Forum Mailbag: Leverage, Long Wave Investing, Market Timing, And More!

There is so much great information on personal finance forums. I regularly participate on several message boards, including Bogleheads, White Coat Investor, and Rockstar Finance. This is a roundup of my favorite discussions happening around the internet.

1. White Coat Investor: Leverage/Options to Turbocharge Returns

Question: Potatoducks believes he is very risk tolerant and can handle large swings in his portfolio. Therefore, he would like to know whether there is any way he can use leverage or options to increase his returns beyond the expected returns of a 100% stock portfolio. Of course, he knows such a portfolio would have increased risk as well.

WSP’s Take: First, it’s hard to know how risk tolerant you are until you’ve experienced a strong downturn. Many people believe they are very risk tolerant when the stock market is rising, as it has for the past 8 years. Fewer people who have invested through the 2000 or 2008 are so confident in their risk tolerance levels. If you are young and you didn’t lose any sleep during the 2000 and 2008 stock market downturns, then a 100% stock portfolio may be for you.

Leveraging your portfolio to turbocharge your return is most commonly done through the use of margin investing. You borrow money from the brokerage firm at an interest rate and invest it in stocks. Using margin, investors can typically become up to 200% invested in the stock market. However, if the stock market falls, your brokerage may require you to infuse more cash into the account to cover your losses. If you don’t, the brokerage may sell some of your holdings without your consent. This is called a margin call.

The interest rate for the money you borrow is typically very high at the standard brokerage houses. For example, the margin rate at Fidelity starts at 8.25%, but can be as low as 4% if you borrow more than $500,000. At these rates, it’s probably not worth it to buy index funds on margin. Interactive Brokers offers margin rates in the 2% range. You could probably borrow at 2% and make a return higher than 2% in the stock market, but you’d have to be able to handle the increased risk and possible margin calls.

Options do not make sense as a way to turbocharge your returns. I discussed the basics of options in this post and this post. Options are derivative products, and are a zero-sum game. When you buy an options, someone is selling you that option. You and the seller both believe their side of the trade is profitable.

2. White Coat Investor: Investing using the “Long Wave“

Question: Crixus read about a concept called the “Long Wave”, and was wondering whether anyone on the forum was concerned about a future decline in the stock market.

WSP’s Take: I had never heard of the “Long Wave” except perhaps with respect to supercycles in Elliott Wave theory, but Crixus may be referring to Kondratiev waves. In short, these theories believe that markets are cyclical and declines occur at pre-specified intervals. According to the Wikipedia article, the last Kondratiev wave began in 1971 and waves last 45-60 years. Therefore, we are nearing the end of a cycle, meaning a decline in the stock market is near.

In short, I am not concerned in the least. At least I understand where people are coming from when they think the stock market will decline because Donald Trump will torpedo the economy. But the concept that there is a pre-specified length that a technological cycle should or should not last? I’m sorry, but no.

3. Bogleheads: Allocation to International Stocks

Question: Dinosaur Dad has noticed that the P/E of U.S. stocks is high compared to that of international stocks. He was wondering whether he should increase his allocation to international stocks?

WSP’s Take: The amount of money that should be allocated to international stocks is a subject of intense debate. Some investors, including the great John Bogle of Vanguard, do not believe any money needs to be allocated to international stocks. Others argue that you should allocate money to international stocks in accordance to relative market capitalization, which is 50% U.S.  / 50% international. I favor the mix used by target-date funds, which is approximately 70% domestic / 30% international.

What I would not advise, however, is to adjust your allocation to international stock because of relative valuations, or recent underperformance or overperformance of international stocks.

4. Bogleheads: Timing the Market

Question: GKaplan wants to discuss a recent column by John Rekenthaler of Morningstar about market timing.

WSP’s Take: In the article, Mr. Rekenthaler shares a story from a reader who has had horrific market timing. The reader sold shares in April 2005, when former Fed Chairman Paul Volcker wrote a pessimistic op-ed in the Washington Post. He missed out on market gains from 2005-2007, but felt vindicated when the financial crisis hit in 2008. He briefly bought into the stock market at the lows of 2009, but then sold his shares and switched to the Hussman Strategy Growth Fund, which fared well during the financial crisis, but lost significant money from 2012-2015 in spite of the strong bull market. The reader finally has switched to a more standard portfolio of 60% stocks and 40% bonds.

This is of course a cautionary tale about the dangers of market timing. When you are wrong, things can go very wrong. However, for every “bad” market timer, there must be a “good” market timer as well. The “good” market timer will shout from the rooftops how smart he is, and he will start a hedge fund and attract lots of money from those who want to ride on the bandwagon. Market timing is not a skill, but a roll of the dice. Some will get lucky, and some will not.

Wall Street Shares: 5 Articles I Enjoyed Reading This Week

1. Ten Factorial Rocks: Learning From The Investment Oracle (not the one you think) – Loved this article celebrating Warren Buffett’s sidekick, Charlie Munger, and his mentor, Benjamin Graham.
2. White Coat Investor: Designing Your Glide Path – I’m a big fan of just using the standard Vanguard/Fidelity target date funds as your glide path, but WCI discusses many other reasonable approaches to adjusting your asset allocation as you get older.
3. Physician On Fire: Dr. E’s Path to Financial Independence: A High-Income Case Study – I love spreadsheets, and PoF discusses different scenarios for a high income / high expenses physician who wants to work less.
4. Dads, Dollars, Debts: I am a hypocrite! – DDD admits he spends a lot more than other financial bloggers, but to be honest, that’s ok! You can get away with it as a physician.
5. Go Finance Yourself!: Warren Buffett’s $1 Million Bet – Having written about this topic myself, I liked reading another person’s take on the infamous Warren Buffett vs. Hedge Fund bet, even if we disagree about actively managed mutual funds.

What do you think? Do you agree or disagree with any of my responses? What’s your take on the topics in this week’s forum mailbag?