Hello all,
Markets are up, so it's time to talk about leveraged investing again. I would like to test out a framework for thinking about leveraged investing as betting on the equity risk premium. This isn't lifecycle investing, it's more buying the dip.
If we know that stocks have historically had greater returns than bonds over many periods, and that the theoretical framework for this is the equity risk premium, which varies over time, then what can we do with that information?
Many of us just invest in equities, even 100% equities. But it feels like, depending on individual circumstance and risk tolerance, we could go a step forward and bet on the equity risk premium, buying a broad equity etf, like VTI/VXUS, with leverage from selling box trades about a year out at just above the T-bill rate. This feels like a pretty specific bet on the equity premium - i.e. the strategy's returns = equity returns minus the t-bill rate. I don't expect it to work every year, but you can just roll over the box trade until it does, and not pay down the box trade until equity prices are higher than the price at which the purchase was made.
The next question becomes, ok well when is this strategy more vs less likely to succeed? And for that my best guess would be buying the dip. Returns tend to be greatest after a correction, but many of us are wisely full invested and don't have extra cash to invest. We could develop a simple framework along the lines of, oh a 10% crash happens every 1.5 years, if the market falls by that much we could buy the amount of equity that we would have invested over 1.5 years (or some % of it), a 20% crash happens every 4 years, when that happens buy the amount we would have invested over the next four years.
Importantly, there is of course the risk of a margin call, but if you have a decent sized portfolio then making 1.5 years of equity investment in advance may not be dangerous until facing large drawdowns - 75%, from point of purchase, for what I'm modeling for myself. That would be a 77.5% fall from market peak after a 10% dip. While that may happen, it would take several months to happen during which you could pay down the margin, and if a fall is much faster or deeper than that, in this day and age, then it feels like I have bigger problems than money and will be thinking more about my bullets and baked beans allocation.
Ready to have this torn apart, but it feels like it solves a problem for folks that have the risk tolerance and want to take advantage of temporary dislocations in the market. I welcome the feedback of the forum.
Markets are up, so it's time to talk about leveraged investing again. I would like to test out a framework for thinking about leveraged investing as betting on the equity risk premium. This isn't lifecycle investing, it's more buying the dip.
If we know that stocks have historically had greater returns than bonds over many periods, and that the theoretical framework for this is the equity risk premium, which varies over time, then what can we do with that information?
Many of us just invest in equities, even 100% equities. But it feels like, depending on individual circumstance and risk tolerance, we could go a step forward and bet on the equity risk premium, buying a broad equity etf, like VTI/VXUS, with leverage from selling box trades about a year out at just above the T-bill rate. This feels like a pretty specific bet on the equity premium - i.e. the strategy's returns = equity returns minus the t-bill rate. I don't expect it to work every year, but you can just roll over the box trade until it does, and not pay down the box trade until equity prices are higher than the price at which the purchase was made.
The next question becomes, ok well when is this strategy more vs less likely to succeed? And for that my best guess would be buying the dip. Returns tend to be greatest after a correction, but many of us are wisely full invested and don't have extra cash to invest. We could develop a simple framework along the lines of, oh a 10% crash happens every 1.5 years, if the market falls by that much we could buy the amount of equity that we would have invested over 1.5 years (or some % of it), a 20% crash happens every 4 years, when that happens buy the amount we would have invested over the next four years.
Importantly, there is of course the risk of a margin call, but if you have a decent sized portfolio then making 1.5 years of equity investment in advance may not be dangerous until facing large drawdowns - 75%, from point of purchase, for what I'm modeling for myself. That would be a 77.5% fall from market peak after a 10% dip. While that may happen, it would take several months to happen during which you could pay down the margin, and if a fall is much faster or deeper than that, in this day and age, then it feels like I have bigger problems than money and will be thinking more about my bullets and baked beans allocation.
Ready to have this torn apart, but it feels like it solves a problem for folks that have the risk tolerance and want to take advantage of temporary dislocations in the market. I welcome the feedback of the forum.
Statistics: Posted by skinnybuddha — Wed Aug 14, 2024 9:17 am — Replies 4 — Views 256