Article Review: Leverage for the Long Run

"Leverage for the Long Run" is one of my favorite articles. It shows that young investors should start by using leverage early on, and only once you meet your investment goals should you pull back and take less risk. In the long run, leverage is less risky as your overall returns are higher. In a stock market crash, you could lose 60% and still have more than very conservative investments like bonds.

I wish I knew about this 5 years ago. I could have had much higher returns, especially in this never-ending bull market post 2011.

Electronic copy available at: https://ssrn.com/abstract=2741701 

Leverage for the Long Run PDF

 

My Experience using Leverage/Margin

I started using margin in 2021, after many years of using a cash only account. I read a lot of articles spreading FUD (fear, uncertainty, and doubt) about using margin. They told stories of how people lost all their money very quickly using margin, leveraged ETFs, and options.  So I was terrified and never even considered using margin for many years. One day, I started using 3x leveraged ETFs during big stock market selloffs (15% drawdown), buying TQQQ at the dip. I was amazed at how quickly I was able to make money. The conventional wisdom says that it is only for the short term, but the chart clearly shows it's great performer as a long term hold. I did deeper research into using leverage, including actual research articles and extensive backtesting on historical data. I found it was actually an excellent idea to use leverage. Ever since, I converted my account to a margin account, which was the same concept but more versatile. 

The issue was the margin interest was 7.5%. During the bull market since 2011, the 7.5% interest is not a problem since it is easy to make 30% or greater returns almost every year. But during bad times, that 7.5% interest would really sting. Thus, I looked for a stock brokerage with cheaper margin. This led me to find M1 Finance and Interactive Brokers. Interactive Brokers (IBKR) had the cheapest margin at 1.6%, but goes down to less than 1% if you borrow more money. Their rate is based on the overnight Fed funds rate, so it is far lower than any other broker. 

So, I got a portfolio margin account at IBKR. They allow up to a 10x leverage if you use an index fund such as VOO. Most stocks are 5x leverage. For very volatile stocks, unfortunately you can't use leverage during times of volatility. Once my stocks went up every day for a couple weeks, yet I still almost got margin called because their algorithm stopped allowing margin on one of my stocks. The reason people fear using margin to invest in stocks (as opposed to mortgage on real estate) is due to the dreaded margin call. During a stock market crash, you could be forced to sell your stocks at the worst time, when you should be buying instead. Well, under good times, margin calls are no big deal. You simply sell some stocks. Or if you're confident your stocks will go up more, you can just do nothing and wait as your dividends slowly pay off the margin. 

What is different about leveraged investing vs a cash-only account?

For one, you need to do more active management. Another is you need to be more diversified. Owning long term treasury bonds is a must. I use TMF 3x Long Term Treasury Bonds. If you look at the chart, it increases over the long term, thus makes a good investment on its own. The magic is during black swan events. In every major stock market crash, in 2000, 2008, and 2020, it shoots up dramatically as disaster strikes. Your TQQQ and other stocks will go wrecked, but TMF will save your account. So what do you do? You sell the TMF and rebalance that into TQQQ, which should now be super cheap. This is the active management part of TQQQ. Another thing you can do, is to sell the TQQQ if it's obvious the market is crashing. These are rare events every 20 years. You should not do this for the 10% selloffs that happen every year.

Remember in 2014 after a three year bull run everyone said that stocks were too overvalued and expensive??? Well, TQQQ was $4 back then. Today it is $137! I've found TQQQ to not be as volatile as many individual stocks, especially the growth stocks. If you can hold stocks like TSLA, AMD, MU, or SAVA, then TQQQ is like child's play. I've found the best stocks to all be very volatile. Actually TMF is also more volatile than TQQQ, and it's based on U.S. treasury bonds!

Currently, I'm 300% stocks, 100% bonds. Account is up 30% every month. Not every year, but every month. A 15% drawdown is expected and should be fine. A black swan event causing a 50% drawdown would hurt. However, the portfolio should be fine due to the fact that I am adding some money every month. Dollar cost averaging (DCA) into stocks is very synergistic with using leverage, as the fresh money buys more shares during bad times. Backtesting shows with DCA, even with a 90% drawdown you end up way ahead of a cash-only account. With high leverage, I am also betting on significantly increasing the account size before any pain happens. This creates a buffer effect.

I talk more about my investing strategy in my 10 Rules of Investing article.