I liked — and still like — the fundamental idea here, which Nalebuff sloganizes very well:
Another way of saying it is we believe in stocks for the long run, but most people when they have lots of stocks don’t have the long run and when they have the long run don’t have lots of stocks.
What I’m not at all sure about is the practical mechanics of doing this:
Ayres: That’s a good question. If 2-to-1 is great, why not go to 3-to-1 or 4-to-1? The answer is, the cost of levering becomes too expensive. One of the great pieces of news in this book is that it’s really cheap to borrow money to take levered positions in stock at a 2-to-1 rate. But if you go beyond 3-to-1, it gets prohibitively expensive to borrow money…
Over the past 138 years, the wholesale lending rate for margin loans was just 0.34 percentage points above the T-bill rate. Don’t do it from Vanguard or Fidelity — they don’t have competitive margin rates. But if you shop around places like Interactive Brokers, you can basically borrow very close to the T-bill rate, if you stay at a 2-to-1 basis.
Nalebuff: It’s also possible to do this via long-term options. Ideally, this idea will catch on and there will be funds that do it for you. Today there are a few, like the Ultra Bull fund from ProFunds.
There’s a lot not to like here — starting with the idea of 20-year-olds opening up margin accounts at Interactive Brokers, and continuing with the fact that things like the Ultra Bull fund have a tendency to underperform the stock market even when the stock market is rising. When I first wrote about this idea, I quoted John Waggoner, who pointed out that over the previous five years, the Ultra Bull fund was up 8.8%, while the S&P 500 was up 18.6%.
That was in April 2008, when the Ultra Bull fund was trading at about $60 per share. Since then, it fell to less than $15; it’s still under $40. The fund has high fees; what’s more, it exacerbates the fact that stocks are volatile, and that if you go down 10% and then up 10%, or up 10% and then down 10%, you end up lower than where you started. While I like the idea of adding a bit of leverage to your portfolio when you’re young, I don’t like the idea of doing so via an ETF like this one, and I’m very worried about the fact that Nalebuff is citing it as a possibility.
More generally the amount of discipline that you need in order to successfully prosecute this strategy is absolutely enormous, and human beings tend not to be particularly financially disciplined, especially when they’re young. They’ll abandon the buy-and-hold strategy at exactly the wrong time, selling low and then buying back in at high points; they’ll start using their margin account to try to pick stocks or trade options; they’ll use any profits on expenses rather than keeping them invested and letting them compound.
Meanwhile, of course, the Wall Street institutions letting you borrow on margin are going to be encouraging you to do all those things, while making it as hard as possible for a 20-something to get anything near “the wholesale lending rate for margin loans”.
I haven’t read the book, and so I don’t know how much detail it goes into with respect to actually doing this in reality. But if the best that the authors can come up with is a strategy of buying and rolling over deep-in-the-money LEAP call options, I wouldn’t recommend this to anybody except the extremely financially sophisticated. Who are probably going to make lots of money over their lifetime anyway.