Fifteen years ago, when I was still pretty much a novice investor, I went to an AAII meeting to hear Jeremy Siegel speak about his new book, “Stocks for the Long Run.”? I brought my copy to have him sign it.? I hung around after the talk to? listen to some of the more informal things he might say, and in a dead moment, I asked him (something to the effect of),? “You suggest that young people should lever up to buy stock; do you really mean that?”? His answer was and unreserved “Yes.”
Dr. Siegel is brighter than me.? The guys who write the CXO Advisory Blog are brighter than me as well.? Felix Salmon is clever, and he puts up this supporting piece.
I am here to disagree.? Why?? It is all very well and good for academics to assume that returns occur randomly, but returns occur in streaks.? Think of all of the “lost decade” articles you have seen in the recent past.? Here’s my main reason for not levering up while young: It won’t work well about? one-third of the time, because young people will take humongous losses during a “lost decade,” and in the panic, they will sell at the wrong time.? My secondary reason, is that in really bad markets, such as 1929-32, 1973-4, and 2000-2002, you could be wiped out.
Don’t trust the results that rely on the veracity of Modern Portfolio Theory, when those ideas would have failed off of historical returns.? As I often say, “The markets always have a new way to make a fool out of you.”? This is another example.
One final note, perhaps more scholarly: the idea of levering up requires buying and holding, and that bad markets happen randomly, with no streaks.? Unfortunately, the equity market returns less than a buy-and-hold investor receives, because people buy and sell at the wrong times.? Buy-and-hold investors are daring people; they confront the natural tendencies toward greed and panic, and they do better than average in the long run.? One buying and holding on leverage would have to have a steel gut, which is not characteristic of younger investors.
So, don’t lever up.? I say this to investors young and old, experienced and inexperienced.? Getting an equity-like return is difficult enough in the long run.? Don’t make your life more difficult by levering up.
I don’t think the paper relies on portfolio theory or CAPM at all. And it’s entirely open about the fact that young people might end up taking large losses near the beginning of their savings lives, or even being wiped out entirely. In other words, it *agrees* that you could be wiped out, and says that leverage is *still* a good idea.
As for buying and holding, young people do that all the time, without a steel gut: it’s called a retirement account, which can’t really be touched until you retire. You hold onto that because you have no choice.
Finally, I’d ask where in the paper there’s an assumption that “bad markets happen randomly, with no streaks”. Yes, it uses Monte Carlo simulations, but I can assure you that bad streaks do pop up in such things!
There is an intense discussion on this topic in the bogleheads forum, complete with one guy who is actually trying it and posting his (currently negative) net worth.
While I personally don’t support using leverage to buy equities, I think that the issue is more complex than that. There are a few key conditions that must be met first:
1) You have a solid, stable job with repeatable earnings (dentist, doctor, teacher, etc.)
2) You only lever up when you are young.
In this case, if you go bust, you can use your earnings stream to “refuel.” As your investments grow, you de-lever over time.
Again, I think that this theory underestimates the power of the market to crash at the right time and also estimates the frictional costs of borrowing and bankruptcy.
FWIW, I was wiped-out twice before finally (knock on wood) getting it right. To say it was gut-wrenching would be a huge understatement.
I did the math though, and after ~13 years my average compounded rate of return is ~16%. To say the third time was the charm would be an equally huge understatement.
And to be sure I don’t recommend my method. But interestingly, I do meet Doug’s two conditions and did “refuel.” It was psychologically a very tough thing to do.
Felix, thanks for posting here. I value your blog and your opinions. The paper did not rely on MPT directly, but relied on assumptions that underly MPT.
1) Past returns are indicative of future returns.
2) Correlations in the past will hold in the future.
3) If we suggest a change in investor behavior, it will have little effect on the markets as a whole.
4) Investment strategies are constant, and there are not better or worse times to implement them.
I am against leverage on stocks generally, because the historical record indicates that average people can’t tolerate the volatility. It has not worked in the past. It is unlikely to work in the future.
DougM and AllanF,
I salute you both. It is difficult to learn to invest/trade, and yes, the ability to refuel makes a difference. Wealthy people can take more risk, which is what one should expect.
Thanks David.
I think it is incredibly difficult to learn on one’s own without any kind of mentorship. I didn’t have any, but I think mentorship would be invaluable to calm the nerves and help one maintain perspective. Also, too many “pundits” make copy just to fill a quota. I’ve never read anyone say, “nothing to do today, go take a walk or a nap.” Rev Shark comes closest in his own unique way, but even then it’s somewhat between the lines.
Also, I’ll reiterate how hard it was to “refuel” the second time. Probably the toughest decision I’ve ever had to face for myself. But it worked, and fortunately it’s changed my life. Ultimately, I think that is the litimus for successful investing. To make enough that it makes a difference. It’s a high bar to be sure, but for how hard it is, for how much one has to sacrifice especially in the early years, anything less I don’t think would be worth it.
And I thank God everyday. And give back to charity every year.