This one was really interesting. I didn’t take any of these notes while I was reading it because I just tore through it and was done in a day. So unfortunately my notes my not be the most detailed.
The basic idea of this book is that people should be diversifying across time in the same we diversify across asset classes. Diversification has been shown to be beneficial in that it reduces the unit risk (volatility) for a given expect return.
People are significantly overexposed to stocks in their last few years of working, and significantly underexposed at the beginning of their working life This is true even if they have an “aggressive” 100% stock portfolio when young and a more conservative 50-50 portfolio as they approach retirement. The reason for this is that they have so few absolute dollars to put in the stock market at the start 100% of $10,000 is $10,000, but 50% of $1,000,000 is $500,000, 50 times as much, a significant stock market hit near the end of their working life will have a much more significant impact on the value of their portfolio at retirement compared to one at year 2, even though they are proportionally less exposed to equities They quantify this by the idea that your future income is very much like a bond, and its value should be taken into account when allocating investments. If someone has $50,000 that is 100% stocks, but 30 years of working left where the present value of their future savings is $450,000, they’re really only 10% invested in stocks.
Their proposal for ideal time diversification would be to have the same percent of your total assets, including the value of future savings, invested in stocks every year This is the concept of the Samuelson Share, it is the percent of your lifetime portfolio you want in stocks. So if you are a conservative 50% Samuelson share and have $500,000 in current investments and $500,000 in present value of future savings, you should actually be 100% invested in stocks that year
Now where their proposal gets the most controversial is they actually advocating taking on leverage in an attempt to get closer to your Samuelson Share during the early years of your working life, up to a maximum 100% leverage, which they cap to avoid margin calls. This sounds crazy, but they analyzed historical market performance and showed that, even taking into account interest expense on margin, the Lifecycle investing strategy they propose outperforms traditional investing strategies, with the outperformance growing stronger the larger the number of working years it is applied.
I took their data and have been analyzing it myself, adding the ability to easily change the number of working years and also checking with increased margin interest rates to see how durable this strategy is. My early results have been pretty favorable, as with timelines of a decade or more it comes out ahead in almost every way even with slightly increased margin rates from their calculated ones.
For achieving market leverage they discuss either using margin or buying deep in the money LEAP options expiring 1-2 years in the future. They would like to see funds set up to do all this for people, but it doesn’t look like that’s gonna happen anytime soon.
Unfortunately, achieving this leverage is harder to achieve then it sounds for the average smart saver. You can’t leverage investments or buy options in a 401k and margin is also prohibited in IRAs, though they do allow option purchasing. Unfortunately, from my analysis, right now at least the option method is significantly less attractive as margin is easily available at about 2.5% interest but the implied interest of a 50% in the money S&P 500 LEAP option is closer to 4%, high enough that the strategy likely would loose most of its benefits, especially once you take into account the difficulty of rebalancing with options, as their unit sizes are huge. Regular rebalancing is quite important for this strategy, particularly to avoid getting wiped out during downturns.
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