*Lifecycle Investing*

That's the title of the new book by Ian Ayres and Barry Nalebuff and the subtitle is A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio.  Their point is simple: if diversification across asset classes is so good, why not also seek greater diversification across time periods?  In other words, you should want to hold stocks for longer periods of time and to do this when you are young you should incur additional debt to play the market.

Yikes!

They propose a fifty percent down payment on stocks when you are young, with the rest financed by leverage.  At another place in the book, they mention aiming to spend a constant fraction of lifetime savings on stock.

But is this less risky?  To what extent is this multiplication of risks (adding more time periods) and to what extent is it subdivision of risk (spreading a given sum of money across more stocks or across more time periods)?  To what extent does early investment sidestep the price risk of later periods, if you're holding the assets through that period anyway?  The authors do present various simulations where this strategy works out well.  They also argue that if you are pessimistic you should invest less in stock, but still spread out your investing over time.

If I were a young man, I would not take this plunge, mostly out of fear that a historically unique equity premium configuration was doing the major work of the argument.  Still, I found this to be a stimulating and well-written book with a clearly demarcated proposal for betterness. 

It was published by Basic Books, which also is putting out Jeff Miron's Libertarianism: From A to Z.

Comments

I used to discuss with a lot of people, never being quite confident in my position, that levering to buy a house increases the competition for the house and raises prices.

They would always roll their eyes and say something like "spreading the cost of an asset over the service life is perfectly reasonable." They were always 100% confident in their position.

One really confident guy argued that libertarianism was a joke because the government should at least be involved in supporting home ownership because home ownership is a good thing.

I bet these individuals don't remember those conversations.

Not to sound churlish, but since when are they financial experts? They are fine economists, but I don't see much evidence of a strong background in finance.

For those who don't want to wade through the book, the underlying economics is in this paper from 2008. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1139110

This is lifestyle investing for the rich and famous--wealthy kids from Yale whose parents are well diversified.

If you look at the Amazon reviews, here are the caveats STATED in the book:

Red flags #1, #2, #3, #4, #5, and #6 come from Ayres and Nalebuff themselves, who say you should not try their strategy if ANY of these situations apply to you:

* You have credit card debt.
* You have less than $4,000 to invest.
* Your employer matches contributions to a 401k plan.
* You need the money to pay for your kids' college education.
* Your salary is correlated with the market.
* You would worry too much about losing money.

Ask yourself: how many young people just getting out of college do not have any of these red flags apply to them. The only ones I know are the kids whose parents paid their way to Yale, come out debt free, and, because of parent wealth, go into wealth management on Wall Street. There are such people, I know many of them, and this book is for them.

But, not for many others.

From the same review Bill cites:

"A graduate student in economics read "Mortgage Your Retirement," a 2005 article by the same authors describing an earlier version of the plan, and tried it out. He used margin. He thought he was doing it right, but in 2008 he lost $200,000 of borrowed money, which he is slowly paying back. He says he probably will never buy stocks again. The authors mention this student in their book. Their take? He wasn't following their plan correctly."

It seems like the only caveat they need is to say "only use this plan if you are smarter than everyone else" and all their bases will be covered.

Incurring additional debt. What a great idea! Debt to buy a house. A note to buy early life insurance. A car loan. Student loans for education.

So when do you pay off this debt? When you have kids? (Ha) When your parents run through their savings and you have to help out? When you lose your job and have to spend 6 months looking for another one?

"They propose a fifty percent down payment on stocks when you are young, with the rest financed by leverage."

This is an idea that I had myself. I have advised my children to invest heavily in stock (whenever the yields are good) even going on margin from time to time (although being careful to avoid the margin man) while they are young. Of course I would not advise them to borrow at 10% interest to buy stocks if the VTI (Vanguard Total Stock Market ETF) PE is 10 or greater but say the VTI PE was 10 and you could borrow at 6%, that looks good. If you are young you can make up losses. Investing is all about yield and potential future yields. Today one might be able to borrow at 5.5 percent and buy utilities that yield 6%. For a person blow 30 that might be a good strategy.

If you were a young man, what would you do with your money?

The best strategy is patience, because the markets move according to their own timetables, not ours.

Young or old, it's very unwise to buy any asset during a bubble. A real-estate mortgage also represents diversification across time periods and was a spectacularly bad idea for so many people recently.

Conversely, when there's a crisis or a severe credit crunch, valuable assets pass from failing hands into stronger hands at attractive discounts. That's the time to step up to the plate with a fistful of dollars and an ounce of courage. You might have to wait a decade or so, patiently accumulating capital until you're ready to make your move.

Young people should leverage their best assets: their sharp minds, creative thinking, vast capacity to learn quickly, and (often) abundant spare time. They should invest in educating themselves about investing, and about the social, technological and demographic trends that drive long-term gains and losses of value. Also invest in improving your focus, time management and attention span. Read a lot. Never before in human history has there been such a firehose of valuable information available for free to so many on the Internet, never before have so many "open secrets" been in plain sight for months at a time (if not years) but lost amid all the distractions of our multitasking betwittered lives.

Hrm... doesn't greater long run safety imply reversion to some mean return? And wouldn't that actually imply that you could time the market over long timeframes, and just outperform it that way? Or in other words: what Dave (citing Arnold Kling) said. The whole stocks-are-better-in-the-long-run is basically one of the many lies that brokers tell in order to collect their commissions.
In any case, even if you can identify two classes of investments that appear to have independent variability in returns (thus giving you an opportunity to reduce overall risk via diversification) it is worth remembering that this independence is itself a finite resource that can and probably will be arbitraged away.

Glad to see someone has written a book on this fairly obvious concept. For years, I've made the argument to young folks starting their careers. If you consider your future salary to be like a bond, you start your career heavily weighted to fixed income. For actual invested assets, 100% of a small portfolio in stocks still leaves you overweighted to bond-like assets once you add in human capital's present value.

Add to this the fact that typical career spending patterns are backweighted, so you have a very long time horizon. The strategy makes perfect sense. It's mostly our aversion to regret with its focus on the starting point, and our liquidity needs, that make it counterintuitive.

If you treat the present value of salary like a bond, you'll also easily reach a more precise version of common rules of thumb on age and allocation to stocks. The salary-bond disappears as you reach retirement, although social security and any pension remain as bond-like assets.

Finally, let me add that conceptually the real risk-free asset wouldn't be bonds or T-bills, but an inflation indexed annuity kind of asset (assuming you have sufficient health and disability insurance).

I haven't read the book, but I have read the paper the book is based on. Mr. Ayres was kind enough to present the paper at my university two years ago. The theory to their argument is strong, but the paper's fatal weakness was that it required the individual to be able to borrow at the risk free rate, an assumption that is no where near reasonable (he contended during the presentation that while individuals can't borrow at the risk free rate they can short and hedge to effectively borrow at the risk free rate...an assumption that is also not feasible, due to SEC regulations).

Maybe they addressed this short coming in the book, or show that their strategy is still profitable with realistic borrowing costs (margin/shorting costs are often 2-3 times the risk free rate). If so I would be interested to look at it again. But if not then this is merely another example of the ivory tower pontificating and not worth serious consideration (I say this as an academic as well...).

A stock is not a hard asset. It is a claim on future earnings or on underlying assets, and therefore is a multiple of present earnings or a multiple of earnings-generating assets less leverage.

It is one thing to borrow to create an earnings stream from hard assets. It is quite another to pay a multiple of underlying asset value and to finance that from the income stream. You're better off opening your own business, or being an equity investor in a small business if you intend to finance your investment. At least then your earnings are paying down debt at a one-to-one multiple of hard assets.

Bbartlog, JRP's argument is actually quite valid in a lot of circumstances, e.g. if you're a tenured teacher. Your calling it "retarded" doesn't quite pass as a good counter-argument, I'm sorry to say.

Actually, Zvi Bodie -- after tearing down the Fallacy of Time Diversification -- explains JRP's argument in his financial markets book (by Bodie/Kane/Marcus). He also gives examples where the opposite is true, i.e. cases where someone might want to increase his allocation to equities as he gets older.

While we're at it, Bbartlog, impugning his motives is just childish. If you didn't understand his point, just ask for a clarification.

Comments for this post are closed