Author Topic: Investing for Maximum Gains  (Read 8125 times)

Schpeet

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Investing for Maximum Gains
« on: August 29, 2014, 11:36:03 PM »
OK, so I've been reading the MMM post and a lot of the investing advice is on the conservative side - which is the way it should be, if you are retired and are comfortably living off your returns.

However, what if you are young, single with no dependants?  And have a higher tolerance for risk?  I'm curious what the thoughts are on more 'riskier' types of investments that would allow someone to increase their net worth faster than investing in an index fund for instance.  I guess this would be techniques such as using leverage to buy multiple investments properties, or margin loans for investing?

Are there any great blogs that talk about topics, or any books that would be good to read?

Beric01

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Re: Investing for Maximum Gains
« Reply #1 on: August 29, 2014, 11:57:51 PM »
OK, so I've been reading the MMM post and a lot of the investing advice is on the conservative side - which is the way it should be, if you are retired and are comfortably living off your returns.

However, what if you are young, single with no dependants?  And have a higher tolerance for risk?  I'm curious what the thoughts are on more 'riskier' types of investments that would allow someone to increase their net worth faster than investing in an index fund for instance.  I guess this would be techniques such as using leverage to buy multiple investments properties, or margin loans for investing?

Are there any great blogs that talk about topics, or any books that would be good to read?

I'm young and single like you, but my understanding is that the risk-reward ratio of the Vanguard index funds is about as good as it gets. When you get into leverage, you get a lot more risk for not so much more gain. With leverage, you could lose everything if the market goes bad. I want to do everything to accelerate FIRE, but I also don't want to take the risk that my FIRE will delay by 10 years due to inordinate risk.

EDIT: currently reading this post on the Bogleheads forum which seems to apply.

Quote
Summary: Econ grad student applies Mortgage Your Retirement theory at the top of the last bull market, starting around 2x leverage, loses $210K of borrowed money, and is forced is to sell what's left of his portfolio at S&P 821 in November 2008. The complete wipeout results in a reflective period where he recollects the circumstances that led him to adopt this strategy, some of which will be included in a book. He spends five weeks in Asia and begins writing about how risk and progress can be framed. Returning to the US, he slashes his expenses, finds several ways to increase income, earns 914% on the IRBLTG Fund, and pays off all his high interest credit card debt. Net worth tracker continues to be updated.
« Last Edit: August 30, 2014, 12:06:28 AM by Beric01 »

Schpeet

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Re: Investing for Maximum Gains
« Reply #2 on: August 30, 2014, 12:13:41 AM »
Hmm, interesting but why you not get higher gain through leveraging?  Technically you are investing much more money than you currently have so there would a much higher return (assuming you didn't get screwed by a downturn in the market).  Obviously a pretty risky strategy, but it seems like there is a potential high reward as well.

Anyway, isn't investing in real estate just an example of leveraging and is quite common?

Not trying to be argumentative just looking for some opinions from people that know more than me!

I guess my thoughts are, if starting out whilst relatively young you should have a higher risk tolerance to maximise long-term gains and curious what options are out there since MMM's advice seems quite conservative...

Beric01

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Re: Investing for Maximum Gains
« Reply #3 on: August 30, 2014, 12:26:21 AM »
Hmm, interesting but why you not get higher gain through leveraging?  Technically you are investing much more money than you currently have so there would a much higher return (assuming you didn't get screwed by a downturn in the market).  Obviously a pretty risky strategy, but it seems like there is a potential high reward as well.

Yes, you could get great returns, but you could also lose everything. Think about that for a moment - everything you've saved for. Even as a young single, unattached, I don't particularly want that to happen. You also have to deal with borrowing money, which isn't going to be 0%, which means your returns on your leveraged investment won't be as good.

There's a lot of good content in the Bogleheads thread I posted - I'm reading it now. Many of your questions seem to have been asked already.

Anyway, isn't investing in real estate just an example of leveraging and is quite common?

There's a reason your house is a terrible investment. One reason: it's leveraged. Remember that many lost their homes during the housing crisis. Leverage. The same thing happens when investing in real estate for income - if you leverage too much, things can get hairy.

I guess my thoughts are, if starting out whilst relatively young you should have a higher risk tolerance to maximise long-term gains and curious what options are out there since MMM's advice seems quite conservative...

I guess the big question is when you plan to FIRE. I'm 24 and plan to FIRE by 33. How can I know with leverage the market won't have tanked and my net worth be zero at that specific point in time?

And no problem with disagreeing - I've been intrigued by your point in the past too. It's just always seemed like too much risk for too little gain.

EDIT from the thread:

Quote
I've learned what it feels like...
1. For people to lose confidence in my decision making ability.
2. To be subject to the whim of the market.
3. To face the likely prospect of being $200K in debt with nothing to show for it.
4. To be a like bank, borrowing short and lending long.
5. To have both liquidity and solvency problems.

I'm not sure what I'd do differently. I always knew this type of decline was a possibility.

LOL
« Last Edit: August 30, 2014, 12:44:31 AM by Beric01 »

Schpeet

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Re: Investing for Maximum Gains
« Reply #4 on: August 30, 2014, 12:57:57 AM »
Hmmm, a lot to think about.  I'm reading through that thread now as well!

milesdividendmd

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Re: Investing for Maximum Gains
« Reply #5 on: August 30, 2014, 02:10:19 AM »
There are two big structural problems with leverage as I understand it.

 The first is that if you use leverage to increase your position in Stocks you are increasing volatility. When the stock market goes up you will gain more money, and when the stock market goes down, you will lose more money. And the problem is that downside volatility is more destructive than upside gain is beneficial. As an example if you lose 25% of your portfolio you must gain 33% of it to get back to your starting point. This means that a drop in the stock market by 50% can sink you, whereas it is very easy to overcome such a drop if you simply buy-and-hold.

The second problem with leverage is that it comes with added expenses. (Unless you can borrow money at zero interest.) So if you lever up to two times stock holdings you will not actually get two times upside because the expenses come out of the upside and are compounded, much as an expensive mutual fund eats away at your value over time. Unfortunately the borrowing costs mean that you get more than two times downside risk. If you win you pay and if you lose you pay too.

These factors both contribute to making your portfolio incredibly inefficient. You take on much more risk in exchange for much less upside. You're  tilting the playing field against yourself.

Better to focus on the things you can actually control. Low-cost funds, and robust savings percentages, will get you where you want to be very quickly.

If you want too swing for the fences in a tax sheltered account. I like this momentum play:

http://www.milesdividendmd.com/stop-being-active/

Raay

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Re: Investing for Maximum Gains
« Reply #6 on: August 30, 2014, 06:03:30 AM »
The most important and apparently highly overlooked problem with employing leverage is: it can force you to close your position at a very unfavorable time. The more leverage you use, the more likely it is going to happen when markets turn, as they undoubtedly will at some time. This is the kind of risk which does not concern you with non-leveraged investments (except that you are going to "suffer" part of the price movement incurred by other people who took on leverage; but unlike them, you will be able to hold out). As I like to put it, if buying stocks on credit was something with a worthwhile risk-reward profile, your broker would be doing it instead of offering the cheap margin credit to you (same goes for creators of leveraged ETFs, real estate brokers etc.)

If you really must seek to improve gains in financial markets (by speculation, not investing), try finding a niche in which you have some sort of tactical advantage over other idiots who are trying to get rich like you are. Becoming a financial intermediary is the obvious kind, but difficult to pull off because of regulation. Feeding on young naive traders' incompetence is another, but also a much riskier proposition (don't forget there are people who want to feed off your incompetence). For example, I used to do sell short stocks of insolvent German companies based on an observation that most novices are just speculating on the long side because shorting is/was both less known and more difficult to do here. It worked, but even so, I could not claim that I could actually quantify the risk (especially the risk of my broker forcibly closing a position).

hodedofome

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Re: Investing for Maximum Gains
« Reply #7 on: August 30, 2014, 12:15:03 PM »
Leverage on stocks is limited for the small fry. If you went on 200 percent margin (the max allowed) and the market goes down just a little bit you'll get a margin call. Please look at the rules of margin trading and the minimum requirements first.

There are leveraged ETFs available like 2x or 3x the S&P 500 but it's not that simple. They track the DAILY performance of the S&P and can have large tracking errors over time. They are designed for day Traders not investors. For instance the S&P may be up 10 percent for the year but the leveraged ETF may actually be down, not up 20 percent like you expected.

Before trying to make a lot of money, BECOME A RISK MANAGER FIRST. I cannot stress this enough. You must first find out how much you can lose, before figuring out how much you can gain. As a general rule, you want the upside to be at least 3x the downside. I could get into the math for this but I'm on my phone so I won't. Just trust me. So if you find an investment that has a downside of 10 percent, you want the gain to be at least 30 percent otherwise pass it up.

If the downside is you'll lose everything, then that is a very risky investment. You have to view it like an angel investor would. They know that out of 20 companies they invest in, only 1 may do anything special. The others will lose the entire investment. However, that 1 winning company will pay for all the Losers and then some. They will typically invest no more than $25-100k per company and that's coming from a person that may be worth $20 million or more. So the investment is a tiny, tiny part of their net worth.

You should treat this investment you are talking about just the same. Use less than 1-2 percent of your entire portfolio for ideas like this. Don't have enough $$ for this to be worth it? Then don't do it.

Schpeet

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Re: Investing for Maximum Gains
« Reply #8 on: August 30, 2014, 05:13:11 PM »
Thanks everyone for your advice!

It sounds like the overwhelming response is that it's highly risky and generally not worth the risk.

I guess thinking that if it goes to shit, I'm not going to end back at square one but square negative $60k or wherever means it probably isn't worth the risk.

Investing in an index fund sounds like it's slow going, but if I'm honest with myself I don't know anywhere near enough to be able to intelligently do much else at this stage!

dividendman

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Re: Investing for Maximum Gains
« Reply #9 on: August 30, 2014, 06:57:21 PM »
I considered that when I started my investing journey (about 7 years ago when I was 25). Thankfully I didn't have much wealth, but leveraged just before the crash and lost a lot (well, it seemed like a lot at the time).

Now, I have a portfolio of about 500k, but I still don't invest for maximum gains. Why? The simple answer is I now know my own personality. I have 10 index funds that I re-balance when I add new funds or get "itchy". Why do I have 10 and not 1 or 2 broad market funds like VTI only? Because I like the feeling of doing something - not rational. Of those 10 (each having 10% of my portfolio) two are bond funds.

Every time something happens in the market or I'm tempted do to something, I just rebalance since I have all of these funds. This probably isn't optimal for the long run but prevents me from being stupid.

(the funds - 10% each): TIP, IGOV, EFV, VDE, VEU, VWO, VBR, VNQ, VTI, Spartan S&P 500 (through 401k). The weighted MER is 0.17%. This is not optimal (just junking everything into VTI is probably best for the long run, and there is a lot of overlap) but for the reasons above I like it. Real estate goes up? Yay, I have that. Energy index doing well? Yay, I have that. etc. In case you are like me you might find this more acceptable to the feeling of doing something. Note I didn't come up with this myself, I copied it from here http://assetbuilder.com/lazy_portfolios/ with some modifications.

Cottonswab

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Re: Investing for Maximum Gains
« Reply #10 on: August 31, 2014, 12:50:11 AM »
Leverage is one method. 

The other way is to get an information advantage over the rest of the market.  This generally requires a lot of time spent researching either individual investments or general market inefficiencies.

For example, since I work in the energy industry, I have a better understanding of how to value energy companies than most other investors.  I pay close attention to any major changes in the stock prices of energy companies and public news regarding the energy industry that would affect valuations, and invest accordingly. 

On the other hand, I have no advantage when it comes to investing in industries that I am not familiar with (advertising, banking, etc.), so I avoid investing in these industries outside of diversified funds/ETFs.   

Raay

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Re: Investing for Maximum Gains
« Reply #11 on: August 31, 2014, 04:27:28 AM »
The above risk management advice is good - I'll add to it that in general you should distinguish two kinds of risk: risks that you can mitigate with some effort and risks totally out of your control. Taking on the former category of risks is known as investment, taking on the latter category of risks is known as speculation or gambling. Unfortunately, telling them apart is not trivial in many cases, but it helps to ponder the matter.

Diversification is one means of mitigating risks (related to failure of individual investments), and it takes little effort. Value investing (and frugality as a kind of it) is another way, which requires you to get informed about market prices and estimate the actual values of assets (easy to do when comparing e.g. prices/quality of everyday products, not so easy with more complicated or unique items such as real estate, also very difficult when comparing prices/quality of companies because of armies of competing analysts that affect the prices). Finally, there is this old-fashioned thing of becoming a seasoned professional in some field: this is the best way to effectively personally mitigate risks and be rewarded for it with high income - because other, clueless people will gladly pay for your superior risk-reducing skills (your only concerns will be education, insurance and other, competing professionals).

That's one reason why doctors get high pay - they understand the risks for their patients and they know how to reduce them. Same goes for engineers, of course. A financial adviser's highest risk, same as quack's, would be his clients figuring out that he is in reality unable to provide any risk-reducing service for them and instead ripping them off with fees. His skill consists in a large part of the ability to conceal this fact...

thedayisbrave

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Re: Investing for Maximum Gains
« Reply #12 on: August 31, 2014, 08:17:40 AM »
I will never buy stocks on margin.  Just won't do it. 

That said, I have a more favorable opinion of leverage when it comes to real estate.  Probably more so than the typical MMM reader.  I'm young as well and feel I can take the risk, BUT I am smart about it so it is pretty well thought out risk.  I'm not against leverage, and in fact I am a big fan of using OPM (other people's money).  The key though is to recognize your limits and stop well short of it.  Don't over-leverage and you'll be fine.  Take your time, be patient, and do your due diligence.  And don't go all in - the eggs in one basket theory.  (Full disclosure: I am a real estate investor)

Re the BH thread.  Doesn't make any sense to me.  Look up Rick Ferri's "Flight Path Approach to Asset Allocation." That, to me, is more in line with how young people who are just getting into it should be investing.

LAWson

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Re: Investing for Maximum Gains
« Reply #13 on: August 31, 2014, 12:28:15 PM »
Try looking for guys with crazy long-term returns. One thing you'd notice is that most of them take a value approach. Another common theme is a concentrated portfolio. IMO, short-term trading strategies are trash and the least replicable. But for the biggest returns, it's a combination of strong analytical skills and balls of steel.

One guy I came across has ~30,000% return in 10 years of investing. I've seen less than a handful of people with 10k% returns since 2003 (disregarding bitcoin). He's had several 50% drawdowns, but it comes with the territory. He used leverage when there were obvious discrepancies in price and value. Ex: FFH LEAPS during the 2006 and 2008 drops, ORH LEAPS late 2008, BAC LEAPS early 2012. I believe his position sizing for these was close to 100%. Another trade he posted is a ~$500K investment in MBI last year, late April.

Maybe you'd be interested in Jesse Stine's book. The intro chapters are entertaining- free on Amazon. He used a little leverage to get his returns, no options. His approach seems hard because of the time it takes to search for and analyze stocks with massive growth potential.

If you're not willing to put in the work and can't stand 50% drawdowns, then index funds are best. Investing in markets is basically a bet that the market consensus will evolve over time and eventually reflect the fundamentals.

hodedofome

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Re: Investing for Maximum Gains
« Reply #14 on: September 01, 2014, 08:49:16 AM »
Jesse is a decent trader that has a system that fits him and his personality. There's no reason to believe some random guy has the same personality as Jesse. His book is about his system and his style, not how anyone can learn to make money in the market.

NorCal

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Re: Investing for Maximum Gains
« Reply #15 on: September 01, 2014, 10:50:20 AM »
It's all about asset allocation and your tolerance for risk.  I'm young (well, I like to think I'm young), yet I am more risk averse when investing than people significantly older than I am.

Don't underestimate the risk of index funds.  Just investing in the S&P 500 (which is NOT investing in the broad "market") gives you years where you'll see increases in value of 10%,15%, and even 25%, yet years where you'll lose half.  That's pretty friggin volatile.  I'm personally not willing to lose 50% of my total investment in a bear market.

If you want to make the maximum risky investment for the maximum possible gain, go buy some out-of-the-money call options on a TSLA.  You'll most likely lose everything, but if you win, you'll see 10x-100x your initial investment.  Might as well go to Vegas.

The better answer is to diversify into riskier investments and routinely rebalance.  This gives you more upside, and can actually reduce the risk of your overall portfolio.  Add some Emerging Markets and Frontier Markets to your portfolio.  Also add some long dated treasuries (the long bonds are up 10.3% in the last 6 months while the S&P is up 6.6%).  VNQ (Domestic REIT's) are up nearly 9% over the past 6 months.

There are tons of alternatives out there that can increase your returns over time and will actually reduce your portfolio risk.

UnleashHell

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Re: Investing for Maximum Gains
« Reply #16 on: September 01, 2014, 11:18:15 AM »
Try looking for guys with crazy long-term returns. One thing you'd notice is that most of them take a value approach. Another common theme is a concentrated portfolio. IMO, short-term trading strategies are trash and the least replicable. But for the biggest returns, it's a combination of strong analytical skills and balls of steel.

One guy I came across has ~30,000% return in 10 years of investing. I've seen less than a handful of people with 10k% returns since 2003 (disregarding bitcoin). He's had several 50% drawdowns, but it comes with the territory. He used leverage when there were obvious discrepancies in price and value. Ex: FFH LEAPS during the 2006 and 2008 drops, ORH LEAPS late 2008, BAC LEAPS early 2012. I believe his position sizing for these was close to 100%. Another trade he posted is a ~$500K investment in MBI last year, late April.

Maybe you'd be interested in Jesse Stine's book. The intro chapters are entertaining- free on Amazon. He used a little leverage to get his returns, no options. His approach seems hard because of the time it takes to search for and analyze stocks with massive growth potential.

If you're not willing to put in the work and can't stand 50% drawdowns, then index funds are best. Investing in markets is basically a bet that the market consensus will evolve over time and eventually reflect the fundamentals.

you must be talking about Eric :D

Its a rare individual investor who is going to be heading into leaps.
That kind of investment and portfolio concentration , plus the knowledge and research is hard to achieve.
I invested in FFH - but in the common and not enough.. or I'd be close to retirement.

I wouldn't recommend individual stocks or a concentrated portfolio to anyone unless they had the gumption to get off their butt and do the hard slog of understanding what they are doing.

Most I have in any one stock is 15% of my net work - and it was less when I bought it. I can take volatility but too much in a stock that goes wrong cause a lot of heart ache - and I have had 2 stocks that have gone to crap.

I currently have 8 individual stocks in my portfolio - and that account still only makes up  40% of my invested amounts.

If you want to go that route then research value investing.. for the massive returns then calls and big investments when all the signs are right - and the rest of the market is wrong - is the way to go.. I can't go that far myself...

LAWson

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Re: Investing for Maximum Gains
« Reply #17 on: September 01, 2014, 03:13:39 PM »
you must be talking about Eric :D

lol, yup! that guy has a perspective options and leverage that I have not seen anywhere else. It takes some big balls to do what he does.

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Re: Investing for Maximum Gains
« Reply #18 on: September 02, 2014, 01:22:44 PM »
You may think you have nothing to lose, but by losing a gamble, you actually stand to lose the most important thing you have, which is time.  I need to do it again, but a while back I figured up that although my investments from the first couple of years investing only made up 20% of my contributions, they accounted for over 50% of my balances at the time.  Always remember you are an investor seeking longterm returns, not a gambler looking for the rush of a "win".   

Guizmo

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Re: Investing for Maximum Gains
« Reply #19 on: September 02, 2014, 01:44:20 PM »
I took a hard money loan at around 12% interest per year as well as a family loan to purchase my rental condo. It wasn't a lot of money but I didn't have 25k at the moment. I'm glad I did that because now my condo is worth almost 40% more than when I bought it. I paid off the loans and I average 5k a year in profits before taxes.