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Save like a pessimist, invest like an optimist

221 points by mtm7 6y ago

fairity 6y ago
One question that's been top of mind lately for me is how optimistic you should be in your investing strategy. IBK currently allows retail investors to trade on margin with an annual interest rate of only 1% (yes, really). You can borrow up to 2x your principle at this rate. If you were extremely optimistic, you would borrow 2x your principal and expect to 3x your annual return. If you were optimistic but wanted to avoid risk of ruin, you would borrow between 0-1x of your principal. Curious if anyone here has considered this or has a strong opinion on it. Side-note: I'm assuming my "principle" in the above scenarios is the remaining cash I have on hand after my rainy day fund (i.e. the saving like a pessimist part).
- kd5bjo 6y ago
  I personally don’t invest on margin. It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead. In short, there’s no set of circumstances where my decision tree comes down on the side of taking the loan.
  - fairity 6y ago
    > It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead. I see. Would your thinking change if your emergency fund was sufficiently large but much smaller than your investable cash? For example, let's say your rainy day fund was $10, and you have $100. You have $90 to invest. In this case, the short-term loan you're taking out could range from $0-270 (the majority of cases would not be covered by your rainy day fund).
    - kd5bjo 6y ago
      No. If a margin call came in a down market, it would wipe out my emergency fund; that’s the exact opposite of “saving like a pessimist.” If I have $90 to invest, then I have $90 to invest; I’m not going to gamble with someone else’s money whatever the odds.
      - deleted 6y ago
        [deleted]
      - smabie 6y ago
        Let's say you found a strategy that had 10% return and 1% volatility. you really wouldn't leverage this? Even after 4x leverage is applied, it would still be considerably less risky than the S&P 500.
        kd5bjo 6y ago
        Those numbers sound too good to be true. I’d stay as far away as possible, smelling a con. I certainly wouldn’t invest money I can’t afford to lose.
        smabie 6y ago
        They're not too good to be true. it's just the people making those kinds of returns aren't taking retail investment. For example in crypto, market makers are commonly making 100% return. You haven't heard of these firms and they aren't interested in your money. Market makers usually do quite well for themselves, but are capacity constrained: they can earn stellar returns on tens of millions of capital, but maybe not hundreds of millions or billions. You probably haven't heard of most of these firms and they would prefer to keep it that way. of course if you want a public example, look at RenTec. They are unique in generating eye popping returns with such a large amount of capital. This is extremely uncommon. However generating comparable returns on 500-1000x less capital is significantly more common. These returns often don't compound tho, as they are severely capacity constrained.
  - Moodles 6y ago
    I actually have a somewhat controversial opinion (that shouldn’t be controversial because it’s all math, but it still is regardless) that, after you save 5-6x your emergency fund, you don’t need an emergency fund at all and you’re better off investing it all in a total market index fund. The reason being that even if there is a market crash, you’ll still be able to afford the emergency since you’ve saved multiples of it already, and in general in the long run having stocks instead of cash or T-bonds in an EF will be better. Various blogs have done the math and it all checks out, but people still push back at me for this. Having an EF if your net worth is a few multiples of your emergency fund, is entirely psychological. Which is fine. But people should just be aware that it’s a bias they have. Perhaps investing on margin is the same. I have personally taken the leap and got rid of my emergency fund. But I haven’t looked at investing long-term on margin yet. I did see a test from HEDGEFUNDFIE on bogleheads forums about this. But I haven’t looked into it. I definitely think taking out a margin loan while simultaneously having an EF in cash makes no sense though.
    - fairity 6y ago
      I’ve thought about this too, and came to a different conclusion. The primary reason is just because the markets haven’t collapsed more than 85% over a months long period before, doesn’t mean it won’t in the future. And, my marginal utility for money gets so high below a certain level, that it’s not worth risking this outcome when the marginal utility of more money is relatively smaller.
      - Moodles 6y ago
        Yeah, it’s essentially just estimating the probability of you getting an emergency which coincides with a total market collapse so horrific it reduces your semi-liquid net worth to less than your emergency. I’m at a point where I’m ok with that risk. At some point you would be too: 85%? 90%? 99%? Clearly we agree Jeff Bezos doesn’t need 6 months cash on hand at all times. So the limit is somewhere. I think a total market collapse reducing the Dow Jones to like 3,000 is pretty unthinkable at this point. Or rather, if it did happen, there are bigger problems than my cash, like the zombie apocalypse which caused this horrific stock market collapse.
  - marcosdumay 6y ago
    I imagine that if there are large transaction costs on moving money out of your main investment, a short term load would make sense. I am personally too risk adverse to go taking loans all the time. But I can imagine it being a good option.
  - karmakaze 6y ago
    I myself also don't trade on margin, but I don't disagree with it. An optimal trading strategy should be positive and often could include some amount of margin trading that beats interest rates as well as accounting for additional risk. The reason I don't trade on margin is that I don't put so much effort into it to optimize to such a level.
  - smabie 6y ago
    Leverage allows the execution of strategies that have a high Sharpe but low natural return. I work at a small prop trading firm and we run 10x or even more leverage most of the time. Without leverage, we wouldn't be able to run the vast majority of our strategies. Basically, leverage is immaterial: what matters is the risk of the strategy. A leveraged strategy could be less risky than an unleveraged one. Things that you should consider when deciding leverage: beta exposure, correlation to the market, volatility of the strategy, and the risk adjusted return of the strategy. A classic example of this is risk parity: risk parity uses high leverage but is often safer than a classic 60/40 portfolio.
    - fairity 6y ago
      To be honest, what you just said went right over my head, but I really want to learn more. Can you recommend where to start given that the strategy I'm evaluating is akin to levering up 1x and investing in index funds?
      - smabie 6y ago
        I have a blog post I wrote awhile ago that might be of interest: Diversification, Risk and Leverage https://cryptm.org/posts/2019/11/28/div.html https://cryptm.org/posts/2019/11/28/div.html If I was rewriting the post today, I would make some changes, but by and large, I stand by the post.
        ptsneves 6y ago
        @smabie: Thanks a lot for the post. I am for the first time understanding concepts that in words were very hard to process. The math connection you make really helps, as basic calculus as statistics are part of an engineering background.
        smabie 6y ago
        I really appreciate it! Finance can be a really opaque topic and there's a lack of rigorous yet straightforward material about the subject. Most information about trading either falls into the total bullshit camp designed for idiot retail investors, or complex papers/books designed for academics or professionals. My blog tries to straddle the two: providing rigorous material but geared to those without a background in finance.
- deleted 6y ago
  [deleted]
- marioletto 6y ago
  I think the answer is more philosophical than a formula that applies to everyone: in that sense i would say: save like your pessimist self would save and invest like your optimistic self would do. Like a grandpa would say, "To Each Their Own" My optimistic self will probably always invest way more conservatively than someone investing on margin...
- spekcular 6y ago
  The book Lifecycle Investing by Nalebuff and Ayres, both professors at Yale, argues fairly convincingly that trading on margin is optimal for young people, especially those expecting high-earning careers (e.g. software developers). The calculations in the book use much more pessimistic annual interest rates than the 1% you quote, too. I'm too risk averse to actually do this, even though I believe their arguments. However, it has convinced me that at least 100% stocks, 0% bonds is optimal, if we avoid margin (for a young person expecting a good job).
  - paulpauper 6y ago
    path dependency is the main problem with margin trading. S^P 500 fell 60% in 2007-2008. So that should give you an idea of how much of a cushion you need to give yourself for the worse case scenario.
    - xchaotic 6y ago
      If this is just retirement money, so what? It rebounded pretty well since.
      - paulpauper 6y ago
        if you have have 100% margin and the market falls 50%, the broker will close out all your positions at a large loss to protect its own assets (often well before the 50% target), at which point it will not matter how much the market rebounds after that
- smabie 6y ago
  One should target volatility, not leverage. Without leverage, you can usually only take the most risky of strategies in order to get a return. If you're willing to take on leverage, you are much more likely to find a good strategy. Source: work at a small prop firm that takes on around 10x leverage. Even at this leverage ratio, we are considerably less risky than the S&P 500. Even at 10x, our volatility is somewhere between 1/2 to 1/3 of the S&P. If you take on very little directional risk and are doing stat arb like us, there's nothing wrong with taking on a lot of leverage. Even at 10x, we are safer than the vast majority of retail portfolios in existence. Leverage (through futures, options, shorts, or borrowing) is the cornerstone of almost all active outperformance in the industry. Without leverage, you will be forced into high beta names that trade at a premium compared to their risk adjusted return. See the "low beta anomaly" for more information.
  - marvin 6y ago
    And certainly you are well protected against black swan type events, even at 10x leverage...?
    - paulpauper 6y ago
      it really depends on the underlying asset. short dates bond trading involves large leverage because short-term bonds tend to not move much
    - smabie 6y ago
      Shit happens and even the smartest people can get fucked, just look at the LTCM blow up. So of course it's possible. It's impossible to eliminate all risk, regardless of the leverage ratio. I'm just saying that leverage isn't a reasonable proxy for risk. You have to dig deeper.
      - marvin 6y ago
        That sounds reasonable at first glance, but it would be really interesting to see a proper study of leveraged investments throughout the modern era, and their tendency to blow up compared to the volatility of what would be the reasonable alternative.
- paulpauper 6y ago
  Absolutely not because of risk of ruin owing to path dependency. I would recommend 2-3x ETFs instead because there is no risk of ruin but there are still possible path dependency issues.
- np_tedious 6y ago
  Do you mean IBKR, Interactive Brokers? I looked up IBK and was surprised to st Industrial Bank of Korea
  - fairity 6y ago
    Yea, typo. Interactive Brokers's margin loan rates are BM + 1% (or 1.09%, at present). https://www.interactivebrokers.com/en/index.php?f=46376 https://www.interactivebrokers.com/en/index.php?f=46376
jameslk 6y ago
The article is kind of fluffy. Not everyone should save and invest the same way. Someone who's closer to retirement shouldn't necessarily be investing like an "optimist" (i.e. more risky long-term portfolio), and they'll probably want more liquid assets than someone who's in their 20s with very limited obligations. Having an emergency fund can benefit everyone but beyond that your portfolio should ideally be driven by your goals and their timeline. If you have no goals and you're just trying to make as much money as possible in the stock market like a lot of new retail investors, this definitely should be given some thought. I think most could be better served by learning and applying goal-based investing and modern portfolio theory to achieve what this article is clumsily trying to suggest. https://en.wikipedia.org/wiki/Goal-based_investing https://en.wikipedia.org/wiki/Goal-based_investing https://en.wikipedia.org/wiki/Modern_portfolio_theory https://en.wikipedia.org/wiki/Modern_portfolio_theory
- gingerlime 6y ago
  My takeaway from the article was actually matching exactly what you're saying. You understand that investment in the long term should be profitable, but can be negative in the shorter term. And that's exactly why when you're younger you don't need to worry too much about bumps along the way, because you have a longer horizon. When you're older, your horizon is shorter and you have to adjust accordingly.
  - sokoloff 6y ago
    Unless you have more invested than you’ll plausibly need to withdraw, in which case your investment horizon can be longer than your lifetime. (My investing horizon is ideally more based on my future grandchildren’s lifespan than my own.)
    - gingerlime 6y ago
      very true. I was considering a narrower case. I think the key here is your own horizon (however near or far you see it)
    - chii 6y ago
lixtra 6y ago
> You could tell three things about Bill Gates pretty quickly. He was really smart. He was really competitive; he wanted to show you how smart he was. And he was really, really persistent. Of course he was also a lier (vapor ware). And a cut throat business man. You might like nowadays Bill Gates philanthropist, but there is a reason people hated him for decades. I don’t understand why retrospectives on him ignore this side.
- paulpauper 6y ago
  The vast majority of famous people also have a lot of haters
  - xenihn 6y ago
    You can't climb to the top without crushing a few throats.
- FpUser 6y ago
  >"Of course he was also a lier (vapor ware). And a cut throat business man." You could say the same thing about any business person. And the bigger the business the bigger are the qualities you mentioned (or should I say they just cause bigger effect). It is obvious. Also it is not reserved specifically for business person.
- earthtobishop 6y ago
  The author is quoting Paul Allen about his first impression of Bill Gates. How is him being a cut throat business man relevant at all ? This is a pointless comment.
- nprz 6y ago
  Public relations.
riffraff 6y ago
> Once the odds are in your favor, compounding takes hold. And then …. boom I am not sure this is all the story, the specific way in which you bet matters too. Consider investing in daily leveraged ETFs in contrast with non-leveraged ones, for example.
bittercynic 6y ago
Is there any way to estimate the total amount of investments that are vulnerable to a margin call or similar mechanisms that can force a sale during a downturn?
- tuberelay 6y ago
  Dow dropped 90% in great depression, so even trading the dow with 10% leverage would've wiped you out. Dow also dropped >50% in GFC, so 2x leverage would've ended you. Taking ultra risky bets when you are young is sensible because it isn't actually risky. This is because for a 30yo with good career prospects, your future career is probably worth an amortized $5 million dollars. If you have $200k in savings, that is only 4% of your true net worth. If you lose it, you still really have $5 million dollars. Therefore playing loose with it is pretty reasonable. If you're 63 and will retire in 2 years, your amortized future career earnings are probably $200k and your assets $5million, and then you should be conservative.
marioletto 6y ago
"Save like a pessimist, invest like an optimist." Beautiful! Just what i was looking for. So simple and reasonable. How did I not think of this before?
spaetzleesser 6y ago
My advice is “do your best but also have a certain amount of luck”
kulig 6y ago
Why do people get so obsessed instead of Just living life
yojo 6y ago
I’m skeptical of the closing claim that exponential growth keeps happening forever. Yes, you can grow GDP 2% for 200 years, that results in an economy 50x the start size. Expand it to 1000 years and you’re talking about an economy 400 million times as large. After 2100 years you’re up to an economy a QUINTILLION times as large. At some point the exponential curve has to go S-shaped. Maybe we’re still in the happy exponential looking part of the curve. There are also signs we might be transitioning. Population growth has slowed, productivity growth has slowed, and the marginal return on capital seems to be somewhere around zero given modern interest rates.
- emteycz 6y ago
  Consider the last 2000 years. The global market went from nothing to outlandish emperor-level luxuries available to multiple billions of humans + all the stuff that we have that even emperors didn't imagine. I think quintillion times growth in "actual value to humans" is not that off. And thinking about the next 2000 years, I don't see any hard limits there too.
  - ben_w 6y ago
    A quintillion is larger than the ratio of a synaptic refractory period and a human lifetime by a factor of about 1.5 million. Even with my optimism about transhumanism, I’d be very surprised if that was accurate or will ever be.
    - emteycz 6y ago
      It's not about transhumanism, it's simply the (Kardashev) scale of society.
- ericmay 6y ago
  Well, eventually what will happen is countries will disappear, wars will destroy things, and other events will wipe out economies, savings, or entire companies. The growth model will probably always be exponential, but from time to time things will reset to 0.
a4444f 6y ago
Save like a donkey, invest like a monkey.
RickJWagner 6y ago
1. Live below your means, always. 2. Have an appropriate allocation in stocks and fixed income. 3. Prosper.
GoodJokes 6y ago
Bill gates never took risk. He could always fall back on his family, which is the main problem with the article. Before you save and before you invest you have to have a good amount of money.
simonebrunozzi 6y ago
The entire blog post is just a platitude. I didn't get anything out of it.
sanderjd 6y ago
I'm totally philosophically aligned with this article and enjoyed reading it, but I'm just interested to hear whether anyone else has this problem: More and more stuff I read seems to be name-droppy like this. For instance, I've been reading "The Psychology of Money" recently, and I'm enjoying it, but its style is a lot like this article; an endless series of anecdotes about famous and semi-famous people, with insights from the author tying them together. Is this a new trend of some kind, or has it just become more obvious to me lately? Edit: Ha! I did not catch the part at the end where this is the same author as that book. Ok then!
- idoh 6y ago
  It’s not a new trend, it is common in non fiction writing. Everything Malcolm Gladwell writes is in this style, and the same for many non fiction business / self help type books.
  - paulpauper 6y ago
    It is annoying though when it get voted to the front page. You are expecting something that is interesting or insightful and it is just generic, repackaged investment insights/aphorisms/advice that is used as an indirect sales pitch to promote a likely equally mediocre investing service.
  - ajot 6y ago
    "There’s this writing style in popular non-fiction that I’ll call the ‘Malcolm Gladwell method of shoving-a-story-in-your-face’. It substitutes argumentation for storytelling and anecdote, and in so doing sidesteps the difficulty of making a case, since the reader is too distracted by narrative to comprehend the point the author is actually attempting to make. Whenever this happens, I take care to pay special attention, because often the point is banal, or flawed, or too inconsequential to stand on its own. (I happen to know this because I’ve used this technique a few times on this very blog, and I know from reader feedback how effective it is)." https://commoncog.com/blog/range-book-summary/ https://commoncog.com/blog/range-book-summary/
- jnsie 6y ago
hsbauauvhabzb 6y ago
‘Bankroll management’ concepts in the poker community were a fantastic learning tool about concepts such as variance and risk of ruin. The ‘tldr’ recommendation is to keep 20 x buyins of a cash game or 100 x for tournaments, but inside the nitty gritty, as Opponent skill increases proportionally to your own, Winrate decreases, meaning more buyins are required to offset risk. ‘Running bad’ can last hundreds of thousands of hands too - 100-year disasters happen every few hundred hands in what mentally seems mathematically improbable is actually likely to happen at an unexpectedly high frequency. Even if you have a 10,000 buyin bankroll, there’s no guarantee you won’t go bust even with a significant skill edge. Be a slight losing player and you will forever appear to be ‘running bad’ but just turns out you suck. Applying this to real world business concepts is interesting too - corona was a great example, and for all we know next year could be unrelated total world war, past has some indication of future trends but only when the sample size is substantially large (in the case of geopolitics and disasters, all known global history is an insignificant sample)
paulpauper 6y ago
pretty generic advice >Compounding is easy to underestimate because it’s not intuitive, even for smart people. Michael Batnick once explained it. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8x8x8x8x8x8x8x8x8, your head will explode (it’s 134,217,728). what does this have to do with anything. no kidding that multiplication is harder than addition (it requires many additions). Using Microsoft and Bill Gates as an examples is major example of survivorship bias. What about the hundreds or thousands of other companies and founders that tried such an approach and still failed. Yeah, in hindsight anything Microsoft does will look like genius given how successful Bill Gates and Microsoft are. if Bill gates had policy of tying his shoes at work instead of at home, people would probably read into that as part of his success.
el_nahual 6y ago
I'm a foreigner that's lived in the US since college. Half of my friends and family are american and the rest foreign. There's a huge cultural difference between both sides' approach to wealth. My american f&f (outside of silicon valley) think of wealth in terms of "saving for retirement." 401ks, tax strategies, etfs, stocks etc. It's very passive, probably "correct", and very unambitious. The foreign side is totally different. They have very little interest in saving for retirement--they think in terms of investing in businesses. They don't buy etfs or stocks. They buy (small, then larger) businesses. It's very active and after age 40 or so takes up most of their time. The goal is to never retire, but rather to build a series of cash producing entities for ever. Part of this is certainly cultural. In lots of the world, being a boss is higher status that being an *employee", regardless of the actual income each activity generates. The owner of a business with 200k in revenue is higher status than a McKinsey employee with a 500k salary. This cultural difference is reflected in a desire to escape "wages" as soon as possible, not necessarily "save for retirement".
- darkerside 6y ago
  > The owner of a business with 200k in revenue is higher status than a McKinsey employee with a 500k salary. What makes you say that?
  - yeetman21 6y ago
    He can sell the business or still run it in retirement, McKinsey employee works 25 hours a day and is a slave to his boss
    - icedchai 6y ago
      A small business like that is likely very, very dependent on its owner. The owner may be a slave to his customers. The employee can just walk away.
      - darkerside 6y ago
        Exactly. You don't make money without having a boss (or many bosses).
xcambar 6y ago
I wonder if the author had Antonio Gramsci in mind during the redaction. It would be pretty funny they hadn’t.

221 points by mtm7 6y ago

One question that's been top of mind lately for me is how optimistic you should be in your investing strategy. IBK currently allows retail investors to trade on margin with an annual interest rate of only 1% (yes, really). You can borrow up to 2x your principle at this rate. If you were extremely optimistic, you would borrow 2x your principal and expect to 3x your annual return. If you were optimistic but wanted to avoid risk of ruin, you would borrow between 0-1x of your principal. Curious if anyone here has considered this or has a strong opinion on it. Side-note: I'm assuming my "principle" in the above scenarios is the remaining cash I have on hand after my rainy day fund (i.e. the saving like a pessimist part).

kd5bjo 6y ago
I personally don’t invest on margin. It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead. In short, there’s no set of circumstances where my decision tree comes down on the side of taking the loan.
- fairity 6y ago
  > It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead. I see. Would your thinking change if your emergency fund was sufficiently large but much smaller than your investable cash? For example, let's say your rainy day fund was $10, and you have $100. You have $90 to invest. In this case, the short-term loan you're taking out could range from $0-270 (the majority of cases would not be covered by your rainy day fund).
  - kd5bjo 6y ago
    No. If a margin call came in a down market, it would wipe out my emergency fund; that’s the exact opposite of “saving like a pessimist.” If I have $90 to invest, then I have $90 to invest; I’m not going to gamble with someone else’s money whatever the odds.
    - deleted 6y ago
      [deleted]
    - smabie 6y ago
      Let's say you found a strategy that had 10% return and 1% volatility. you really wouldn't leverage this? Even after 4x leverage is applied, it would still be considerably less risky than the S&P 500.
      - kd5bjo 6y ago
        Those numbers sound too good to be true. I’d stay as far away as possible, smelling a con. I certainly wouldn’t invest money I can’t afford to lose.
        smabie 6y ago
        They're not too good to be true. it's just the people making those kinds of returns aren't taking retail investment. For example in crypto, market makers are commonly making 100% return. You haven't heard of these firms and they aren't interested in your money. Market makers usually do quite well for themselves, but are capacity constrained: they can earn stellar returns on tens of millions of capital, but maybe not hundreds of millions or billions. You probably haven't heard of most of these firms and they would prefer to keep it that way. of course if you want a public example, look at RenTec. They are unique in generating eye popping returns with such a large amount of capital. This is extremely uncommon. However generating comparable returns on 500-1000x less capital is significantly more common. These returns often don't compound tho, as they are severely capacity constrained.
- Moodles 6y ago
  I actually have a somewhat controversial opinion (that shouldn’t be controversial because it’s all math, but it still is regardless) that, after you save 5-6x your emergency fund, you don’t need an emergency fund at all and you’re better off investing it all in a total market index fund. The reason being that even if there is a market crash, you’ll still be able to afford the emergency since you’ve saved multiples of it already, and in general in the long run having stocks instead of cash or T-bonds in an EF will be better. Various blogs have done the math and it all checks out, but people still push back at me for this. Having an EF if your net worth is a few multiples of your emergency fund, is entirely psychological. Which is fine. But people should just be aware that it’s a bias they have. Perhaps investing on margin is the same. I have personally taken the leap and got rid of my emergency fund. But I haven’t looked at investing long-term on margin yet. I did see a test from HEDGEFUNDFIE on bogleheads forums about this. But I haven’t looked into it. I definitely think taking out a margin loan while simultaneously having an EF in cash makes no sense though.
  - fairity 6y ago
    I’ve thought about this too, and came to a different conclusion. The primary reason is just because the markets haven’t collapsed more than 85% over a months long period before, doesn’t mean it won’t in the future. And, my marginal utility for money gets so high below a certain level, that it’s not worth risking this outcome when the marginal utility of more money is relatively smaller.
    - Moodles 6y ago
      Yeah, it’s essentially just estimating the probability of you getting an emergency which coincides with a total market collapse so horrific it reduces your semi-liquid net worth to less than your emergency. I’m at a point where I’m ok with that risk. At some point you would be too: 85%? 90%? 99%? Clearly we agree Jeff Bezos doesn’t need 6 months cash on hand at all times. So the limit is somewhere. I think a total market collapse reducing the Dow Jones to like 3,000 is pretty unthinkable at this point. Or rather, if it did happen, there are bigger problems than my cash, like the zombie apocalypse which caused this horrific stock market collapse.
- marcosdumay 6y ago
  I imagine that if there are large transaction costs on moving money out of your main investment, a short term load would make sense. I am personally too risk adverse to go taking loans all the time. But I can imagine it being a good option.
- karmakaze 6y ago
  I myself also don't trade on margin, but I don't disagree with it. An optimal trading strategy should be positive and often could include some amount of margin trading that beats interest rates as well as accounting for additional risk. The reason I don't trade on margin is that I don't put so much effort into it to optimize to such a level.
- smabie 6y ago
  Leverage allows the execution of strategies that have a high Sharpe but low natural return. I work at a small prop trading firm and we run 10x or even more leverage most of the time. Without leverage, we wouldn't be able to run the vast majority of our strategies. Basically, leverage is immaterial: what matters is the risk of the strategy. A leveraged strategy could be less risky than an unleveraged one. Things that you should consider when deciding leverage: beta exposure, correlation to the market, volatility of the strategy, and the risk adjusted return of the strategy. A classic example of this is risk parity: risk parity uses high leverage but is often safer than a classic 60/40 portfolio.
  - fairity 6y ago
    To be honest, what you just said went right over my head, but I really want to learn more. Can you recommend where to start given that the strategy I'm evaluating is akin to levering up 1x and investing in index funds?
    - smabie 6y ago
      I have a blog post I wrote awhile ago that might be of interest: Diversification, Risk and Leverage https://cryptm.org/posts/2019/11/28/div.html https://cryptm.org/posts/2019/11/28/div.html If I was rewriting the post today, I would make some changes, but by and large, I stand by the post.
      - ptsneves 6y ago
        @smabie: Thanks a lot for the post. I am for the first time understanding concepts that in words were very hard to process. The math connection you make really helps, as basic calculus as statistics are part of an engineering background.
        smabie 6y ago
        I really appreciate it! Finance can be a really opaque topic and there's a lack of rigorous yet straightforward material about the subject. Most information about trading either falls into the total bullshit camp designed for idiot retail investors, or complex papers/books designed for academics or professionals. My blog tries to straddle the two: providing rigorous material but geared to those without a background in finance.
deleted 6y ago
[deleted]
marioletto 6y ago
I think the answer is more philosophical than a formula that applies to everyone: in that sense i would say: save like your pessimist self would save and invest like your optimistic self would do. Like a grandpa would say, "To Each Their Own" My optimistic self will probably always invest way more conservatively than someone investing on margin...
spekcular 6y ago
The book Lifecycle Investing by Nalebuff and Ayres, both professors at Yale, argues fairly convincingly that trading on margin is optimal for young people, especially those expecting high-earning careers (e.g. software developers). The calculations in the book use much more pessimistic annual interest rates than the 1% you quote, too. I'm too risk averse to actually do this, even though I believe their arguments. However, it has convinced me that at least 100% stocks, 0% bonds is optimal, if we avoid margin (for a young person expecting a good job).
- paulpauper 6y ago
  path dependency is the main problem with margin trading. S^P 500 fell 60% in 2007-2008. So that should give you an idea of how much of a cushion you need to give yourself for the worse case scenario.
  - xchaotic 6y ago
    If this is just retirement money, so what? It rebounded pretty well since.
    - paulpauper 6y ago
      if you have have 100% margin and the market falls 50%, the broker will close out all your positions at a large loss to protect its own assets (often well before the 50% target), at which point it will not matter how much the market rebounds after that
smabie 6y ago
One should target volatility, not leverage. Without leverage, you can usually only take the most risky of strategies in order to get a return. If you're willing to take on leverage, you are much more likely to find a good strategy. Source: work at a small prop firm that takes on around 10x leverage. Even at this leverage ratio, we are considerably less risky than the S&P 500. Even at 10x, our volatility is somewhere between 1/2 to 1/3 of the S&P. If you take on very little directional risk and are doing stat arb like us, there's nothing wrong with taking on a lot of leverage. Even at 10x, we are safer than the vast majority of retail portfolios in existence. Leverage (through futures, options, shorts, or borrowing) is the cornerstone of almost all active outperformance in the industry. Without leverage, you will be forced into high beta names that trade at a premium compared to their risk adjusted return. See the "low beta anomaly" for more information.
- marvin 6y ago
  And certainly you are well protected against black swan type events, even at 10x leverage...?
  - paulpauper 6y ago
    it really depends on the underlying asset. short dates bond trading involves large leverage because short-term bonds tend to not move much
  - smabie 6y ago
    Shit happens and even the smartest people can get fucked, just look at the LTCM blow up. So of course it's possible. It's impossible to eliminate all risk, regardless of the leverage ratio. I'm just saying that leverage isn't a reasonable proxy for risk. You have to dig deeper.
    - marvin 6y ago
      That sounds reasonable at first glance, but it would be really interesting to see a proper study of leveraged investments throughout the modern era, and their tendency to blow up compared to the volatility of what would be the reasonable alternative.
paulpauper 6y ago
Absolutely not because of risk of ruin owing to path dependency. I would recommend 2-3x ETFs instead because there is no risk of ruin but there are still possible path dependency issues.
np_tedious 6y ago
Do you mean IBKR, Interactive Brokers? I looked up IBK and was surprised to st Industrial Bank of Korea
- fairity 6y ago
  Yea, typo. Interactive Brokers's margin loan rates are BM + 1% (or 1.09%, at present). https://www.interactivebrokers.com/en/index.php?f=46376 https://www.interactivebrokers.com/en/index.php?f=46376

jameslk 6y ago

The article is kind of fluffy. Not everyone should save and invest the same way. Someone who's closer to retirement shouldn't necessarily be investing like an "optimist" (i.e. more risky long-term portfolio), and they'll probably want more liquid assets than someone who's in their 20s with very limited obligations. Having an emergency fund can benefit everyone but beyond that your portfolio should ideally be driven by your goals and their timeline. If you have no goals and you're just trying to make as much money as possible in the stock market like a lot of new retail investors, this definitely should be given some thought. I think most could be better served by learning and applying goal-based investing and modern portfolio theory to achieve what this article is clumsily trying to suggest. https://en.wikipedia.org/wiki/Goal-based_investing https://en.wikipedia.org/wiki/Goal-based_investing https://en.wikipedia.org/wiki/Modern_portfolio_theory https://en.wikipedia.org/wiki/Modern_portfolio_theory

gingerlime 6y ago
My takeaway from the article was actually matching exactly what you're saying. You understand that investment in the long term should be profitable, but can be negative in the shorter term. And that's exactly why when you're younger you don't need to worry too much about bumps along the way, because you have a longer horizon. When you're older, your horizon is shorter and you have to adjust accordingly.
- sokoloff 6y ago
  Unless you have more invested than you’ll plausibly need to withdraw, in which case your investment horizon can be longer than your lifetime. (My investing horizon is ideally more based on my future grandchildren’s lifespan than my own.)
  - gingerlime 6y ago
    very true. I was considering a narrower case. I think the key here is your own horizon (however near or far you see it)
  - chii 6y ago

lixtra 6y ago

> You could tell three things about Bill Gates pretty quickly. He was really smart. He was really competitive; he wanted to show you how smart he was. And he was really, really persistent. Of course he was also a lier (vapor ware). And a cut throat business man. You might like nowadays Bill Gates philanthropist, but there is a reason people hated him for decades. I don’t understand why retrospectives on him ignore this side.

paulpauper 6y ago
The vast majority of famous people also have a lot of haters
- xenihn 6y ago
  You can't climb to the top without crushing a few throats.
FpUser 6y ago
>"Of course he was also a lier (vapor ware). And a cut throat business man." You could say the same thing about any business person. And the bigger the business the bigger are the qualities you mentioned (or should I say they just cause bigger effect). It is obvious. Also it is not reserved specifically for business person.
earthtobishop 6y ago
The author is quoting Paul Allen about his first impression of Bill Gates. How is him being a cut throat business man relevant at all ? This is a pointless comment.
nprz 6y ago
Public relations.

riffraff 6y ago

> Once the odds are in your favor, compounding takes hold. And then …. boom I am not sure this is all the story, the specific way in which you bet matters too. Consider investing in daily leveraged ETFs in contrast with non-leveraged ones, for example.

bittercynic 6y ago

Is there any way to estimate the total amount of investments that are vulnerable to a margin call or similar mechanisms that can force a sale during a downturn?

tuberelay 6y ago
Dow dropped 90% in great depression, so even trading the dow with 10% leverage would've wiped you out. Dow also dropped >50% in GFC, so 2x leverage would've ended you. Taking ultra risky bets when you are young is sensible because it isn't actually risky. This is because for a 30yo with good career prospects, your future career is probably worth an amortized $5 million dollars. If you have $200k in savings, that is only 4% of your true net worth. If you lose it, you still really have $5 million dollars. Therefore playing loose with it is pretty reasonable. If you're 63 and will retire in 2 years, your amortized future career earnings are probably $200k and your assets $5million, and then you should be conservative.

marioletto 6y ago

"Save like a pessimist, invest like an optimist." Beautiful! Just what i was looking for. So simple and reasonable. How did I not think of this before?

spaetzleesser 6y ago

My advice is “do your best but also have a certain amount of luck”

kulig 6y ago

Why do people get so obsessed instead of Just living life

yojo 6y ago

I’m skeptical of the closing claim that exponential growth keeps happening forever. Yes, you can grow GDP 2% for 200 years, that results in an economy 50x the start size. Expand it to 1000 years and you’re talking about an economy 400 million times as large. After 2100 years you’re up to an economy a QUINTILLION times as large. At some point the exponential curve has to go S-shaped. Maybe we’re still in the happy exponential looking part of the curve. There are also signs we might be transitioning. Population growth has slowed, productivity growth has slowed, and the marginal return on capital seems to be somewhere around zero given modern interest rates.

emteycz 6y ago
Consider the last 2000 years. The global market went from nothing to outlandish emperor-level luxuries available to multiple billions of humans + all the stuff that we have that even emperors didn't imagine. I think quintillion times growth in "actual value to humans" is not that off. And thinking about the next 2000 years, I don't see any hard limits there too.
- ben_w 6y ago
  A quintillion is larger than the ratio of a synaptic refractory period and a human lifetime by a factor of about 1.5 million. Even with my optimism about transhumanism, I’d be very surprised if that was accurate or will ever be.
  - emteycz 6y ago
    It's not about transhumanism, it's simply the (Kardashev) scale of society.
ericmay 6y ago
Well, eventually what will happen is countries will disappear, wars will destroy things, and other events will wipe out economies, savings, or entire companies. The growth model will probably always be exponential, but from time to time things will reset to 0.

a4444f 6y ago

Save like a donkey, invest like a monkey.

RickJWagner 6y ago

1. Live below your means, always. 2. Have an appropriate allocation in stocks and fixed income. 3. Prosper.

GoodJokes 6y ago

Bill gates never took risk. He could always fall back on his family, which is the main problem with the article. Before you save and before you invest you have to have a good amount of money.

simonebrunozzi 6y ago

The entire blog post is just a platitude. I didn't get anything out of it.

sanderjd 6y ago

I'm totally philosophically aligned with this article and enjoyed reading it, but I'm just interested to hear whether anyone else has this problem: More and more stuff I read seems to be name-droppy like this. For instance, I've been reading "The Psychology of Money" recently, and I'm enjoying it, but its style is a lot like this article; an endless series of anecdotes about famous and semi-famous people, with insights from the author tying them together. Is this a new trend of some kind, or has it just become more obvious to me lately? Edit: Ha! I did not catch the part at the end where this is the same author as that book. Ok then!

idoh 6y ago
It’s not a new trend, it is common in non fiction writing. Everything Malcolm Gladwell writes is in this style, and the same for many non fiction business / self help type books.
- paulpauper 6y ago
  It is annoying though when it get voted to the front page. You are expecting something that is interesting or insightful and it is just generic, repackaged investment insights/aphorisms/advice that is used as an indirect sales pitch to promote a likely equally mediocre investing service.
- ajot 6y ago
  "There’s this writing style in popular non-fiction that I’ll call the ‘Malcolm Gladwell method of shoving-a-story-in-your-face’. It substitutes argumentation for storytelling and anecdote, and in so doing sidesteps the difficulty of making a case, since the reader is too distracted by narrative to comprehend the point the author is actually attempting to make. Whenever this happens, I take care to pay special attention, because often the point is banal, or flawed, or too inconsequential to stand on its own. (I happen to know this because I’ve used this technique a few times on this very blog, and I know from reader feedback how effective it is)." https://commoncog.com/blog/range-book-summary/ https://commoncog.com/blog/range-book-summary/
jnsie 6y ago

hsbauauvhabzb 6y ago

‘Bankroll management’ concepts in the poker community were a fantastic learning tool about concepts such as variance and risk of ruin. The ‘tldr’ recommendation is to keep 20 x buyins of a cash game or 100 x for tournaments, but inside the nitty gritty, as Opponent skill increases proportionally to your own, Winrate decreases, meaning more buyins are required to offset risk. ‘Running bad’ can last hundreds of thousands of hands too - 100-year disasters happen every few hundred hands in what mentally seems mathematically improbable is actually likely to happen at an unexpectedly high frequency. Even if you have a 10,000 buyin bankroll, there’s no guarantee you won’t go bust even with a significant skill edge. Be a slight losing player and you will forever appear to be ‘running bad’ but just turns out you suck. Applying this to real world business concepts is interesting too - corona was a great example, and for all we know next year could be unrelated total world war, past has some indication of future trends but only when the sample size is substantially large (in the case of geopolitics and disasters, all known global history is an insignificant sample)

paulpauper 6y ago

pretty generic advice >Compounding is easy to underestimate because it’s not intuitive, even for smart people. Michael Batnick once explained it. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8x8x8x8x8x8x8x8x8, your head will explode (it’s 134,217,728). what does this have to do with anything. no kidding that multiplication is harder than addition (it requires many additions). Using Microsoft and Bill Gates as an examples is major example of survivorship bias. What about the hundreds or thousands of other companies and founders that tried such an approach and still failed. Yeah, in hindsight anything Microsoft does will look like genius given how successful Bill Gates and Microsoft are. if Bill gates had policy of tying his shoes at work instead of at home, people would probably read into that as part of his success.

el_nahual 6y ago

I'm a foreigner that's lived in the US since college. Half of my friends and family are american and the rest foreign. There's a huge cultural difference between both sides' approach to wealth. My american f&f (outside of silicon valley) think of wealth in terms of "saving for retirement." 401ks, tax strategies, etfs, stocks etc. It's very passive, probably "correct", and very unambitious. The foreign side is totally different. They have very little interest in saving for retirement--they think in terms of investing in businesses. They don't buy etfs or stocks. They buy (small, then larger) businesses. It's very active and after age 40 or so takes up most of their time. The goal is to never retire, but rather to build a series of cash producing entities for ever. Part of this is certainly cultural. In lots of the world, being a boss is higher status that being an *employee", regardless of the actual income each activity generates. The owner of a business with 200k in revenue is higher status than a McKinsey employee with a 500k salary. This cultural difference is reflected in a desire to escape "wages" as soon as possible, not necessarily "save for retirement".

darkerside 6y ago
> The owner of a business with 200k in revenue is higher status than a McKinsey employee with a 500k salary. What makes you say that?
- yeetman21 6y ago
  He can sell the business or still run it in retirement, McKinsey employee works 25 hours a day and is a slave to his boss
  - icedchai 6y ago
    A small business like that is likely very, very dependent on its owner. The owner may be a slave to his customers. The employee can just walk away.
    - darkerside 6y ago
      Exactly. You don't make money without having a boss (or many bosses).

xcambar 6y ago

I wonder if the author had Antonio Gramsci in mind during the redaction. It would be pretty funny they hadn’t.