Scott and Watson's Floor-Leverage Rule

[aim-high]

I think this type of strategy fits my psychology . . .

So what is the floor-leverage rule? Essentially, it is a barbell strategy. With traditional rebalancing, one buys stocks after they lose value which can lead to portfolio depletion in worst-case scenarios. With the floor leverage rule, one doesn’t buy stocks after they fall in value, but rather only sell stocks after they gain in value. This is accomplished by building a safe and secure spending floor with 85% of the assets in the financial portfolio. This provides a lifetime floor which spending can never fall below. Next, they put the remaining 15% of financial assets in a highly-volatile 3x-leveraged equity portfolio. Finally, they conduct annual portfolio reviews. If the equity portion of the portfolio exceeds 15% of the portfolio asset allocation, then sell enough equities to return to the 15% allocation and use the proceeds to ratchet up the spending level supported by the secure spending portfolio. Otherwise, do nothing.

Wade Pfau's Retirement Researcher Blog: Scott and Watson's Floor-Leverage Rule

 

[FIRE'd@51]

It seems to me that the 3X leverage is not really 3X leverage in the traditonal sense (i.e. beta = 3). If it were, a decline in the equity portion of the portfolio of more than 5% would wipe out the equity portion and begin to invade the floor. I suspect they are talking about using some type of levered ETF which can't go below zero and thus, requires a daily rebalancing in the ETF, which can lead to a substantial frictional drag on up-moves in a volatile market.

 

[karluk]

It strikes me as incredibly irresponsible to present this strategy as a viable alternative to traditional rebalancing without accompanying it with an EXTREMELY clear presentation of the dangers inherent in using leveraged ETFs to obtain the required 3x leveraging. There are endless articles available that discuss this issue. Here is one author's take.

In conclusion, the deterioration risk that exists in leveraged ETF is real, it is pronounced in single entity ETF and 3x ETF, each for different reasons. Single entity ETF can be easily manipulated, 3x ETF have extremely high rollover costs, but broad market based 2x ETF do not have the same level of deterioration risks and in fact can do exactly what they are supposed to do over long periods of time as well.

The myth behind leveraged ETFs - MarketWatch

 

[karluk]

And if you belatedly discover that your leveraged ETF fails to deliver the performance you might reasonably expect from it, you're the one who's out of luck. The ETF provider has included all the required disclaimers to protect itself from investor lawsuits.

But some misfired during the financial crisis, when big market swings caused bullish and bearish funds alike to plunge simultaneously—in some cases, by 50% or more over the course of a year.
...
In his ruling this month, U.S. District Court Judge John G. Koeltl of the Southern District of New York dismissed the case against ProShares. His ruling concluded that the plaintiffs should have had a basic understanding of the risks, and that ProShares's warnings had been as clear as the law demanded.

Burned by Leveraged ETF? Don't Bet on Sympathy From the Bench - WSJ.com