Gyroscopic Investing

I already know Harry Browne's answer to this, but driving in to work every day I can't help but hear those Interactive Brokers ads on Bloomberg - "Borrow $500,000 on margin for every $100,000 invested, at only 1.5% interest", and thinking I would never leverage my retirement, but could a leveraged PP play work as a second Variable Portfolio?

I think the main risk of leverage is that a few months of bad returns could force a margin call that you might not be able to cover. But, I'd be interested to hear others take on this.

What if you took an extra $100K you had lying around (stuffed in a mattress perhaps) and did a leveraged PP, $125K in each asset?  Suppose you had some extra money lying around in liquid assets to cover any margin calls for a 1-2 year period of time (worst case scenario, hopefully).

Would there be any benefit to employing this strategy?  I personally don't think I'd ever do it, but with money as cheap as it is, it's helpful for me to reevaluate the wisdom of never using margin.

This is an interesting thought - I never reasonably considered using Margin, as the rates that I would qualify for would completely defeat the purpose... 

That said, if you could be guaranteed no margin calls...  this might be a reasonable plan.  My fear with Margin calls could be that you'd get hit on your poorest performing asset right at the incorrect time.  The drawdowns on the PP are low, but I've been seeing quotes of PP's taking 10-15% hits - which would likely trigger a Margin call on the worst asset class.  You'd subsequently be forced to sell your other asset classes to rebalance at this point.  I think the net effect would be that of locking-in your losses.

Still, this is an interesting idea - perhaps using less margin such that any calls become overwhelmingly unlikely.

Another idea would be to use Options - Call options a year ahead - and then constantly sell and renew the option every 3 months...  This would work well in years where there's high volatility, but probably not as well in less volatile times.

Storm wrote: I already know Harry Browne's answer to this, but driving in to work every day I can't help but hear those Interactive Brokers ads on Bloomberg - "Borrow $500,000 on margin for every $100,000 invested, at only 1.5% interest", and thinking I would never leverage my retirement, but could a leveraged PP play work as a second Variable Portfolio?

Here's the scoop on leveraged investing:

If it was such a good idea, why is the investment house loaning you that cash for a paltry 1.5% a year when they could just invest it themselves and make a killing in the market?

I think the main risk of leverage is that a few months of bad returns could force a margin call that you might not be able to cover. But, I'd be interested to hear others take on this.

There are risks of completely losing all of your capital very quickly as you point out. The broker has the right to sell your securities, without your permission, to cover margin loans. Also realize that there is the psychological stress created in your life as well knowing this is happening. Finally, there is a strong desire to put more money into the brokerage to meet a margin call and this could cause you to throw good money after bad, as it were.

Would there be any benefit to employing this strategy?  I personally don't think I'd ever do it, but with money as cheap as it is, it's helpful for me to reevaluate the wisdom of never using margin.

I think leveraged investing is a tremendously bad idea. Taking on debt to invest in the market has been the downfall of many.

craigr wrote: I think leveraged investing is a tremendously bad idea. Taking on debt to invest in the market has been the downfall of many.

As expressed in the quote below...

I don't think I would ever want to use a margin account with the PP because of the potential for margin calls. However, I think it could make since to avoid paying off your house as soon as possible and instead invest your extra money in the PP i.e., taking out a 30 year loan when you could afford a 15 year. This is similar to using leverage but offers more flexibility. You will also be less likely to miss a mortgage payment in case of losing work because you will have money socked away. As long as you think your PP will outperform your interest rate on your mortgage you come out ahead. Not to mention the financial flexibility.

You are all correct, of course.  I think the biggest risk of leveraged PP is that a margin call on one under performing asset might trigger involuntary liquidation of another over performing asset, which kills the momentum the PP needs to achieve optimum returns via re-balancing intelligently.

Thanks for your feedback.

In my case, I use a small form of leverage, for example, rather than paying cash for a vehicle, I recently got a 1.89% loan, simply because I can probably get a better return with my money on PP than the 1.89% money cost.

Speaking of this, the mortgage strategy you mentioned - I often struggle with this.  In the next few years the wife and I are planning on buying a home.  We have more than enough for 20%, of course, but what is the best strategy?  In a low interest rate environment, should we just put the 20% down necessary to avoid mortgage insurance, and invest the rest in PP, or should we put as much down as possible (probably 50% or more)?  I hate the thought of that money going away and being locked up in an illiquid asset like housing.

It seems like the best retirement strategy might be just to rent and invest the rest in PP.  After all, housing never really appreciates over a 30-40 year time frame more than 1% a year or so.

For ultimate flexibility, and long term returns, I think renting is the best solution.

Many people are tied down by their house. They are encumbered by large interest payments, and hard to access liquidity. Selling a house can take months, with hefty broker fees.

Also, if you are renting, it is much easier to pick up and move if you are laid off. With the PP, you can access your money whenever you want because all of the assets are ultra liquid, and they aren't tied to any one location like with a house.

Many people equate owning a home with freedom. In my view it is more limiting than freeing. You are concentrating your wealth in a single, static, and illiquid asset.

Reido wrote:Another idea would be to use Options - Call options a year ahead - and then constantly sell and renew the option every 3 months...

I've been thinking about that too. Use LEAPS instead of buying the ETFs. TLT, GLD and SPY could be used...

I had this thought a while back as well, but considered the longest dated leaps available.  I wouldn't do this with more than play money, but it is an interesting idea.  At the end of the day I am not sure it would return any more than a conventional PP though.

Hi,

as the PP has a small risk, with small yearly drawdowns, why shouldn't we use 2x leverage?

Everything would double:

Average return = 16%

Drawdown = 10%


Waiting your comments I remain.

Thank you.

frugal wrote:as the PP has a small risk, with small yearly drawdowns, why shouldn't we use 2x leverage?

Everything would double:

Average return = 16%

Drawdown = 10%


Waiting your comments I remain.

Thank you.

Leverage never works that way. The people I know that have lost the most money the fastest investing have all used leverage to do it. When risk shows up, the damage multiplies and emotional stress also goes 2X as well. Plus the leveraged products available all have issues in their structure. They are more short-term speculation vehicles than long-term investments.

I think anyone looking to use leverage for investing study this thread on the Bogleheads closely. It's about an investor using leverage in 2007, then going through the 2008 crash:

http://www.bogleheads.org/forum/viewtopic.php?t=5934

Here are my responses:

http://www.bogleheads.org/forum/viewtop ... 934#p73221

Here are my quotes from 2007 there. I stand by all of them even today. Stay away from leverage!

Whenever you hear stories about people going completely broke with their investments it usually involves investing with borrowed money and/or leveraging. One of the fastest ways to lose everything you've saved is to invest with borrowed money.

Using borrowed money to invest is not less risky. Borrowed money used for investing in any form always amplifies your risks. You take on the risk of the stock market and the risk you can't pay back the loan. The most likely scenario is that both show up at the same time: The stock market dives, you lose your job and can't service the loan and have to sell your depressed shares to keep up on the payments. I'm sure there are many other unforeseen risks hidden as well.

Also you are making assumptions of future stock market performance as part of the plan. However history has shown that equity performance is not predictable nor guaranteed.

I think what you are proposing is interesting, but using borrowed money for investing always involves significant risks even if they aren't readily apparent.

Just my opinion…

I used to lambast margin until I actually tried it.  I use it for my income portfolio, which is a relatively conservative portfolio.  My monthly dividends exceed my monthly margin costs by  just enough to make it worthwhile.  With PP, there is no monthly income (and miniscule income overall) and no guaranteed rate of capital appreciation to offset the monthly margin costs, so it is more of a gamble.  And PP is slow-growing... there could be a lot of time where the portfolio is going nowhere yet margin is being paid on it.  That said, if I could get a 1.5% margin rate, I would jump on it and lever up most all of my conservative investments...even PP.  But that is an unrealistic figure.  For retail investors, the rate is more like 3-8%, depending on how much you are borrowing.

There is a learning curve involved and there are many flavors of maintenance requirements that need to be watched.  If one has a good margin rate (better than the normal retail rate), has a conservative or PP-type portfolio, and has an adequate cash cushion to use for meeting maintenance requirements, it shouldn't be a problem.  You just have work out the math and decide if it's cost effective.

In the business world, and of course trading/investing, vast fortunes have been built with leverage.  It can and many times is a good thing.  Of course timing is of the essence of your performance with leverage.

I am not using leverage right now, but the next time we hit a 10% DD on the total portfolio, I will probably go up to 1.3 to 1.5 leverage.  If we ever see a -20% DD, I would probably try to crank that up closer to 2x.

For my own savings, I would avoid margin and leverage of any sort at all costs. TANSTAAFL.

craigr wrote: I think anyone looking to use leverage for investing study this thread on the Bogleheads closely. It's about an investor using leverage in 2007, then going through the 2008 crash:

http://www.bogleheads.org/forum/viewtopic.php?t=5934

Oh, the humanity!

I'm reading this thread and it's like watching a horror movie you've never seen before, but that someone told you the exact minute when the hero(ine) will meet their end. I keep wanting to scream, "You fool, get out now!" I know when it's coming, but he doesn't! Oh god, oh god, it's getting closer...

Market Timer wrote:This is unbelievably frustrating. My retirement account, after gaining 100% at the beginning of the week, is now being liquidated to meet margin calls.

I do all that I can to raise capital and in one day the market makes all that effort worthless. Today I ran from bank to bank wiring money that is now mostly lost. I'm a slave to the S&P 500 index. It's an endless cycle of raising capital, running to the bank, and making sacrificial offerings. One must imagine MT happy.

http://www.bogleheads.org/forum/viewtop ... 78#p303778

Market Timer wrote:Insomnia returns. S&P futures down after hours, now at 941. About 4% away from another margin call. Waiting on $12K to arrive in the next day or two. Instead of counting sheep, I'm counting credit lines: Discover, 99% utiliization; Discover Business, 99% utilization; Amazon Chase, 99% utilization; and so on. Repeat the cycle, hoping a new line will magically appear. Instead of drowsiness, only more anxiety is produced. The Great Reset of interest rates in the spring is pushed to a corner of my mind where I conveniently ignore unpleasant things like mortality. Ah, but here's USBank, at only 40% utilization and growing, but it's charging 15% interest. Called Wachovia today: they'll lend me a cash advance at 20% interest. Even with charging all my expenses, my monthly income is insignificant in comparison to the stock market's volatility. The seemingly mild 5% decline in S&P futures just in the last 24 hours wiped out four months of pre-tax income, and I'm only at $220K exposure. Still holding on for dear life like a bull rider at a rodeo. The bull is torment and hope.

http://www.bogleheads.org/forum/viewtop ... 81#p309781

There are no words.

Pointedstick wrote: There are no words.

Oh yes there are words: Don't use leverage to invest!

Gary wrote: I used to lambast margin until I actually tried it.  I use it for my income portfolio, which is a relatively conservative portfolio.  My monthly dividends exceed my monthly margin costs by  just enough to make it worthwhile.  With PP, there is no monthly income (and miniscule income overall) and no guaranteed rate of capital appreciation to offset the monthly margin costs, so it is more of a gamble.  And PP is slow-growing... there could be a lot of time where the portfolio is going nowhere yet margin is being paid on it.  That said, if I could get a 1.5% margin rate, I would jump on it and lever up most all of my conservative investments...even PP.  But that is an unrealistic figure.  For retail investors, the rate is more like 3-8%, depending on how much you are borrowing.

There is a learning curve involved and there are many flavors of maintenance requirements that need to be watched.  If one has a good margin rate (better than the normal retail rate), has a conservative or PP-type portfolio, and has an adequate cash cushion to use for meeting maintenance requirements, it shouldn't be a problem.  You just have work out the math and decide if it's cost effective.

I understand you guys that avoid leverage but I understand better the position of Gary.
When you have an edge on a PP system you can use leverage up to a point depending on the historical DD of the PP system.
You pay 2% interest to the broker, but you hope to win 8% in the longrun, correct?
It is the only way to increase the turnover of this small risk and small return PP system. Otherwise it will win not much more than inflaction.
Please clarify.

Pointedstick wrote: There are no words.

What a dumbass!  He abandoned his strategy in March 2009, right at the bottom.  So obviously he had no real clue what he was getting into and had no plan beforehand to deal with such a situation.  To his credit, he pulled himself out of the hole by 2011, but I sure wouldn't want to be him.  If I had to guess, I'd say he was Asian for reasons that will probably sound too much like stereotyping.

However, it appears like he used future contracts which is a lot different than trading stocks on margin that is being proposed here.  The limit is 2:1 or 4:1 with portfolio margin.

If you have an edge that won't fail, it makes sense to use leverage if you can live with the resulting risk increase.  The PP doesn't fail in nominal terms, but I'm unclear how leverage would react with it in declining real terms.

frugal wrote: I understand you guys that avoid leverage but I understand better the position of Gary.
When you have an edge on a PP system you can use leverage up to a point depending on the historical DD of the PP system.
You pay 2% interest to the broker, but you hope to win 8% in the longrun, correct?
It is the only way to increase the turnover of this small risk and small return PP system. Otherwise it will win not much more than inflaction.
Please clarify.

It always sounds like a good idea to magnify the gains, doesn't it? The key word there is "hope". What if you earn a -8% return instead? Congrats, you've just gained exposure to call risk. Market Timer's exercise is a perfect example of how call risk can force you to buy high and sell low, even if you're fully aware of what you're doing, because you have no choice.

If I was ever, ever forced to use leverage for some reason, I would use levered ETFs rather than actually purchasing securities with money I didn't have. If you're paying 2% to a broker to borrow their money, you're exposing yourself to call risk should your positions fall, leading to a spiral of needing to raise more cash or sell assets (thereby selling low). This was Market Timer's big lesson, and not knowing it beforehand proved to be his undoing. He lost $200k over a very short time.

Don't overestimate your own cleverness. Smart people do it all the time, with devastating consequences. Take risks with your career, not your investments. If you don't understand why beating inflation should be your goal, or how much the PP can consistently do it by, you need to become more knowledgeable about your own psychology and PP theory before you lever it up in a very dangerous way.

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.

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.

Speaking of SCV, I would not want to try to row upstream:

frugal wrote:

I understand you guys that avoid leverage but I understand better the position of Gary.
When you have an edge on a PP system you can use leverage up to a point depending on the historical DD of the PP system.
You pay 2% interest to the broker, but you hope to win 8% in the longrun, correct?
It is the only way to increase the turnover of this small risk and small return PP system. Otherwise it will win not much more than inflaction.
Please clarify.

I don't think you were addressing me specifically/exclusively, but let me clarify that I think leverage is a lot better for an income-based portfolio where there is less "hope" involved.  Income funds may occasionally cut their distributions, but usually do not if you have selected them well, so you are in essence "guaranteed" to get a return in INCOME above the margin rate.  That is great for retirees who are living off their income.  Income funds are popular with retirees and you may get substantial price appreciation as well. 

With PP, there is essentially zero income, so there are no guarantees that you will meet or exceed your margin payments on either income or capital gains.  Historically, PP has returned 9%+ a year but that may not happen forever.  You could have a couple of years of 2% returns yet you are paying, say, 5% margin.  Not a good deal.  If margin rates were 1.5%, it would be harder to lose on a leveraged PP portfolio, but I wouldn't bet on retail investors getting a 1.5% rate anytime soon.

Pointedstick wrote:

frugal wrote: I understand you guys that avoid leverage but I understand better the position of Gary.
When you have an edge on a PP system you can use leverage up to a point depending on the historical DD of the PP system.
You pay 2% interest to the broker, but you hope to win 8% in the longrun, correct?
It is the only way to increase the turnover of this small risk and small return PP system. Otherwise it will win not much more than inflaction.
Please clarify.

It always sounds like a good idea to magnify the gains, doesn't it? The key word there is "hope". What if you earn a -8% return instead? Congrats, you've just gained exposure to call risk. Market Timer's exercise is a perfect example of how call risk can force you to buy high and sell low, even if you're fully aware of what you're doing, because you have no choice.

If I was ever, ever forced to use leverage for some reason, I would use levered ETFs rather than actually purchasing securities with money I didn't have. If you're paying 2% to a broker to borrow their money, you're exposing yourself to call risk should your positions fall, leading to a spiral of needing to raise more cash or sell assets (thereby selling low). This was Market Timer's big lesson, and not knowing it beforehand proved to be his undoing. He lost $200k over a very short time.

Don't overestimate your own cleverness. Smart people do it all the time, with devastating consequences. Take risks with your career, not your investments. If you don't understand why beating inflation should be your goal, or how much the PP can consistently do it by, you need to become more knowledgeable about your own psychology and PP theory before you lever it up in a very dangerous way.

Thank you for your comment.
Well, maybe you are putting all your savings in PP, isnt it?
I would only risk a % of my savings in any lazy portfolio.
I would prefer to use CD + Bond funds + Lazy Portfolio + ...
Also only in CD's it is possible to make better than inflation here in my country.
Keep comment please.

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