Leveraged PP?

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frugal
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Re: Leveraged PP?

Post by frugal » Sun Nov 11, 2012 4:09 pm

melveyr wrote: I second everything that Pointedstick just said. There is leverage embedded in the market closer to the risk-free rate than you will be able to get on your own. Grab that first before turning to margin.

1) Remove Cash
2) Use 30 year STRIPs
3) Use SCV and EM for equities

None of this is a financial recommendation of course, but this would be the order of operations I would use.
Do you put ALL your savings in PP?
What means point 2)

Thank you
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Re: Leveraged PP?

Post by melveyr » Sun Nov 11, 2012 4:17 pm

frugal wrote:
melveyr wrote: I second everything that Pointedstick just said. There is leverage embedded in the market closer to the risk-free rate than you will be able to get on your own. Grab that first before turning to margin.

1) Remove Cash
2) Use 30 year STRIPs
3) Use SCV and EM for equities

None of this is a financial recommendation of course, but this would be the order of operations I would use.
Do you put ALL your savings in PP?
What means point 2)

Thank you
If I were running a leveraged PP I would have a small emergency fund that was separate from the PP.

A STRIPs is a Treasury with the coupon payments stripped away. The only thing getting discounted back to today is the principal payment. This means that a 30 year STRIP has a duration of 30, whereas a normal 30 year treasury with the coupon payments would have duration of around 25 or so.

A STRIP is more volatile, giving you more leverage than a regular 30 year bond, which means you could hold less of it and more equities while still being at risk parity (the PP is basically just a risk parity strategy that is easy enough for retail investors to implement).
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Re: Leveraged PP?

Post by Pointedstick » Sun Nov 11, 2012 4:19 pm

frugal wrote:
Pointedstick wrote: And Frugal, margin is NOT the "only way to increase the turnover of this small risk and small return PP". You can loosen your rebalance bands. You can use pseudo-leverage by swapping your 30-year bonds with zeroes and total market fund for an SCV fund. You can reduce or remove the cash allocation, or replace it with higher-yield commercial paper (i.e. online savings account or a "total return" fund). You can replace both cash and LTTs with a 50% exposure to moderate-duration bonds (4-7 yrs). You can arbitrage between GLD and GTU with your gold allocation. Juicing returns is dangerous, but if you must do it, there are far safer, saner ways to do it than investing with borrowed money.
where can I read more about this idea?
Or can you explain please.
Regards
You just read about it.  ;)

But to expand a but further, the idea is to magnify volatility inside the portfolio without using leverage or fundamentally altering what makes it a permanent portfolio. The portfolio works because the individual assets are volatile, smoothing each other out in the aggregate due to the closed nature of macro capital flows (one trader's sale of gold is another's purchase of it, for example, and you always hold some of whatever asset people are falling all over themselves to buy). You can increase the average return by substituting the individual assets with more volatile versions of themselves.

For example, zero-coupon bonds are basically more volatile versions of 30 year treasuries. Small-cap value funds are more volatile than the broad market. Gold is hard to increase in volatility without resorting to a levered ETF, but it's already the most volatile asset, and you can do some simple and safe arbitrage by investing in the GTU fund in addition to another gold ETF, which is a closed-end fund, so it often trades at a premium or discount. The idea there is that you buy some when its trading at a discount relative to the other fund, and sell some when it's trading at a premium. Cash exists mostly to smooth the portfolio out since the situations where it is the most popular asset are less frequent, so you can put your cash in a high-yield savings account or shorter-duration "total return" fund rather than T-bills, or even get rid of it entirely if you're feeling brave! Getting rid of cash is dangerous though, as you can get destroyed during tight-money recessions, and times when interest rates are slowly rising but remain strongly positive in real terms (your bonds and gold will get clobbered, and will collectively fall faster than your stocks can save you). Another option is to replace both the bonds and cash with a single 50% allocation of moderate-duration bonds, which pack more punch than cash, but less than long bonds.

frugal wrote:
melveyr wrote: I second everything that Pointedstick just said. There is leverage embedded in the market closer to the risk-free rate than you will be able to get on your own. Grab that first before turning to margin.

1) Remove Cash
2) Use 30 year STRIPs
3) Use SCV and EM for equities

None of this is a financial recommendation of course, but this would be the order of operations I would use.
Do you put ALL your savings in PP?
What means point 2)

Thank you
Harry Browne said to put the money you can't afford to lose in your PP. I have cash in checking and savings account that are for short-term uses, but all my truly indispensable money is in a PP of some sort (I maintain three separate ones with different funds, bonds, and brokerages)

30-year STRIPS = zero coupon bond. You should at a minimum learn what all these things are before you even THINK about using leverage. I do not want to see you destroy yourself like poor Market Timer did!
Last edited by Pointedstick on Sun Nov 11, 2012 4:31 pm, edited 1 time in total.
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Re: Leveraged PP?

Post by Pointedstick » Sun Nov 11, 2012 7:16 pm

It's been my observation that the folks most interested in using leverage are often the ones who understand it the least, while the ones who understand it the most (such as yourself) will eschew it entirely or only use it in extremely targeted, limited ways. Anyone looking to use leverage would be wise to observe this pattern and do some introspection as to what it might mean.
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Re: Leveraged PP?

Post by Gary » Sun Nov 11, 2012 8:43 pm

Slotine wrote:
BM + 1.5% is realistic at IB.  However, seeing as how you've used it in the past, I don't think you should.  I'm saying this now because I know you'll eventually stumble across it - I just want to get the warning in.  Do you have a plan to unwind the carry trade?
Sorry, I missed this earlier.  I periodically sell some of my positions when valuations seem lofty and my capital gains rack up too quickly (e.g., the equivalent of 2 years of income in 3 months).  I buy back at better valuations or just buy different securities.  So basically, the amount I am borrowing fluctuates.  To me, that's the only prudent way of doing it.  I have been doing this for 3-1/2 years and wish I had started earlier.  I realize this is much different than the more buy-and-hold PP, but I felt compelled to defend margin since it is only bad when done carelessly and with the goal of unbridled greed as opposed to more modest expectations. 
Last edited by Gary on Sun Nov 11, 2012 8:45 pm, edited 1 time in total.
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Re: Leveraged PP?

Post by MachineGhost » Mon Nov 12, 2012 12:14 pm

Slotine wrote: BTW, how do you feel about this graph?
Looks like a 50% peak-to-trough drawdown for the 2x leveraged.  Consider the psychological ramifications of losing HALF YOUR WEALTH in just 2.5 years.
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Re: Leveraged PP?

Post by clacy » Mon Nov 12, 2012 2:02 pm

MachineGhost wrote:
Slotine wrote: BTW, how do you feel about this graph?
Looks like a 50% peak-to-trough drawdown for the 2x leveraged.  Consider the psychological ramifications of losing HALF YOUR WEALTH in just 2.5 years.
This is why I could only consider scaling in with leverage if there was already a 10% DD or greater, on the normal PP.
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Re: Leveraged PP?

Post by Gary » Mon Nov 12, 2012 4:05 pm

Slotine wrote:
Sorry Garry, that is not a exit plan.
Slotine, you seem to have missed the part where I said I sell when valuations seem lofty.  That is a major key to risk control.  (And yes, I said "seem" since valuation is somewhat subjective, but I  err on the side of being conservative.)  I don't expect a leveraged trade to always be an investing sweet spot, because at some point, the Fed is going to raise the cost of leverage.  But at present, anyone (with a past history of exercising risk control and who favors conservative investments) who doesn't take advantage of low borrowing rates is, in a way, fighting the Fed. 

Don't get me wrong, I  only advocate margin for income-generating investments.  The PP has times where it goes nowhere and having income-generating investments, including those boosted via margin, pays you to wait.  That makes it a good candidate for a Variable Portfolio that complements the PP.  I don't advocate this for new investors, but only for those who have been around the block, understand the yield curve, understand the responsibilities that come with a margin account; and understand how to select securities, assign valuations to them, and exercise good selling discipline.  I will concede that may eliminate most of the people on this board.  But even if only a few people qualify, that is just that many more people who can take advantage of this unusual period in history where we are actually being encouraged to borrow by an accommodating Fed.  Using margin on income-generating investments is a lot less risky than some of the things I've seen on the Variable Portfolio board.  And it is a gazillion times safer than using leveraged ETFs.
Last edited by Gary on Mon Nov 12, 2012 4:07 pm, edited 1 time in total.
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Re: Leveraged PP?

Post by clacy » Mon Nov 12, 2012 5:16 pm

Slotine wrote:
clacy wrote:
MachineGhost wrote: Looks like a 50% peak-to-trough drawdown for the 2x leveraged.  Consider the psychological ramifications of losing HALF YOUR WEALTH in just 2.5 years.
This is why I could only consider scaling in with leverage if there was already a 10% DD or greater, on the normal PP.
Its easier said than done.  I leveraged through the 2008 drawdown (equity only), slowly creeping the leverage ratio up as it progressed.  The losses compound, DOWNWARD.  At the end of it all, I consider myself lucky for Fed intervention.  Granted, I had uncorrelated illiquid assets that kept my net-worth above zero, but my brokerage account was hemorrhaging cushion.  It was re-funded several times from the other accounts.  Even with that eventual safety net, it's a hard psychologically to see newly minted money enter the abyss at ever increasing rates.  Are you seriously prepared for that?  No one calls bottom EVER, and the determining factor is how you plan on acting when you call it too early.

The second most important call is how you plan on unleveraging.  That roller-coaster graph would have you leveraged up after the first drawdown, only to be hit on the second wave.  Double dip recessions aren't rare.

As for leveraging only when there's a guaranteed edge, I probably had one of the best edges available - even better than the PP: selling insurance during market collapse at obscene rates.  Knowing that doesn't make it any easier.
I agree it's ways easier said than done however I would not leverage into just one asset class like you did with stocks as that throws the entire "edge" of the PP out the window.  And I would only do it based on a portfolio draw down rather than an individual asset class.

The other big problem is that even if you're right on your timing of introducing leverage, when do you back out of the leveraged portion?
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Re: Leveraged PP?

Post by Gary » Tue Nov 13, 2012 3:41 pm

Slotine wrote: Gary, I've never been a big fan of using the words conservative and leverage together in the same sentence.  A leveraged + conservative portfolio isn't slightly less conservative.  It's an entirely different risk profile.  And I didn't miss the part where you said "valuations seem lofty".  I just couldn't reconcile that a safe guaranteed investment could even have a lofty valuation.  Capital gains from dropping interest rates isn't a lofty valuation to me.
Slotine, by lofty valuations, I am talking about investor sentiment, i.e., overbought conditions.  That is a time to take something off the table.  When you get the equivalent of two years of income in four months, investors are being irrationally exuberant.  It doesn't matter if the fundamentals are still good, you take some or all off the table. 
I think most people on this board are smart enough to educate themselves on leverage.
The discussion on this thread was pretty one-sided, portraying margin as "the great evil".  Which is why I thought the other side needed to be presented.  I don't believe in excluding a useful investment tool because some people don't know how to handle it.  There may never be another chance in our lifetime where leverage costs are so low and there is such a variety of fixed income investments with good yields. 
I am glad you recognize the low interest rates are a temporary thing but that didn't come across in the post.
We could be in a low-rate environment for another ten years, even longer.  Carry trades don't last forever, but in this case, they may last quite a while.
I'd further note that the fact that the PP doesn't throw off income is immaterial.  Aside from trading commissions and possible tax implications, distribution yield is inconsequential for any investment.  It takes a while to digest that.
For those who want to "eat their seed corn", go right ahead.  Me?  I've had the experience of having to sell shares at the wrong time.  No thanks.  As a retiree, I like the predictability of regular monthly income.  It is also a morale booster during turbulent or indecisive markets to have gobs of cash being thrown off in one's portfolio.  Some of the income is tax-free, BTW.  I think much of the misunderstanding about income comes from discussions about equity income.  Fixed income is quite different.
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Re: Leveraged PP?

Post by MachineGhost » Tue Nov 13, 2012 4:06 pm

It is alluring seeing your I-Bonds go up like clockwork to offset the losses in the other components.  T-Bills cannot say the same.
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Re: Leveraged PP?

Post by Storm » Fri Nov 16, 2012 5:12 pm

craigr wrote:
Pointedstick wrote: There are no words.
Oh yes there are words: Don't use leverage to invest!
I just came back across this thread that I started over 2 years ago and see it has been zombified and is now very much alive!  ;D

One thing I heard from a friend of mine recently is that casinos have studied human psychology very extensively and know a lot of information about how the human loss reaction works.  They use this to their advantage when you are playing there.  For example, if you have lost some money, they know a human loss response kicks in and you will risk more money because you need to win back what you have already lost so that you don't end up coming out behind where you started from, overall.

I think this is the biggest risk with margin of any type.  Once you have lost a significant amount of money, and are negative, the human loss emotions kick in and you start to play increasingly dwindling odds bets trying to get back to positive territory - this thread is an amazing viewpoint into it.  You can see him with a -$200K net worth and he is leveraging 20% debt on unsecured credit lines just in the hope that a 10% market rally tomorrow will push him back into the black.  It's sick, really...  like a junkie halfway between withdrawal and overdose.

This almost makes me think the retail investing market is made to exploit suckers like this, in the same way that a casino does.  (in fact, now that I write that, there is no "almost" about it, they're clearly setup to part fools from their money just like a slot machine in vegas)
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Re: Leveraged PP?

Post by Gary » Fri Nov 16, 2012 7:52 pm

Storm wrote:  

One thing I heard from a friend of mine recently is that casinos have studied human psychology very extensively and know a lot of information about how the human loss reaction works.  They use this to their advantage when you are playing there.  For example, if you have lost some money, they know a human loss response kicks in and you will risk more money because you need to win back what you have already lost so that you don't end up coming out behind where you started from, overall.

I think this is the biggest risk with margin of any type.  Once you have lost a significant amount of money, and are negative, the human loss emotions kick in and you start to play increasingly dwindling odds bets trying to get back to positive territory - this thread is an amazing viewpoint into it.  You can see him with a -$200K net worth and he is leveraging 20% debt on unsecured credit lines just in the hope that a 10% market rally tomorrow will push him back into the black.  It's sick, really...  like a junkie halfway between withdrawal and overdose.

This almost makes me think the retail investing market is made to exploit suckers like this, in the same way that a casino does.  (in fact, now that I write that, there is no "almost" about it, they're clearly setup to part fools from their money just like a slot machine in vegas)
There is no reason why you, as a savvy retail investor, can't take advantage of the "panicky investor" phenomenon just like the casino/Wall Street broker does.  When investors are panicking and margin calls are flying that is exactly when YOU buy.  It's amazing how many people can recite the "buy low, sell high" adage but don't understand how the greed-panic cycle works:  Dumb investors buy high.  When markets get too rich and sell off, stops get triggered, scared investors sell, margin calls fly...this continues for days until capitulation.  The savvy investor then steps in and buys.  That is the low-risk buy point and the point where leverage is used to best advantage. 
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Re: Leveraged PP?

Post by Gary » Sat Nov 17, 2012 2:10 am

Slotine wrote:
Here's a question, do you honestly believe that there's easy money left on the table during a market rout by just buying stock?  If it was a clear-win, don't you think these bright minds at wall street would have picked it up faster than you?
Who said anything about stocks?  Who said anything about investments that "the big guys" invest in?  I play in areas that are too small for anything but the retail crowd, which makes it easy to play on sentiment.  Or should I say "prey" on sentiment?
Another one: Since most people who recite the 'buy low, sell high' mantra also tend to be believers of Warren Buffett, what does leverage do to your margin of error?  Even assuming that the market has somehow seriously under-priced the stock, is bleeding out 2% every year worth it?  Don't you balk at percentage if it was an expense ratio on a mutual fund?
Again, who said anything about stocks?
I'm sorry if I seem rather harsh on you Gary.  But throwing leverage on top is never less risky.  I hate it when anyone says that.  Probably too passionately.  You're exhibiting all the hallmarks of the greedy without realizing it.  Of course, you're using it responsibly.  You're not as greedy as other people.  Of course you're using it intelligently.  You're not as stupid as that other person selling out of fear.  That's what everyone says.  But the kicker is, there's no other person.  He's just a figment of your imagination to make it feel more 'right' or 'safer'.
Slotine, you have good intentions, I respect that.  You happen to be making a lot of wrong assumptions about ME, my experience, the types of things I invest in, what my goals are, how I manage risk, and what my overall portfolio looks like.  But you are right that the majority of people should not be engaging in leverage.  My original intent here was just to add a shade of grey to the black-and-white way that margin was being portrayed here.  But in the process, I seem to have gotten into investing/trading techniques that are outside the scope of this board. 
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Re: Leveraged PP?

Post by hedgehog » Wed Dec 04, 2013 10:18 am

Could you make a dummy simulation of this one - just for education purposes?

Having another PP for a VP but with a 2:1 leverage (using CFDs)?
http://gyroscopicinvesting.com/forum/va ... ing-cfds)/

To see at what times it gets close to a margin call. That would be interesting. Thanks.
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