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Save like a pessimist, invest like an optimist

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Re: Save like a pessimist, invest like an optimist

#31

Post by Moodles »

pedrosorio wrote: post #29
Moodles wrote: post #25

Earlier quoted context omitted.

Because there are actually two goals, not one: 1. To have enough money to survive an emergency no matter what. 2. To maximize long-term net worth on average. I was only talking about 1. You are talking about 2. But, to address your point: yes, stocks can indeed go down, but on average they go up. Sometimes your emergency will coincide with a good stock market. You're literally choosing the worst possible situation an…

People don’t keep EFs to maximize their expected net worth. They do it to keep worst case scenarios within reasonable bounds. You argue keeping stocks is ideal for 2 (sure) and it doesn’t hurt 1 (assuming your net worth is significantly higher than what you’d keep as EF). Agreed. An EF is for 3. Maximize long-term net worth in x th percentile of outcomes (where x EDIT: “ you must really be against investing on margin…

Ok but now we're just personally disagreeing on what x is, which as I said in my first post, is fine. But just be aware of the bias.

Re: Save like a pessimist, invest like an optimist

#32

Post by spekcular »

fairity wrote: post #2

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 a…

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).

Re: Save like a pessimist, invest like an optimist

#33

Post by karmakaze »

kd5bjo wrote: post #3
fairity wrote: post #2

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 a…

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.

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.

Re: Save like a pessimist, invest like an optimist

#34

Post by gingerlime »

jameslk wrote: post #7

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 b…

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.

Re: Save like a pessimist, invest like an optimist

#35

Post by imtringued »

Moodles wrote: post #6
kd5bjo wrote: post #3

Earlier quoted context omitted.

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.

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…

You have $100k. Put 80% of it in the stock market. The stock market drops by 40%, your investment is worth $48k and you withdraw nothing but spend your entire emergency fund. The market recovers and now your portfolio is worth $80k.

You have $100k. Put all of it in the stock market. The stock market drops by 40%, your investment is worth $60k and you withdraw $20k. The market goes back to 100% and now you have $67k in your portfolio.

If the market dropped by 80% your portfolio would be gone entirely. Meanwhile if you had enough emergency funds you would have kept everything.

The worse the emergency, the higher the ROI of the emergency fund. Since there is no upper bound for how bad an emergency can be the theoretical ROI of an emergency fund is also unbounded.

In this comment the definition of an emergency is a stock market drop combined with unexpected unemployment.

Re: Save like a pessimist, invest like an optimist

#36

Post by tuberelay »

bittercynic wrote: post #17

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?

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.

Re: Save like a pessimist, invest like an optimist

#37

Post by sokoloff »

imtringued wrote: post #35
Moodles wrote: post #6

Earlier quoted context omitted.

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…

You have $100k. Put 80% of it in the stock market. The stock market drops by 40%, your investment is worth $48k and you withdraw nothing but spend your entire emergency fund. The market recovers and now your portfolio is worth $80k. You have $100k. Put all of it in the stock market. The stock market drops by 40%, your investment is worth $60k and you withdraw $20k. The market goes back to 100% and now you have $67k i…

That’s another use of margin. Invest 100% (but not more). Emergency hits and you can withdraw cash without selling stocks (up to a point).

Re: Save like a pessimist, invest like an optimist

#38

Post by sokoloff »

gingerlime wrote: post #34
jameslk wrote: post #7

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 b…

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.

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.)

Re: Save like a pessimist, invest like an optimist

#39

Post by yojo »

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.

Re: Save like a pessimist, invest like an optimist

#40

Post by gingerlime »

sokoloff wrote: post #38
gingerlime wrote: post #34

Earlier quoted context omitted.

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.

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.)

very true. I was considering a narrower case. I think the key here is your own horizon (however near or far you see it)
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