, for this strategy, I would use either margin or LETFs. Margin rates at IBKR are very low, and from what I have read, even after expenses the implied borrowing rates on LETFS are quite low as well. Roth IRAs cannot use margin, so that leaves LETFs there. Taxable portfolios with balances under $110k cannot use margin at IBKR, so until you hit that balance you would also have to use LETFs. Because I believe in global diversification, my preferred LETF allocation (given a 60/40 US/non-US split) would be 34% UPRO + 66% VXUS. With quarterly rebalancing (or rebalancing through contributions), this would achieve 1.68:1 leverage while maintaining global diversification. Once I’m able to use margin, I would simply buy VT at 2:1 leverage.

Addressing my skepticism

My main concerns about the applicability of the results to my life were these:
  1. How does the levered lifecycle strategy (200/s) compare to the unlevered lifecycle strategy (100/s)? Is it always optimal to use leverage?
  2. Does the optimality of the leveraged lifecycle strategy hold in FIRE-like timelines (15-25 years)? I don’t plan to retire early, but I would like to frontload my retirement savings so that I can donate a ton of money later in life while being financially prudent.
  3. Does that optimality still hold in a Monte Carlo simulation based on Vanguard’s expected return and volatility projections for a globally weighted equity index (6.0%, 16.3%)?
  4. What do I do if margin rates rise without a concurrent rise in expected equity returns?
  5. What happens if I become unexpectedly temporarily disabled? I have chronic pain, so this is a real concern for me.
#4 has a simple answer: If the difference between the expected equity return and the margin rate decreases, your Samuelson share while you are leveraged should also decrease. That means a lower equity target while you are leveraged.

#1, 2, and 3 are where I spent a lot of time. The summary is that yes, knowing nothing about future returns and assuming consistent employment, the levered lifecycle strategy improves my distribution of potential nest eggs at “retirement” relative to an unlevered lifecycle strategy. The right tail of the distribution is expanded without a concurrent expansion of the left tail. This is shown in the below graph for target retirement ages 40, 45, and 50 (for reference, I'm 26):

Image

Using leverage makes the more common good times moderately better and the less common bad times slightly worse (on average):

Image

The improvement from using leverage is larger the longer you plan to work, as you would expect:

Image

#5 is the scariest to me. I do have disability insurance, and it’s unlikely that I will become disabled shortly after my portfolio wipes out, but the possibility is still there. Perhaps I'll rerun this with some probability of disability, but it doesn't feel like plugging a number into a mathematical model is going to assuage my fears.

All in all, ignoring psychological and complexity costs and the risk of unemployment and disability, the use of leverage appears to be worth it, even if you’re planning to FIRE. However, because of all the ways in which this could go wrong, I’m hesitant to follow through with it.

An aside

Until doing this exercise, I didn’t have an appreciation for how risky the CoastFIRE strategy is. This is mainly because I did not sufficiently appreciate the difference between arithmetic and geometric means of returns. The geometric mean will always be less than the arithmetic mean, and this difference increases with the variance of returns. Prior to doing this, I thought that a 3% assumption for real compound growth over 30 years was quite conservative. I found that, based on the Vanguard’s expected return and volatility projections, a globally weighted equity index is expected to return that only 40% of the time:

Image

For a while, I was considering reducing retirement contributions and donating a lot more starting at age 35, but now my plan is to delay that goal until I’m closer to a target retirement number.
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

purg wrote: Sat Dec 11, 2021 4:21 pm #4 has a simple answer: If the difference between the expected equity return and the margin rate decreases, your Samuelson share while you are leveraged should also decrease. That means a lower equity target while you are leveraged.
It sounds intuitive to reduce leverage when the cost of borrowing is higher vs. the expected return (in other words, when the equity risk premium (ERP) is lower).

But I think whenever the cost of borrowing increases, then typically company earnings are lower (all other things being equal). Because companies also issue debt.

There are probably many other factors and correlations at play, which are probably hard to all reverse-engineer and predict. But I personally would be afraid to shoot myself in the foot and end up selling low / buying high, if I were to try micro-managing my leverage ratio based on expected returns and cost of leverage. Let's not forget that any and all equity market predictions including Vanguard's have a wide range of outcomes, with relatively low confidence, and very high sensitivity to model parameters.
zkn
Posts: 67
Joined: Thu Oct 14, 2021 12:45 pm

Re: Lifecycle Investing - Leveraging when young

Post by zkn »

purg wrote: Sat Dec 11, 2021 4:21 pm My main concerns about the applicability of the results to my life were these:
  1. How does the levered lifecycle strategy (200/s) compare to the unlevered lifecycle strategy (100/s)? Is it always optimal to use leverage?
  2. Does the optimality of the leveraged lifecycle strategy hold in FIRE-like timelines (15-25 years)? I don’t plan to retire early, but I would like to frontload my retirement savings so that I can donate a ton of money later in life while being financially prudent.
  3. Does that optimality still hold in a Monte Carlo simulation based on Vanguard’s expected return and volatility projections for a globally weighted equity index (6.0%, 16.3%)?
  4. What do I do if margin rates rise without a concurrent rise in expected equity returns?
  5. What happens if I become unexpectedly temporarily disabled? I have chronic pain, so this is a real concern for me.
  1. This depends what you mean by optimal. It's a little simplified, but I like this framework for understanding Lifecycle Investing: There is a point (Kelly criterion) in which compound annual growth rate (CAGR) maxes out, and any further leverage decreases CAGR because the volatility drag exceeds the gain in expected returns. Lifecycle Investing justifies overleveraging past the Kelly criterion by assuming returns are mean reverting (negatively autocorrelated). Basically, if you get wiped out, you will be compensated for this by being able to invest future contributions at lower valuations (higher expected returns). Alternatively, if valuations sky rocket while you are young, you will get to participate in the bull market (that you would have otherwise largely missed out on) and are saved from having to put all your contributions in at high valuations.
  2. Yes. A challenge with FIRE (even more so than traditional retirement) without Lifecycle Investing is that there is only a short period of time prior to retirement where exposure to the stock market is close to max. Maximum exposure is only satisfied over a few years immediately after retirement. This means that FIRE people are very vulnerable to stock market returns immediately after retirement -- this is discussed a lot in the FIRE community as "sequence of return risk". With Lifecycle Investing you get to have max stock exposure for longer and prior to retirement, more time at max exposure means more time diversification, and if you get a bad sequence, you have more flexibility in delaying retirement because you haven't retired yet.
  3. Yes, consider them with respect to current cost of borrowing (<1%).
  4. In theory they should be related as margin rates should be related to bond yields which in turn are related to expected equity returns.
  5. This depends on whether you need to withdraw from your portfolio or you will just be forced to make less or no contributions afterwards (surviving on the disability payments). If the latter, the justification for leveraging past the Kelly criterion is more tenuous, but leveraging under could still make sense. As to what the Kelly criterion is, under certain assumptions (normal random walk), K = (M-rf)/SD^2, so you using your numbers and rf = 1.5 (10-year treasury), K = 1.7 or 170% stock. That's a pretty rough calculation but to just give you some idea. In fact, if the disability payments are enough to survive on, you could be in a better place to have a leveraged (but not lifecycle overleveraged) portfolio than others who do not have guaranteed sources of income.
Good thoughts on CoastFI. Most discussions of CoastFI treat stock market returns as a constant process (i.e., returning exactly the same amount every year) and underappreciate the variation in how long it can take to actually reach the FI number while coasting.

A couple of other recommendations:
  1. Box spreads serve a similar role as margin but are cheaper. They are also more directly tied to bond yields than margin rates so (4) is less of a concern.
  2. The Lifecycle Investing authors do not consider that bonds can also be a source of risk (return) and therefore stock-bond portfolios can be more optimal than stock only portfolios. Skier linked their thread a few posts back which is a superior portfolio to 100% stocks and superior to Lifecycle Investing but still heavy enough in stocks to have the Lifecycle element to harvest time diversification benefits associated with mean reverting stock market returns. Furthermore, the portfolio has higher Kelly so relies less on the assumption of continued contributions than 100% stock Lifecycle Investing portfolio.
h2cycle
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Re: Lifecycle Investing - Leveraging when young

Post by h2cycle »

comeinvest wrote: Fri May 07, 2021 4:42 am Ok, so I have a taxable account at IB with box spreads and tax-exempt municipal bond ETFs and closed-end funds, among others. NO broker margin loan, i.e. only positive cash balances.
Upon reviewing my account statements, I noticed that I have been receiving dividends-in-lieu taxable at ordinary income tax rates from my municipal bond funds instead of about 50% of the dividends I would normally receive from those funds. OUCH! That kind of negates the point of owning muni funds, doesn't it?
I thought the broker can only lend securities up to 140% of the loan balance from the broker. But it looks like I was mistaken.
What is the value of the securities based on that the broker can lend in an account with options?
My box spreads have very low margin requirement, i.e. the margin of the options cannot be the limit. Is it the value of the short options positions? I'm confused.

The SEC says: "Fully paid securities” are, generally, securities carried for a customer in a cash account as well as securities carried for the account of a customer in a margin account or any special account under Regulation T (12 C.F.R. Part 220) that have no loan value for margin purposes, and all margin equity securities in such accounts if they are fully paid. “Excess margin securities” generally means securities carried in a customer’s margin account that are supporting a margin debit balance and have a market value in excess of 140% of the customer’s adjusted margin debit balance."
Reading this article, it seems you are correct https://ibkr.info/node/1967
Did you continue to get cash-in-lieu-of-dividends?
I was thinking of trying box spreads in my taxable IB account if it helped with cash-in-lieu-of-dividends.
sharukh
Posts: 634
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

YearTrader wrote: Mon Dec 28, 2020 7:16 am
Steve Reading wrote: Fri Aug 28, 2020 9:05 pm ...

For tax-advantaged accounts, just use futures. They're actually pretty easy to use and there's no cash drag any more since interest rates are ~0% any ways.

If taxable, I would recommend IBKR margin. You can sell an SPX box to get even lower financing but you don't have to. You can keep things super simple with just margin. The rates are great already.

I don't like using spreads or synthetic longs with options in taxable because you will have to realize the gains. I did it before but have learned :happy Either way, setting up various spreads probably is more work than just margin.

I don't like long calls only at the moment. The implied rates appear too pricey for my taste (~4.3% for Dec 22 contracts) plus you also realize gains every so often.

I can't talk much about LETFs. I used to dislike them but Uncorrelated has changed my views here. I don't like that they're a bit opaque. I've heard stories of trading desks front running the end-of-day rebalancing they perform for instance. I also have some concerns in terms of counterparty risk of the swaps. I generally feel safer being the one that handles the derivatives. I'd say, if you feel comfortable with them, you could use them, they're definitely the easiest!

Just my 2 cents.
To add a data point for leveraging up the tax-advantaged space. I've thought about the synthetic long approach with buying the call in IRA and selling the put in taxable (because I can't sell naked put in IRA).

After counting paying STCG tax on the put side as part of the effective borrowing rate, the rate for SPY option is optimal at around 2/3 to 3/4 strike/spot ratio (deep ITM), which is 3% at the moment (for my tax situation).

Comparing with ATM synthetic long, it has some vega exposure but shouldn't be an issue if you hold it close to expiration and give up the time value. Also there are fewer things to worry about for the put side (?).

But the implied borrowing rate is around 1% now for futures, so 3% is too much. It seems futures/L-ETFs are still the way to go. I've never used futures before -- wouldn't you spend extra time monitoring the market for future's risk management?
This is awesome idea to lever up tax advantage space. Does this kind of buy call in Roth , sell put in taxable create a wash sale
sharukh
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Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

sharukh wrote: Tue Dec 21, 2021 5:11 pm
YearTrader wrote: Mon Dec 28, 2020 7:16 am
Steve Reading wrote: Fri Aug 28, 2020 9:05 pm ...

For tax-advantaged accounts, just use futures. They're actually pretty easy to use and there's no cash drag any more since interest rates are ~0% any ways.

If taxable, I would recommend IBKR margin. You can sell an SPX box to get even lower financing but you don't have to. You can keep things super simple with just margin. The rates are great already.

I don't like using spreads or synthetic longs with options in taxable because you will have to realize the gains. I did it before but have learned :happy Either way, setting up various spreads probably is more work than just margin.

I don't like long calls only at the moment. The implied rates appear too pricey for my taste (~4.3% for Dec 22 contracts) plus you also realize gains every so often.

I can't talk much about LETFs. I used to dislike them but Uncorrelated has changed my views here. I don't like that they're a bit opaque. I've heard stories of trading desks front running the end-of-day rebalancing they perform for instance. I also have some concerns in terms of counterparty risk of the swaps. I generally feel safer being the one that handles the derivatives. I'd say, if you feel comfortable with them, you could use them, they're definitely the easiest!

Just my 2 cents.
To add a data point for leveraging up the tax-advantaged space. I've thought about the synthetic long approach with buying the call in IRA and selling the put in taxable (because I can't sell naked put in IRA).

After counting paying STCG tax on the put side as part of the effective borrowing rate, the rate for SPY option is optimal at around 2/3 to 3/4 strike/spot ratio (deep ITM), which is 3% at the moment (for my tax situation).

Comparing with ATM synthetic long, it has some vega exposure but shouldn't be an issue if you hold it close to expiration and give up the time value. Also there are fewer things to worry about for the put side (?).

But the implied borrowing rate is around 1% now for futures, so 3% is too much. It seems futures/L-ETFs are still the way to go. I've never used futures before -- wouldn't you spend extra time monitoring the market for future's risk management?
This is awesome idea to lever up tax advantage space. Does this kind of buy call in Roth , sell put in taxable create a wash sale
I simply took the route of futures in IRA
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

Naris wrote: Sat Aug 10, 2019 4:11 pm This has been a very interesting thread -- thanks 305pelusa. I've found your explanations quite clear, and the ideas are very thought provoking. For what it's worth, I also appreciate how patient and thorough you have been in responding to questions / criticisms.

Personally, I was already at 100% stocks in my investment account, along with a degree of leverage (not prepaying low interest rate student loans, not prepaying a mortgage). I had already figured that if stocks did poorly over the next couple years and I came out behind on the money that I could have allocated toward prepaying student loans, then that would mean my other baseline stock purchases would have been made more cheaply. My big concern from a stock market performance perspective has been, and remains, the possibility that stocks will perform quite well for the next 5-10+ years, followed by lengthy underperformance. Even if the aggregate returns end up being pretty typical, the sequencing could hurt.

I haven't seen much discussion of sequence of returns risk for accumulators before, so I've especially enjoyed the way you've framed the discussion.

I'll make substantive point: I think people are underselling how profitable leveraging 0% intro APR credit cards can be. I have personally pulled out in excess of $50,000 from 0% intro APR credit cards (~15month term) at an effective origination fee of approximately 50 basis points. This is the cheapest debt I can find anywhere by a substantial amount. Using a 0% intro APR credit card to pay your baseline living expenses certainly can work, but there are much better alternatives.

For instance, if you have a HELOC, you can send a payment using Plastiq from a Mastercard credit card (e.g. the Citi DoubleCash) to your HELOC, pull the money from the HELOC shortly before the Plastiq payment arrives (to minimize interest), then balance transfer the money from the original card to a Chase Slate credit card. If you have high enough limits with Chase (which Chase allows you to freely shift between your cards at Chase), you can push $30,000 onto the Chase Slate card at a net cost of 0.5% (2.5% Plastiq fee less the 2% cash back on the Citi DoubleCash).

I think there are potentially even better options, such as using 0% intro APR cards to overpay taxes, but I haven't personally used those methods. I have personally used the method outlined above and confirmed that it really does work. Suffice it to say, it is possible to obtain mid-five figures in 0% intro APR credit card balances at extremely minimal costs. I believe this should also be relatively repeatable, albeit you have to be able to cash flow the payoffs in between initiating each round (another place where a HELOC can come in handy).
Hi Naris,

When balance is transferred from citi double cash back to chase slate, wont chase slate charge 3% balance transfer fee ?
I saw today chase slate edge, it charges 3% fee.
vpiguy88
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Re: Lifecycle Investing - Leveraging when young

Post by vpiguy88 »

What are the most efficient ways people have found to leverage funds outside of S&P500, especially international? Futures are really only available for S&P500, and it doesn't look like LETFs work well for Developed or Emerging markets. From my understanding this leaves LEAPs (available for EFA & EEM) or margin.

LEAPs look expensive on EFA & EEM due to their dividend yield, and margin runs into other tax-drag issues because of cash-in-lieu of dividends (which it looks like box spreads can't help avoid).

Leverage on S&P500 seems super easy, with many ways to do it, and bonds can be done with futures without much trouble, but I'm trying to find a somewhat tax efficient way to do it with international and/or factor funds. Any suggestions here other than just straight margin?
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
daze
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Re: Lifecycle Investing - Leveraging when young

Post by daze »

comeinvest wrote: Fri Jan 14, 2022 1:19 am There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

vpiguy88 wrote: Tue Jan 11, 2022 6:01 pm What are the most efficient ways people have found to leverage funds outside of S&P500, especially international? Futures are really only available for S&P500, and it doesn't look like LETFs work well for Developed or Emerging markets. From my understanding this leaves LEAPs (available for EFA & EEM) or margin.

LEAPs look expensive on EFA & EEM due to their dividend yield, and margin runs into other tax-drag issues because of cash-in-lieu of dividends (which it looks like box spreads can't help avoid).

Leverage on S&P500 seems super easy, with many ways to do it, and bonds can be done with futures without much trouble, but I'm trying to find a somewhat tax efficient way to do it with international and/or factor funds. Any suggestions here other than just straight margin?
Usually only S&P500 is needed. For example with 100k you could buy 70k of VXUS and 6 MES. That would be a 2x leveraged 65/35 domestic/intl portfolio.

Or if using LETFs, 50k VXUS + 50k UPRO = 2x leveraged 75/25 portfolio.

Unless > 2x leverage, or >40% international exposure is desired (neither of which would I recommend), S&P500 leverage is usually sufficient.
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

daze wrote: Mon Jan 24, 2022 12:27 am
comeinvest wrote: Fri Jan 14, 2022 1:19 am There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
I think Nikkei is the most liquid. I don't know what's the benefit or drawback of a price weighted index, but I would think it's a benefit if anything, isn't it? Less weight to the mega caps, less concentration, slight smaller cap tilt?
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Re: Lifecycle Investing - Leveraging when young

Post by cos »

comeinvest wrote: Mon Jan 24, 2022 7:32 pm
daze wrote: Mon Jan 24, 2022 12:27 am
comeinvest wrote: Fri Jan 14, 2022 1:19 am There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
I think Nikkei is the most liquid. I don't know what's the benefit or drawback of a price weighted index, but I would think it's a benefit if anything, isn't it? Less weight to the mega caps, less concentration, slight smaller cap tilt?
This is something I've been struggling with in my own portfolio. I'm very tempted to switch from leveraging the S&P 500 to leveraging the Dow Jones Industrial Average due to its reduced sector concentration, reduced volatility, and increased tilt to value, profitability, and investment. In your opinion, does it make more sense to leverage the DJIA instead of the S&P 500?

What's kept me from pulling the trigger is the fact that the DJIA invests in just 30 companies and there is no published, transparent methodology for inclusion. I worry that these facts introduce too much idiosyncratic risk. Do you think these concerns are immaterial?
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

skierincolorado wrote: Mon Jan 24, 2022 12:54 am
vpiguy88 wrote: Tue Jan 11, 2022 6:01 pm What are the most efficient ways people have found to leverage funds outside of S&P500, especially international? Futures are really only available for S&P500, and it doesn't look like LETFs work well for Developed or Emerging markets. From my understanding this leaves LEAPs (available for EFA & EEM) or margin.

LEAPs look expensive on EFA & EEM due to their dividend yield, and margin runs into other tax-drag issues because of cash-in-lieu of dividends (which it looks like box spreads can't help avoid).

Leverage on S&P500 seems super easy, with many ways to do it, and bonds can be done with futures without much trouble, but I'm trying to find a somewhat tax efficient way to do it with international and/or factor funds. Any suggestions here other than just straight margin?
Usually only S&P500 is needed. For example with 100k you could buy 70k of VXUS and 6 MES. That would be a 2x leveraged 65/35 domestic/intl portfolio.

Or if using LETFs, 50k VXUS + 50k UPRO = 2x leveraged 75/25 portfolio.

Unless > 2x leverage, or >40% international exposure is desired (neither of which would I recommend), S&P500 leverage is usually sufficient.
Wouldn't you need a lot more cash margin to hold this in Roth? Is below correct?

For example if 100k was used to buy 70k of VXUS and 6 MES (30k).
- 1.1% drop - one MES force liquidated
- 5.1% drop - two MES force liquidated
- 8.7% drop - three MES force liquidated

For 6 MES - need > $40k to get through a 10% drop without liquidation and $52k to survive 20% drop.

If the this was bought on Jan 4th, 2-3 MES would have been liquidated.

What do folks who hold MES in IRA do?
No individual stocks.
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

impatientInv wrote: Mon Jan 24, 2022 10:06 pm
skierincolorado wrote: Mon Jan 24, 2022 12:54 am
vpiguy88 wrote: Tue Jan 11, 2022 6:01 pm What are the most efficient ways people have found to leverage funds outside of S&P500, especially international? Futures are really only available for S&P500, and it doesn't look like LETFs work well for Developed or Emerging markets. From my understanding this leaves LEAPs (available for EFA & EEM) or margin.

LEAPs look expensive on EFA & EEM due to their dividend yield, and margin runs into other tax-drag issues because of cash-in-lieu of dividends (which it looks like box spreads can't help avoid).

Leverage on S&P500 seems super easy, with many ways to do it, and bonds can be done with futures without much trouble, but I'm trying to find a somewhat tax efficient way to do it with international and/or factor funds. Any suggestions here other than just straight margin?
Usually only S&P500 is needed. For example with 100k you could buy 70k of VXUS and 6 MES. That would be a 2x leveraged 65/35 domestic/intl portfolio.

Or if using LETFs, 50k VXUS + 50k UPRO = 2x leveraged 75/25 portfolio.

Unless > 2x leverage, or >40% international exposure is desired (neither of which would I recommend), S&P500 leverage is usually sufficient.
Wouldn't you need a lot more cash margin to hold this in Roth? Is below correct?

For example if 100k was used to buy 70k of VXUS and 6 MES (30k).
- 1.1% drop - one MES force liquidated
- 5.1% drop - two MES force liquidated
- 8.7% drop - three MES force liquidated

For 6 MES - need > $40k to get through a 10% drop without liquidation and $52k to survive 20% drop.

If the this was bought on Jan 4th, 2-3 MES would have been liquidated.

What do folks who hold MES in IRA do?
I don't think that's correct. Each mes requires 4.2k. 6 mes requires 25.2k. There is 4.8k to spare. Which is 3.7% of 130k.

If the market dropped 3.7%, you would have 125k of mes exposure and 68.5k of intl exposure. You are now 35.5% intl which is above target. Instead of selling the mes you could sell 1k of vxus to get back to target. Or 2 or 3k would be close enough too and give more buffer.

The example is probably too close to margin call you are right, even though I think your math was off slightly. So maintaining 2x in an ira might be tough. But 1.5 or 1.8x shouldn't be a problem. One could still do 2x leverage if the international target was 25-30% instead of 35%. At 25% you would have 50k of capital for 7 mes, which is 21k to spare.

Or for 35% intl with 1.8x leverage you would do 5 mes and 63k of vxus and 5k vti. That's 32k of cash for 5 mes which is 11k to spare. If the market dropped the vti would be sold to maintain the cash buffer while also maintaining the leverage and international targets.
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

cos wrote: Mon Jan 24, 2022 8:09 pm
comeinvest wrote: Mon Jan 24, 2022 7:32 pm
daze wrote: Mon Jan 24, 2022 12:27 am
comeinvest wrote: Fri Jan 14, 2022 1:19 am There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
I think Nikkei is the most liquid. I don't know what's the benefit or drawback of a price weighted index, but I would think it's a benefit if anything, isn't it? Less weight to the mega caps, less concentration, slight smaller cap tilt?
This is something I've been struggling with in my own portfolio. I'm very tempted to switch from leveraging the S&P 500 to leveraging the Dow Jones Industrial Average due to its reduced sector concentration, reduced volatility, and increased tilt to value, profitability, and investment. In your opinion, does it make more sense to leverage the DJIA instead of the S&P 500?

What's kept me from pulling the trigger is the fact that the DJIA invests in just 30 companies and there is no published, transparent methodology for inclusion. I worry that these facts introduce too much idiosyncratic risk. Do you think these concerns are immaterial?
I didn't look into the DJIA yet, but what you are describing sounds like benefits to me, not drawbacks. Including the intransparent methodology, if it means that it might have less frontrunning. I personally have only international equity index futures currently. (Don't ask me why; the reasons are partly historical as I have a huge overweight in international vs domestic, and partly because I think it's more efficient to implement the international equities allocation with futures rather than the domestic, for withholding tax reasons. I use some factor ETFs for domestic equities.)
Booogle
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Re: Lifecycle Investing - Leveraging when young

Post by Booogle »

LGH uses 20% UPRO/SPXL.

Destroys both NTSX and S&P 500.

It is extremely tax efficient as well:

https://screener.fidelity.com/ftgw/etf/ ... ymbols=LGH
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Re: Lifecycle Investing - Leveraging when young

Post by Park »

"But, you might ask, didn’t leveraging at 2:1 “margin out” during the catastrophic three-year bear market from 1929 to 1932 or even in the 2007–2009 one, which saw a loss of more than 50%? No. The constant stream of contributions prevented prevented younger investors from being sold out, while older ones had by that point eliminated their leverage. During severe bear markets, as the authors point out, investors who are leveraged but young will lose “a large percentage of a small amount"

Bernstein, William J. The Ages of the Investor: A Critical Look at Life-cycle Investing (Investing for Adults Book 1) . Efficient Frontier Publications. Kindle Edition.

The peak US unemployment rate in the Depression was 24.9%. If you were one of the 24.9%, would you have been able to continue contributions?
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Re: Lifecycle Investing - Leveraging when young

Post by cos »

comeinvest wrote: Wed Jan 26, 2022 3:06 am
cos wrote: Mon Jan 24, 2022 8:09 pm
comeinvest wrote: Mon Jan 24, 2022 7:32 pm
daze wrote: Mon Jan 24, 2022 12:27 am
comeinvest wrote: Fri Jan 14, 2022 1:19 am There are many equity index futures worldwide, which you can access through many futures brokers, or Interactive Brokers. I use Stoxx Europe 600, Nikkei 225, and the MSCI Emerging Market futures.
Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
I think Nikkei is the most liquid. I don't know what's the benefit or drawback of a price weighted index, but I would think it's a benefit if anything, isn't it? Less weight to the mega caps, less concentration, slight smaller cap tilt?
This is something I've been struggling with in my own portfolio. I'm very tempted to switch from leveraging the S&P 500 to leveraging the Dow Jones Industrial Average due to its reduced sector concentration, reduced volatility, and increased tilt to value, profitability, and investment. In your opinion, does it make more sense to leverage the DJIA instead of the S&P 500?

What's kept me from pulling the trigger is the fact that the DJIA invests in just 30 companies and there is no published, transparent methodology for inclusion. I worry that these facts introduce too much idiosyncratic risk. Do you think these concerns are immaterial?
I didn't look into the DJIA yet, but what you are describing sounds like benefits to me, not drawbacks. Including the intransparent methodology, if it means that it might have less frontrunning. I personally have only international equity index futures currently. (Don't ask me why; the reasons are partly historical as I have a huge overweight in international vs domestic, and partly because I think it's more efficient to implement the international equities allocation with futures rather than the domestic, for withholding tax reasons. I use some factor ETFs for domestic equities.)
The DJIA's concentration in a mere 30 companies doesn't concern you? I fear that it introduces too much idiosyncratic risk. Also, I agree with you that the DJIA's opaque inclusion methodology mitigates frontrunning, but it also makes it very difficult to know with any amount of certainty what the factor characteristics of the index might look like in the future.
comeinvest
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Re: Lifecycle Investing - Leveraging when young

Post by comeinvest »

cos wrote: Wed Jan 26, 2022 2:40 pm
comeinvest wrote: Wed Jan 26, 2022 3:06 am
cos wrote: Mon Jan 24, 2022 8:09 pm
comeinvest wrote: Mon Jan 24, 2022 7:32 pm
daze wrote: Mon Jan 24, 2022 12:27 am

Nikkei 225 is a price weighted index. Alternatively, may consider TOPIX, which is cap weighted.
I think Nikkei is the most liquid. I don't know what's the benefit or drawback of a price weighted index, but I would think it's a benefit if anything, isn't it? Less weight to the mega caps, less concentration, slight smaller cap tilt?
This is something I've been struggling with in my own portfolio. I'm very tempted to switch from leveraging the S&P 500 to leveraging the Dow Jones Industrial Average due to its reduced sector concentration, reduced volatility, and increased tilt to value, profitability, and investment. In your opinion, does it make more sense to leverage the DJIA instead of the S&P 500?

What's kept me from pulling the trigger is the fact that the DJIA invests in just 30 companies and there is no published, transparent methodology for inclusion. I worry that these facts introduce too much idiosyncratic risk. Do you think these concerns are immaterial?
I didn't look into the DJIA yet, but what you are describing sounds like benefits to me, not drawbacks. Including the intransparent methodology, if it means that it might have less frontrunning. I personally have only international equity index futures currently. (Don't ask me why; the reasons are partly historical as I have a huge overweight in international vs domestic, and partly because I think it's more efficient to implement the international equities allocation with futures rather than the domestic, for withholding tax reasons. I use some factor ETFs for domestic equities.)
The DJIA's concentration in a mere 30 companies doesn't concern you? I fear that it introduces too much idiosyncratic risk. Also, I agree with you that the DJIA's opaque inclusion methodology mitigates frontrunning, but it also makes it very difficult to know with any amount of certainty what the factor characteristics of the index might look like in the future.
I personally would relax regarding future factor tilts, or any similar over-reverse-engineering efforts. It will be whatever it will be, and the upside or downside risks are symmetrical.
Regarding concentration risk: https://www.vanguardinvestments.dk/docu ... eturns.pdf
I look at figure 5 and figure 7.
I would prefer a minimum of 50-100 stocks in the long run on a grand total portfolio level, not 30. But the Dow would not be my only equity index futures contract. I would combine it with e.g. the S&P 500 and international indexes, like Stoxx Europe 600, MSCI Emerging Markets, Nikkei or Topix, to achieve an indirect investment in a few hundred if not a few thousand stocks.
I have not yet really looked at the Dow. If and when the tech bubble / concentration is over, I think it will be more of a wash.
There was also a discussion on this forum a long time ago where it was said that the Dow's performance very accurately tracked that of the S&P in the long run, despite having a lot less stocks.
DesertInvestor
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Re: Lifecycle Investing - Leveraging when young

Post by DesertInvestor »

Steve Reading wrote: Thu Mar 07, 2019 11:26 am
bobcat2 wrote: Thu Mar 07, 2019 10:13 am I would put the percentage of young Americans who can reasonably leverage at less than 1%.
You've said that figure twice. Could you tell me how you're coming up with that estimate? Thank you
So is this some for of DCA advocacy in a way?
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Re: Lifecycle Investing - Leveraging when young

Post by Ben Mathew »

DesertInvestor wrote: Tue Mar 08, 2022 10:00 am So is this some for of DCA advocacy in a way?
No. From the Q&A in the OP:
Steve Reading wrote: Thu Feb 28, 2019 11:11 pm How does this compare to DCA?
Lifecycle Investing is basically the opposite of DCA. See:
viewtopic.php?p=4420588#p4420588
Total Portfolio Allocation and Withdrawal (TPAW)
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

Ben Mathew wrote: Tue Mar 08, 2022 10:20 am
DesertInvestor wrote: Tue Mar 08, 2022 10:00 am So is this some for of DCA advocacy in a way?
No. From the Q&A in the OP:
Steve Reading wrote: Thu Feb 28, 2019 11:11 pm How does this compare to DCA?
Lifecycle Investing is basically the opposite of DCA. See:
viewtopic.php?p=4420588#p4420588
See the Monte Carlo simulations when investing $1,000 every month for 30 years.

Compare 60-40, 100% stock and 180-10 using SSO. (Portfolio visualizer doesn't allow leverage for simulation)

Monte Carlo - 60-40

Monte Carlo - 100% stock

Monte Carlo - 90% SSO - 1.8x leverage

Code: Select all

After 30 years
                             10 percentile - 50 percentile - 90 percentile
Monte Carlo - 60-40              $1.8M     -    $2.9M     -    $4.8M
Monte Carlo - 100% stock         $1.6M     -    $3.9M     -    $8.8M
Monte Carlo - 100% SSO           $1.0M     -    $8.2M     -   $59.8M 
Monte Carlo - 90% SSO           $13.8M     -   $42.6M     -   $70.8M 
(1.8x leverage) also gets rebalancing benefit 
Most of us don't have the stomach for leverage. But if executed well, chance of doing well is high.
No individual stocks.
Dry-Drink
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Re: Lifecycle Investing - Leveraging when young

Post by Dry-Drink »

impatientInv wrote: Tue Mar 08, 2022 4:46 pm
Ben Mathew wrote: Tue Mar 08, 2022 10:20 am
DesertInvestor wrote: Tue Mar 08, 2022 10:00 am So is this some for of DCA advocacy in a way?
No. From the Q&A in the OP:
Steve Reading wrote: Thu Feb 28, 2019 11:11 pm How does this compare to DCA?
Lifecycle Investing is basically the opposite of DCA. See:
viewtopic.php?p=4420588#p4420588
See the Monte Carlo simulations when investing $1,000 every month for 30 years.

Compare 60-40, 100% stock and 180-10 using SSO. (Portfolio visualizer doesn't allow leverage for simulation)

Monte Carlo - 60-40

Monte Carlo - 100% stock

Monte Carlo - 90% SSO - 1.8x leverage

Code: Select all

After 30 years
                             10 percentile - 50 percentile - 90 percentile
Monte Carlo - 60-40              $1.8M     -    $2.9M     -    $4.8M
Monte Carlo - 100% stock         $1.6M     -    $3.9M     -    $8.8M
Monte Carlo - 100% SSO           $1.0M     -    $8.2M     -   $59.8M 
Monte Carlo - 90% SSO           $13.8M     -   $42.6M     -   $70.8M 
(1.8x leverage) also gets rebalancing benefit 
Most of us don't have the stomach for leverage. But if executed well, chance of doing well is high.
No. From the Q&A in the OP:
Steve Reading wrote: Thu Feb 28, 2019 11:11 pm Can I backtest Lifecycle Investing?
Not easily (ex: not with portfolio visualizer). The asset allocation is changing constantly throughout the time period and depends on variables like future savings. You can download the data the Professors used to backtest it however:
http://www.lifecycleinvesting.net/resources.html
jshaffer740
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Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
impatientInv
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Re: Lifecycle Investing - Leveraging when young

Post by impatientInv »

jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
No individual stocks.
jshaffer740
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Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

impatientInv wrote: Sun Mar 20, 2022 9:41 am
jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
Which leaves only LEAPS, I suppose.
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
jshaffer740
Posts: 143
Joined: Mon May 03, 2010 7:21 pm

Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

I know the downsides of using LEAPS for this strategy, but for now I've concluded that's my best "option" in my Roth IRA at Fidelity.

For those of you who've used LEAPS, how do you track your effective leverage? For my ETFs, including those bought on margin, it's easy to track and calculate leverage, using negative cash balances. I have a spreadsheet that tracks this. But I'm having trouble conceptualizing how to record the LEAPS. I can't track the option's price, because that understates my effective exposure to SPY.

Does it makes sense to simply track this trade as if I bought 100 shares of SPY and borrowed an amount equal to the option's price? So, assuming SPY is trading at $446, and I bought a LEAP at $225 strike for $228, my spreadsheet would list $44.6k SPY and -$22.8k cash.

My goal isn't to track things down to the penny. I just want to have a general sense of my overall leverage ratio across my entire portfolio, and I need this trade to factor into that relatively accurately.
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
daze
Posts: 59
Joined: Fri Mar 08, 2019 12:09 am

Re: Lifecycle Investing - Leveraging when young

Post by daze »

jshaffer740 wrote: Fri Apr 08, 2022 9:30 am
Does it makes sense to simply track this trade as if I bought 100 shares of SPY and borrowed an amount equal to the option's price? So, assuming SPY is trading at $446, and I bought a LEAP at $225 strike for $228, my spreadsheet would list $44.6k SPY and -$22.8k cash.
For 100 shares of SPY, instead of paying 44600 right now, you pay 22800 now and 22500 later. And you also forego the dividend.
You might want to list it as 100 shares of SPY and -$22.5k cash, if you don't want to bother to update the loan value.
Or you may list it as 100 shares of SPY and -$21.8k cash (446-228= 218), then update the loan value time to time.
skierincolorado
Posts: 2377
Joined: Sat Mar 21, 2020 10:56 am

Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

jshaffer740 wrote: Thu Apr 07, 2022 6:20 pm
impatientInv wrote: Sun Mar 20, 2022 9:41 am
jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
Which leaves only LEAPS, I suppose.
And LETFs. Several of us in the mHFEA thread use UPRO to some extent in 401ks. Need to be careful to maintain overall target AA and fight the daily rebalance a bit.

If you use LEAPs you should figure out how to calculate the implied financing costs, which run about 3% right now. Which is a bit high for my tastes. A lot of that implied financing is really theta decay which can be recouped with certain complex strategies. Efficient investor has some posts outlining this. I find LETFs simpler.
jshaffer740
Posts: 143
Joined: Mon May 03, 2010 7:21 pm

Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

skierincolorado wrote: Fri Apr 08, 2022 11:37 am
jshaffer740 wrote: Thu Apr 07, 2022 6:20 pm
impatientInv wrote: Sun Mar 20, 2022 9:41 am
jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
Which leaves only LEAPS, I suppose.
And LETFs. Several of us in the mHFEA thread use UPRO to some extent in 401ks. Need to be careful to maintain overall target AA and fight the daily rebalance a bit.

If you use LEAPs you should figure out how to calculate the implied financing costs, which run about 3% right now. Which is a bit high for my tastes. A lot of that implied financing is really theta decay which can be recouped with certain complex strategies. Efficient investor has some posts outlining this. I find LETFs simpler.
Thank you. Yes, I have figured out the implied financing rate for my recent LEAP, which was about 3.2%. It’s definitely more than I pay using box spreads in my taxable account, but there is at least some downside protection in there.

Efficient Investor’s ideas for dealing with the theta decay are interesting, but if I understand them correctly, they involve selling a naked put, which I couldn’t do in a retirement account. (Let me know if I’m wrong about that though. I don’t mind the slightly higher complexity, once I feel comfortable that I understand the strategy.)

As for leveraged ETFs, does the volatility decay / daily rebalancing concern you? Those products really seem ill-suited for longterm investors, but I’m always open to hearing why they might work here. They’re certainly simpler and have lower implied financing rates.
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
jshaffer740
Posts: 143
Joined: Mon May 03, 2010 7:21 pm

Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

daze wrote: Fri Apr 08, 2022 11:28 am
jshaffer740 wrote: Fri Apr 08, 2022 9:30 am
Does it makes sense to simply track this trade as if I bought 100 shares of SPY and borrowed an amount equal to the option's price? So, assuming SPY is trading at $446, and I bought a LEAP at $225 strike for $228, my spreadsheet would list $44.6k SPY and -$22.8k cash.
For 100 shares of SPY, instead of paying 44600 right now, you pay 22800 now and 22500 later. And you also forego the dividend.
You might want to list it as 100 shares of SPY and -$22.5k cash, if you don't want to bother to update the loan value.
Or you may list it as 100 shares of SPY and -$21.8k cash (446-228= 218), then update the loan value time to time.
How does the loan value change over time? Is it right to think of it as the price of the option? That would seem counterintuitive, because as the option value increases, my loan hasn’t increased, has it?
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

jshaffer740 wrote: Fri Apr 08, 2022 12:19 pm
skierincolorado wrote: Fri Apr 08, 2022 11:37 am
jshaffer740 wrote: Thu Apr 07, 2022 6:20 pm
impatientInv wrote: Sun Mar 20, 2022 9:41 am
jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
Which leaves only LEAPS, I suppose.
And LETFs. Several of us in the mHFEA thread use UPRO to some extent in 401ks. Need to be careful to maintain overall target AA and fight the daily rebalance a bit.

If you use LEAPs you should figure out how to calculate the implied financing costs, which run about 3% right now. Which is a bit high for my tastes. A lot of that implied financing is really theta decay which can be recouped with certain complex strategies. Efficient investor has some posts outlining this. I find LETFs simpler.
Thank you. Yes, I have figured out the implied financing rate for my recent LEAP, which was about 3.2%. It’s definitely more than I pay using box spreads in my taxable account, but there is at least some downside protection in there.

Efficient Investor’s ideas for dealing with the theta decay are interesting, but if I understand them correctly, they involve selling a naked put, which I couldn’t do in a retirement account. (Let me know if I’m wrong about that though. I don’t mind the slightly higher complexity, once I feel comfortable that I understand the strategy.)

As for leveraged ETFs, does the volatility decay / daily rebalancing concern you? Those products really seem ill-suited for longterm investors, but I’m always open to hearing why they might work here. They’re certainly simpler and have lower implied financing rates.
I just sell a naked put in taxable account to recoup the theta decay, note the gains from selling naked put will be added to yearly taxable income.
jshaffer740
Posts: 143
Joined: Mon May 03, 2010 7:21 pm

Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

What's the after-tax improvement in implied interest rate using that strategy? I use leverage in my taxable account as well. I'm not sure that the increased risk of a margin call that would come from selling the naked put there would be worth the marginal improvement in implied interest rate. But I might be wrong about that.
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
sharukh
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Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

jshaffer740 wrote: Fri Apr 08, 2022 12:41 pm What's the after-tax improvement in implied interest rate using that strategy? I use leverage in my taxable account as well. I'm not sure that the increased risk of a margin call that would come from selling the naked put there would be worth the marginal improvement in implied interest rate. But I might be wrong about that.
I depends on what your strike price is.
My LEAP strike is 200, so the extra money from selling put is $120
http://opcalc.com/JAr

Small difference in grand scheme of things.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

jshaffer740 wrote: Fri Apr 08, 2022 12:19 pm
skierincolorado wrote: Fri Apr 08, 2022 11:37 am
jshaffer740 wrote: Thu Apr 07, 2022 6:20 pm
impatientInv wrote: Sun Mar 20, 2022 9:41 am
jshaffer740 wrote: Wed Mar 16, 2022 8:24 pm I understand that futures are generally the preference for tax-advantaged accounts. My Roth IRA is at Fidelity, which does not offer futures trading. I could transfer to Interactive Brokers, but I’m happy with Fidelity overall, and so I’d like to stay there if I can manage to.

I use box spreads in my taxable account at Fidelity, which as worked out well. Could I use box spreads to achieve some amount of leverage in my Roth IRA? I’m approved for the requisite level of options trading, as well as for “limited margin.” But since I can’t borrow on margin in an IRA, does that preclude me from using box spreads to finance leverage?
Box spreads don't work in IRAs
Which leaves only LEAPS, I suppose.
And LETFs. Several of us in the mHFEA thread use UPRO to some extent in 401ks. Need to be careful to maintain overall target AA and fight the daily rebalance a bit.

If you use LEAPs you should figure out how to calculate the implied financing costs, which run about 3% right now. Which is a bit high for my tastes. A lot of that implied financing is really theta decay which can be recouped with certain complex strategies. Efficient investor has some posts outlining this. I find LETFs simpler.
Thank you. Yes, I have figured out the implied financing rate for my recent LEAP, which was about 3.2%. It’s definitely more than I pay using box spreads in my taxable account, but there is at least some downside protection in there.

Efficient Investor’s ideas for dealing with the theta decay are interesting, but if I understand them correctly, they involve selling a naked put, which I couldn’t do in a retirement account. (Let me know if I’m wrong about that though. I don’t mind the slightly higher complexity, once I feel comfortable that I understand the strategy.)

As for leveraged ETFs, does the volatility decay / daily rebalancing concern you? Those products really seem ill-suited for longterm investors, but I’m always open to hearing why they might work here. They’re certainly simpler and have lower implied financing rates.
You're right selling puts to stay theta neutral wouldn't be possible in a 401k or ira.

I'm not that concerned about volatility decay. All forms of leverage require rebalancing, and if using a lot of leverage all strategies may require selling shares at low prices, and there is nothing particularly different about daily rebalancing of target leverage vs monthly, quarterly, or bands. In some ways it is a benefit because the fund always keeps you at your target leverage ratio. If I was using margin and targeting 2x leverage, I would need to rebalance and sell shares when the market goes down probably using 5% bands. Or I can let SSO do it for me. Of course UPRO plus VOO is cheaper than SSO.

All forms of leverage rebalancing underperform in sideways volatile markets but vastly outperform in low volatility long bull markets. You can reduce your risk of volatility decay by reducing how much your leverage rebalances. If you use margin, you could start at a modest 1.4x leverage and then simply not rebalance, although in a severe downturn your leverage could exceed 2x. In 1929 you would might have been forced to sell shares eventually. In 2009 your leverage would peak at 2.4x briefly.

If using LETF you can fight the volatility decay by trying to maintain constant exposure to the same number of unferlying shares of SPY. For example, targeting 1.67x with VOO and UPRO. Start with 67k VOO and 33k UPRO. That's 371 shares of SPY. If the market drops 10%, you would have 60k VOO and 23k of UPRO. Which would be 318 shares or SPY. You would need to sell VOO and buy UPRO to get back to 371 shares. If you maintain the same number of shares, there is no volatility decay. In a major downturn your leverage would get out of hand if starting from 1.67x. You could start from 1.3 or 1.4x though.

Or you can do something in-between which is what I do. I don't quite keep the same number of shares, but I do allow my leverage to creep up when the market goes down. This reduces volatility decay but doesn't eliminate it. But also allows me to start from higher leverage than I would if I was determined never to sell any shares.

So in order of most volatility decay to no volatility decay:

1) own voo and upro but don't rebalance. Don't do this, you will get excessive volatility decay as your leverage ratio actually drops in market downturns.

2) maintain fixed leverage ratio. For example sso, ntsx. Or own voo and upro and manage to target a fixed ratio like 1.5x. Or use margin and maintain a fixed leverage ratio by selling shares in market downturns.

3) maintain fixed number of SPY shares. For example, using LEAPs. Or MES futures. Or broker margin without selling in market downturns. Or by owning voo and upro and rebalancing into upro in market downturns such that fixed exposure to a number of SPY shars is maintained.

4) attempt to market time by increasing number of SPY shares in market downturns



I do a combination of 2 and 3. Closer to 3. Also overlayed with contributions.
Last edited by skierincolorado on Fri Apr 08, 2022 2:36 pm, edited 1 time in total.
jshaffer740
Posts: 143
Joined: Mon May 03, 2010 7:21 pm

Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

That’s all very interesting and helpful. When you lay it out that way, I guess there is something appealing about the simplicity of LEAPS. They achieve #3 on your list (which I’m most partial to) in about as simple a way as possible.

While cheaper, the URPO / VOO strategy seems like it would take materially more time and oversight to manage, compared to just buying the LEAPS. There’s also more room for behavioral error (or just plain error) it seems. I’d suspect that there are certain transaction costs eating into the cost savings. And then you have to consider the expense ratio as part of the implied financing rate.

Still, I’m certain that LETFs are cheaper. I guess I have to decide whether the cheaper leverage is worth those other tradeoffs.
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

jshaffer740 wrote: Fri Apr 08, 2022 2:01 pm That’s all very interesting and helpful. When you lay it out that way, I guess there is something appealing about the simplicity of LEAPS. They achieve #3 on your list (which I’m most partial to) in about as simple a way as possible.

While cheaper, the URPO / VOO strategy seems like it would take materially more time and oversight to manage, compared to just buying the LEAPS. There’s also more room for behavioral error (or just plain error) it seems. I’d suspect that there are certain transaction costs eating into the cost savings. And then you have to consider the expense ratio as part of the implied financing rate.

Still, I’m certain that LETFs are cheaper. I guess I have to decide whether the cheaper leverage is worth those other tradeoffs.
Given I expect equity returns to be substantially lower going forward, I see 3% implied financing costs above TBill rate to be prohibitive. If equity returns the next 20 years are 5%, then using LEAPS I would get 1.02^20 or 50% returns. Using LETF managed to maintain the same exposure as if I owned LEAPs, I get 1.05^20 or 160% returns.

50% return vs 160% returns.

It might be possible to come up with a strategy where you harvest theta in market downturns. But I have yet to really think that through and don't know how to test it. If the next decade has low volatility youd never get to harvest the theta and would be locked into paying 3% for essentially nothing. If there is a major downturn, you could sell your LEAPs and then buy the same exposure with a lower strike price and higher delta.
Last edited by skierincolorado on Fri Apr 08, 2022 2:15 pm, edited 1 time in total.
jshaffer740
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Re: Lifecycle Investing - Leveraging when young

Post by jshaffer740 »

skierincolorado wrote: Fri Apr 08, 2022 2:07 pm
jshaffer740 wrote: Fri Apr 08, 2022 2:01 pm That’s all very interesting and helpful. When you lay it out that way, I guess there is something appealing about the simplicity of LEAPS. They achieve #3 on your list (which I’m most partial to) in about as simple a way as possible.

While cheaper, the URPO / VOO strategy seems like it would take materially more time and oversight to manage, compared to just buying the LEAPS. There’s also more room for behavioral error (or just plain error) it seems. I’d suspect that there are certain transaction costs eating into the cost savings. And then you have to consider the expense ratio as part of the implied financing rate.

Still, I’m certain that LETFs are cheaper. I guess I have to decide whether the cheaper leverage is worth those other tradeoffs.
Given I expect equity returns to be substantially lower going forward, I see 3% implied financing costs above TBill rate to be prohibitive. If equity returns the next 20 years are 5%, then using LEAPS I would get 1.02^20 or 50% returns. Using LETF managed to maintain the same exposure as if I owned LEAPs, I get 1.05^20 or 160% returns.

50% return vs 160% returns.

It might be possible to come up with a strategy where you harvest theta in market downturns. But I have yet to really think that through and don't know how to test it. If the next decade has low volatility youd never get to harvest the theta and would be locked into paying 3% for essentially nothing.
That makes sense. I guess I’m trying to understand the catch. You seem to be describing a free lunch—identical exposure, higher returns. If we assume market prices are rational, what explains the difference?
1.5x leverage | 45% market-cap [VTI, VEA, VWO] + 45% factor tilted [AVUV, AVDV, AVES] + 10% trend following [KMLM, DBMF]
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

jshaffer740 wrote: Fri Apr 08, 2022 2:13 pm
skierincolorado wrote: Fri Apr 08, 2022 2:07 pm
jshaffer740 wrote: Fri Apr 08, 2022 2:01 pm That’s all very interesting and helpful. When you lay it out that way, I guess there is something appealing about the simplicity of LEAPS. They achieve #3 on your list (which I’m most partial to) in about as simple a way as possible.

While cheaper, the URPO / VOO strategy seems like it would take materially more time and oversight to manage, compared to just buying the LEAPS. There’s also more room for behavioral error (or just plain error) it seems. I’d suspect that there are certain transaction costs eating into the cost savings. And then you have to consider the expense ratio as part of the implied financing rate.

Still, I’m certain that LETFs are cheaper. I guess I have to decide whether the cheaper leverage is worth those other tradeoffs.
Given I expect equity returns to be substantially lower going forward, I see 3% implied financing costs above TBill rate to be prohibitive. If equity returns the next 20 years are 5%, then using LEAPS I would get 1.02^20 or 50% returns. Using LETF managed to maintain the same exposure as if I owned LEAPs, I get 1.05^20 or 160% returns.

50% return vs 160% returns.

It might be possible to come up with a strategy where you harvest theta in market downturns. But I have yet to really think that through and don't know how to test it. If the next decade has low volatility youd never get to harvest the theta and would be locked into paying 3% for essentially nothing.
That makes sense. I guess I’m trying to understand the catch. You seem to be describing a free lunch—identical exposure, higher returns. If we assume market prices are rational, what explains the difference?
Well the benefit of the LEAPS would be if there was a market crash. You wouldn't lose as much. With the LETF you might not be able to maintain the same number of SPY shares depending on how much leverage you started with. So you could start with more leverage with the LEAPs because you have downside protection. Or you could harvest the theta of your LEAPs during a market crash to buy more SPY share exposure than you would have been able to get with LEtFs for the same leverage ratio.

You are right there is no free lunch and there are pros and cons. I do own some of both. The LETF will do better in an up market because I always have delta of 1 and didnt have to pay 3% extra for downside protection. The LEAPs will do better in a crash because the delta falls less than 1. The performance of the LEAPs relative to the LETF seems highly dependent on the price when I roll the option. If I never roll my options in a market downturns. I will never get a benefit.

So far the LEAP I own has nor been of any benefit. I paid 3% for downside protection I have not used. If I had bought it closer to the market peak, it might have helped a little last month, but maybe not enough to make a difference.

I don't find owning LETF to be complicated. Owned in combination with other forms of leverage like margin box spreads, futures, and LEAPs I find my leverage stays right where I want it. I have not had to rebalance at all in the last year. My leverage goes up somewhat in market downturns, consistent with my plan to maintain near constant number of share exposure. The LETFs do sell some shares on my behalf which keeps the leverage ratio from spiking out of control and keeps me somewhere between number 2 and 3 described above. Closer to 3 since I don't own that much letf. Since I'm closer to 3, my leverage is modest at 1.35x
Last edited by skierincolorado on Fri Apr 08, 2022 2:41 pm, edited 1 time in total.
skierincolorado
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Re: Lifecycle Investing - Leveraging when young

Post by skierincolorado »

jshaffer740 wrote: Fri Apr 08, 2022 2:13 pm
skierincolorado wrote: Fri Apr 08, 2022 2:07 pm
jshaffer740 wrote: Fri Apr 08, 2022 2:01 pm That’s all very interesting and helpful. When you lay it out that way, I guess there is something appealing about the simplicity of LEAPS. They achieve #3 on your list (which I’m most partial to) in about as simple a way as possible.

While cheaper, the URPO / VOO strategy seems like it would take materially more time and oversight to manage, compared to just buying the LEAPS. There’s also more room for behavioral error (or just plain error) it seems. I’d suspect that there are certain transaction costs eating into the cost savings. And then you have to consider the expense ratio as part of the implied financing rate.

Still, I’m certain that LETFs are cheaper. I guess I have to decide whether the cheaper leverage is worth those other tradeoffs.
Given I expect equity returns to be substantially lower going forward, I see 3% implied financing costs above TBill rate to be prohibitive. If equity returns the next 20 years are 5%, then using LEAPS I would get 1.02^20 or 50% returns. Using LETF managed to maintain the same exposure as if I owned LEAPs, I get 1.05^20 or 160% returns.

50% return vs 160% returns.

It might be possible to come up with a strategy where you harvest theta in market downturns. But I have yet to really think that through and don't know how to test it. If the next decade has low volatility youd never get to harvest the theta and would be locked into paying 3% for essentially nothing.
That makes sense. I guess I’m trying to understand the catch. You seem to be describing a free lunch—identical exposure, higher returns. If we assume market prices are rational, what explains the difference?
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.
daze
Posts: 59
Joined: Fri Mar 08, 2019 12:09 am

Re: Lifecycle Investing - Leveraging when young

Post by daze »

jshaffer740 wrote: Fri Apr 08, 2022 12:21 pm
How does the loan value change over time? Is it right to think of it as the price of the option? That would seem counterintuitive, because as the option value increases, my loan hasn’t increased, has it?
Consider put-call parity:
C = S -PV(K) - PV(dividend) + P
We can rearrange it as :
C = S - [ PV(K) + PV(dividend) - P ]
Therefore, your loan value would be
PV(K) + PV(dividend) - P

When call option value increases (due to stock price increasing), generally speaking, put option value decreases, but less significantly since the put is deep-out-of-the-money. So your loan value only increases mildly.
PV(K) = K*e^(-rt). When time pass, t decreases and PV(K) increases and approaches to K.
PV(dividend) also increases over time, but decreases when dividend is paid. It goes to zero when all dividends before expiration date are paid.

Another way to rearrange it:
[ PV(K) + PV(dividend) - P ] = S - C
You could update it now and then by looking up today's stock price and call price.

Otherwise, if you only want a ballpark number, just use K as your loan value estimation and call it a day.
mikail15297
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Re: Lifecycle Investing - Leveraging when young

Post by mikail15297 »

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?
sharukh
Posts: 634
Joined: Mon Jun 20, 2016 10:19 am

Re: Lifecycle Investing - Leveraging when young

Post by sharukh »

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
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