gryffindor
Recycles dryer sheets
- Joined
- Mar 8, 2008
- Messages
- 51
Was looking to see if there had been an in-depth discussion of whether changing asset allocation versus adding modest leverage is a better way of increasing investment returns. Which approach gives better returns with less volatility?
If you create the right amount of asset allocation, you get to the spot on the efficient frontier curve of highest return and least volatility. I have an asset allocation approach that considers equities, inflation sensitive assets, deflation sensitive assets and relative value as separate asset types. I'll hold the debate of what the right mix is for now.
Now if once the investor finds the spot on the efficient frontier curve that has the best return for volatility -- should an investor change their asset allocation to improve returns or is it better to add modest leverage? If believe that if interest rates are modest such as today, e.g., current after-tax interest on mortgages are in the 3-4% range, it makes sense to add leverage to a low volatility portfolio rather than shift the asset allocations towards more equity.
However, I've noticed that the "conventional wisdom" that most people follow using traditional investment advice would have them shift their asset allocations to higher equity allocations if they want higher returns.
I would rather have lower volatility and higher returns. Going up the black line in the second graph offers higher returns with less volatility than having a pure equity portfolio.This offers a better solution in my opinion. I've put the efficient frontier graphs and potential additional return form leverage on my blog as I couldn't figure out how to paste them on this post.
Financial Integrity
Now we can debate what the optimal amount of leverage is. Lots of people get worried about leverage or mindlessly seek leverage. As a Dave Ramsey fan, I can appreciate the "debt free" mindset. However, I also like to get better returns.
So my current approach to adjusting leverage is as follows.
1. My top leverage at this point that I will allow myself is 30% on total assets, but in general my rules are to keep this below 20% in general as I can't handle the higher volatility.
2 I tend to look at equity valuations and look at the valuations of the markets based on smarter people than I , such as GMO.
3. When the market is overvalued (e.g., low 10 year returns are expected) -- that's the good time to cut leverage -- maybe all the way to zero, or even raise some cash.
4. When the market takes a drop and valuations start to look better -- that's the time to increase leverage.
Cheers
If you create the right amount of asset allocation, you get to the spot on the efficient frontier curve of highest return and least volatility. I have an asset allocation approach that considers equities, inflation sensitive assets, deflation sensitive assets and relative value as separate asset types. I'll hold the debate of what the right mix is for now.
Now if once the investor finds the spot on the efficient frontier curve that has the best return for volatility -- should an investor change their asset allocation to improve returns or is it better to add modest leverage? If believe that if interest rates are modest such as today, e.g., current after-tax interest on mortgages are in the 3-4% range, it makes sense to add leverage to a low volatility portfolio rather than shift the asset allocations towards more equity.
However, I've noticed that the "conventional wisdom" that most people follow using traditional investment advice would have them shift their asset allocations to higher equity allocations if they want higher returns.
I would rather have lower volatility and higher returns. Going up the black line in the second graph offers higher returns with less volatility than having a pure equity portfolio.This offers a better solution in my opinion. I've put the efficient frontier graphs and potential additional return form leverage on my blog as I couldn't figure out how to paste them on this post.
Financial Integrity
Now we can debate what the optimal amount of leverage is. Lots of people get worried about leverage or mindlessly seek leverage. As a Dave Ramsey fan, I can appreciate the "debt free" mindset. However, I also like to get better returns.
So my current approach to adjusting leverage is as follows.
1. My top leverage at this point that I will allow myself is 30% on total assets, but in general my rules are to keep this below 20% in general as I can't handle the higher volatility.
2 I tend to look at equity valuations and look at the valuations of the markets based on smarter people than I , such as GMO.
3. When the market is overvalued (e.g., low 10 year returns are expected) -- that's the good time to cut leverage -- maybe all the way to zero, or even raise some cash.
4. When the market takes a drop and valuations start to look better -- that's the time to increase leverage.
Cheers