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Lifecycle Investing – The Benefits of Diversifying Across Time





“The point is simple: if diversification across asset classes is so good, why not also seek greater diversification across time periods?” – Ian Ayres

Last Decade Risk

There is a big risk in the way most people save for retirement. The big risk is that the vast majority of the investments most people own during their working years are in the last few years before retirement. We call it “Last Decade Risk”.

Since the 2000-2009 was the second worst decade ever for the stock market, there are many stories of people who saved and invested consistently for 40 years and yet found that one bad decade in investing just before retirement left them far short of the retirement they want.

For example, let’s look at Robert. He invests $10,000/year in his RRSP starting at age 25 and increases that by inflation every year as he gets more RRSP room, like many Canadians do. With an average 8% return, here is how his investments grow:

Age Ending Investments % of Total
25-34 $ 176,000 2%
35-44 $ 617,000 9%
45-54 $1,649,000 25%
55-64 $3,988,000 64%

Here is the scary part – 64% of all the investments that Robert owned over 40 years (age 25-65) were owned in just 10 (after age 55) – and 80% were only owned after age 50!

Just to be clear, “last decade risk”, is not necessarily the end of the world, since statistics show that most Canadians will have another 25+ years of retirement ahead of them to make up for it. But having a lot less than you need in the year you start retirement can still be a huge worry.

How do you avoid “Last Decade Risk”?

Lifecycle Investing – Diversifying across time

The solution to “last decade risk” is the subject of a groundbreaking book by two Yale professors, called “Lifecycle Investing”.1 They advocate borrowing to invest when you are young and paying it off in your 50s. They show how this actually reduces risk by “diversifying across time”.

The book is quite technical and obviously written by two math geeks. But their concepts are very practical.

First, let’s understand “diversifying across time”. Here are the stock market holdings of two brothers at two points in their lives:

Peter Paul
Age 30 $100,000 $200,000
Age 60 $1,000,000 $900,000

Note that they have the same exposure to the stock market during their lives, but Paul is more diversified across time. His “last decade risk” is lower.

The concept of “Lifecycle Investing” is that Paul could do this by borrowing $100,000 to invest at age 30 and allocating $100,000 of his stock market investments to bonds at age 60.

Most people are comfortable with the benefits of diversifying by different types of investments. Why not also diversify across time?

Does Lifecycle Investing Make Sense?

A better question is – does the traditional method of investing really make sense when it usually means having 10-30 times more money in the stock market at age 60 than at age 30?

Lifecycle Investing is what we tend to do with our homes. Most people would think nothing of putting $25,000 down on a $500,000 home. The advantage here is that if you live in that home for 20 years, you have $500,000 invested in real estate each year. This is the Lifecycle Investing concept – borrow a large amount early and slowly pay it off in order to have the same amount of investments every year.

Just to be clear, borrowing to invest is a risky strategy and is not for everyone. If you cannot stomach the ups and downs, may sell or invest less after a crash, or if you chase performance, then borrowing to invest probably is not the right strategy for you.

However, this study proves that if done right as part of a long term strategy, borrowing to invest can actually reduce your retirement risk. If you define risk as the ups and downs of your investments, then borrowing to invest in the early years is obviously more risky than not borrowing. However, if you define risk as the risk of not having the retirement you want, then the risk over your lifetime can be lower with Lifecycle investing.

Asset Allocation with Lifecycle Investing

The solution of “Lifecycle Investing” is to allocate your investments between stocks and bonds based on the total you will invest during your lifetime. This is called “dollar years”.1 If you are going to invest $10,000 every year for 40 years, then you have $400,000 “dollar years”.

You can think of the $10,000 you plan to invest in each of the future years as a bond when you are determining how much to invest into stocks vs. bonds.

For example, let’s say that you want to invest 70% in stocks and 30% in bonds. Instead of investing the $10,000 based on 70/30, with Lifecycle investing you would add up the total investments you will have over the next 40 years ($400,000) and invest 70% of that figure, or $280,000, in stocks.

Since you only have $10,000 in year 1, you would borrow the maximum you are comfortable with each year and invest 100% in equities until you reach $280,000.2

The actual formula3 calls for a very high amount of leverage in period 1. Since the Yale professors are math geeks and not investors, they are not aware of all the methods of borrowing to invest and therefore only advocate 2:1 leverage. The concept is to borrow what you are comfortable with and what you can qualify for in the early years.

Stages of Life with Lifecycle Investing

In practice, this process leads to 3 periods through your working life:

  1. High leverage period – Leverage 2:1 (or more) and invest 100% in stocks – no bonds. If you have $10,000 invested, borrow an additional $10,000 (or more) to invest each year. Typically this period is the first 10 years of your investing life. This period lasts until your stock market investments reach your target percentage of your lifetime investments (e.g. 70% of $400,000 = $280,000).
  2. Reducing leverage period – Reduce leverage portion slowly and maintain 100% in stocks. Typically eliminate leverage by early 50s.
  3. No leverage period – Start introducing bonds moving to your desired allocation (e.g. 70% stocks/30% bonds) by the time you retire.

Does Lifecycle Investing Work?

The study results proved that it resulted in a better retirement for people born every single year since 1848! Lifecycle Investing would have improved the retirement 100% of the time for anyone retiring in the last 96 years.1

Lifecycle Investing can be applied to either provide the same returns as traditional investing with less risk, or to have the same risk but a higher return.

In the book, each strategy is named by the percent in stocks in year 1 and the percent at retirement. For example:

  • Traditional investing: 75/75 means a constant 75% in stocks.
  • Lifecycle strategy: 200/50 means borrowing so you can invest double the cash you have in year 1 (200% in stocks) and then moving down to 50% stocks/50% bonds by retirement.

Here are the results of lifecycle investing strategies vs. a 75/75 traditional portfolio:

  • 200/50 – Same returns as 75/75 with 21% lower risk. Same average investment in stocks as 75/75.
  • 200/61 – Same risk as 75/75 with 18% more investments at retirement.
  • 200/83 – Same worst-case scenario as 75/75 with average 63% more investments at retirement.

Here are the actual results for people that retired between 1914 and 2009 investing a constant percent of their income for 45 years1:

Retirement Investments 75/75 200/50 200/61 200/83
Worst case scenario $ 167,000 $ 291,000 $ 299,000 $ 167,000
Average result $ 749,000 $ 749,000 $ 881,000 $1,220,000
Best case scenario $1,330,000 $1,210,000 $1,460,000 $2,280,000
% Chance of beating 75/75 99% 100% 100%

You may be wondering – is this just better because they invested more in stocks? The answer is no. The 200/50 strategy has the same average investment in the stock market as the 75/75 strategy. This is why the average result is the same. The range between the highest and lowest returns is narrower, though, because of the reduced risk from diversifying across time.

I actually was surprised that the results were better 100% of the time. Remember, this includes people that had the Great Depression of the 1930s either at the beginning or the end of their working life.

Lifecycle Investing vs. Smith Manoeuvre

This strategy is different than the Smith Manoeuvre, which involves borrowing to invest slowly as you pay off your mortgage. The Smith Manoeuvre often involves maintaining the investment credit line through retirement (since this provides a higher retirement income if done right), while Lifecycle Investing suggests paying it off before retirement.

These are two of many possible strategies that can all be valid options to the traditional approach of just slowly investing your hard-earned dollars every year.

Having the right plan & strategy trumps investment returns

Lifecycle investing is worth discussing, because it points out the huge “last decade risk” with traditional investing and shows that the right leverage strategy over many years can sometimes reduce risk.

Most investors in their 30s and 40s believe that the most important part of their future retirement is the rate of return they get on their investments. This often leads them to ignore financial planning and just focus on investments. The concepts here show that having a plan and using the right strategy is far more important than rate of return.

In fact, most people will have 80% of the investments they will own during their working life after age 50. The rate of return you have before age 50 is not that important because it is on a relatively small amount of money.4

For example, the 200/83 strategy only has a moderate $10,000/year of leverage, but still produced a 63% higher retirement income and produced a higher retirement income 100% of the time.

It is difficult for many investment-focused people to believe us when we tell them that the most critical issues for their future are having a comprehensive plan and using the right strategies. The concepts of Lifecycle Investing provide a useful example of the importance of having the correct focus.

Summary

The traditional way of investing money each year creates a big “last decade risk” because 80% of your investments over your working life are usually after age 50. If your last decade is a bad decade (like the last decade), it probably means your rate of return for your entire working life is low. One bad decade can put you far below your retirement goal.

Lifecycle Investing reduces “last decade risk” by diversifying across time. Essentially, you borrow in your first decade of investing and invest 100% in stocks. Then you slowly pay off the leverage by your early 50s, when you start adding bonds, moving to your desired mix by retirement.

The study by two Yale professors proved Lifecycle Investing for your entire working life provided a better retirement 99-100% of the time. This is a practical example of how having a plan and using the right strategies are the most critical issues in having the future that you want.

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.

1 “Lifecycle Investing”, Ian Ayres & Barry Nalebuff, 2009
2 They have scenarios ending at retirement and scenarios including pensions during your retirement years.
3 The actual formula would involve calculating your “dollar years” every year as the sum of your investments today plus all the amounts you plan to invest in the future.
4 Many people become more conservative and allocate more to bonds in the last 10-15 years before retirement. This probably means a lower rate of return. Every 1%/year lower return they make after age 50 wipes out 4%/year of the return they made for the first 25 years from age 25-50, since they will own 80% of their investments after age 50.





30 Comments, Comment or Ping

  1. 1. Steve

    A little bit long for a blog post, difficult to read if you’re a “catch up on all your blogs” for a coffee break type of person.

    I applaud Ed for bring yet another strategy to consider. Being more informed is always better.

    I think it would be very difficult for someone to actually implement this. This plan in order to work optimally would like require maximum leverage ratio when your life is at it’s least stable (student loans, car loans, young kids, elderly parents, etc.)

    Another point is it takes TIME to develop your investment style and truly understand your risks, and along the way you make mistakes.

    This plan is like asking a grade 9 student to write a college math exam. They haven’t learned enough yet.

  2. How do you factor into this analysis the possibility that you get laid off from your job during an economic downturn, are unable to find a job that pays even 75% as much for over a year, are forced to sell your leveraged investments for a big loss to make the loan payments, and 15 years of savings are wiped out?

  3. 3. DanP

    @Michael James

    Cant the same thing be asked about buying a house? What happens if you lose your job and cant pay your mortgage so now you have to sell it or it gets taken by the bank? These are just risks that one should consider. An easy answer would be one should purchase disability insurance if they are looking at running this plan.

  4. @DanP: Good point about the mortgage — it is a similar situation. But I doubt that many people would choose not to buy a home because they plan to leverage their investments. I’d say that the choice most people would be making when considering life-cycle investing is whether to leverage both their house AND their stock investments. This just increases the chances of total ruin. That’s the thing with leverage; when things go well, you end up better off, and when things don’t go well, you’re left starting over.

  5. The high success rate they report is interesting. I’m comfortable enough with investing and I have enough time that something like this could be an advantage. But I avoid borrowing a lot so I’m looking at alternate ways to use these ideas. I’ll be thinking about this for a while! (and just about to publish my own blog post with more ideas on it)

  6. 6. Ed Rempel

    Hi Steve,

    Good point. I agree that most investors in their 20s would probably make the common investment errors most investors make with the investments from an investment loan.

    Clearly, if someone wanted to do this, they either need a solid investment strategy or to get some advice.

    Ed

  7. 7. Ed Rempel

    Hi Michael,

    If you do it right, borrowing to invest should help you if you lost your job. You can always arrange to have your investments send you income until you are working again. Even if investments are down, you can normally get more than enough income to cover the interest payments. If you are doing this leverage with the Smith Manoeuvre, you don’t even need your cash flow to make the loan interest payments.

    Having a large nest egg of investments is how you get financial security. The common perception is that financial security comes from having no debt, but that usually also means having little in investments. Real financial security comes from having a large nest egg of investments to fall back on.

    Borrowing to invest is different from leveraging to buy a house, because you can sell small amounts or have multiple ways to get income, if necessary.

    I agree with your main point that with any leverage strategy, you need to make sure that you won’t be forced to sell at a market bottom.

    Ed

  8. 8. Al

    Hi Ed,

    Wrt your post 7 – I agree that you should be able to cover interest on the loan but what if you get a margin call? Further I would wager that investments falling in price and job insecurity are correlated.

    All in favor of stock market investing for the long-term, but I am very uncomfortable with too much leverage so for me I’ll take the slower but safer road rather than this riskier but potentially more lucrative one.

  9. 9. Ed Rempel

    Hi Value,

    I also found the success rate of 99-100% surprising. It goes back to the principle of “stocks for the long run”. With the traditional method, you have hardly any stocks when you have a long run in front of you and have a lot in the stock market when your time horizon is much shorter.

    To be honest, we don’t actually use this specific strategy much, but the concept is still a real eye-opener. It reveals the flaws in traditional investing methods.

    The principles can be applied to many strategies and are helpful in thinking through both when to leverage and how to allocate your investments.

    In your allocation decisions, is it really a good idea to buy a balanced fund when you are 25? Should your allocation between stocks and bonds vary over your life?

    For leverage decisions, if you have a long time horizon and are investing annually, when does a clearly-defined leverage strategy early on make sense?

    Ed

  10. 10. Ed Rempel

    Hi Al,

    When we do leverage, we always use either a secured credit line or a “No Margin Call” investment loan, so margin calls are never a risk.

    Any leverage must take into account how to avoid margin calls. If you leverage for 30 years, but have one margin call when you are forced to sell most of your investments at a market low, then your 30-year strategy is probably a bust.

    In general, we wouldn’t recommend leveraging with margin. If you use margin, you need to make sure you have capital available to allow you to keep your investments at market lows. You need to plan to avoid all margin risk for the worst case scenario.

    Since our leverage never has margin call risk, we are also in a stronger position to consider adding to investments exactly when others are having margin calls. In general, the best buying opportunities happen while other investors are having margin calls.

    Ed

  11. 11. chad

    I’m on leverage, and getting paid to wait with divy’s.Thanks to ishares and the new vangurd etf’s.Thansk for these low cost etf’s I’m we’ll diversified at very low cost.

    gl to everyone and my tfsa will have these etf’s in them

    chad

  12. Ed,

    What about insured annuities? How about Paying less Taxes and getting 6-8% in retirement even with today’s low rates…guaranteed for life? Plus you get Risk Management tossed in as well.

    You can re read this http://www.milliondollarjourney.com/how-annuities-work.htm

    cheers,

    Brian

  13. @Ed: I’d like to see the analysis that shows that “you can normally get more than enough income to cover the interest payments.” This has been true for credit-worthy borrowers in recent years, but interest rates have not always been low for borrowers and there is no reason to believe that they will stay low indefinitely. The only way I can see to avoid the risk of higher interest rates is to take out a very long-term loan. But these loans come with higher interest rates.

  14. Very interesting post!
    In my opinion getting a loan on stock investment is very risky for a average investor. So I don’t recommend people doing it. My take on last decade risk is that start to invest in income producing product with positive inflation adjusted return. If you start early and keep buying more share when dividends received then your income would growth substantially in your retirement. Try to grow you portfolio dividend income to a point where you don’t need to sell shares to support you retirement. When a bear market come just like the one we had on 2008 you can buy a lot more share at a great price in the end we will get more passive income over time.

    best regard!
    Winn

  15. 15. vsn

    Ed rempel Thank you for posting a useful information. Leverage can be done via options with limited down side risk.Without borrowing one can increase the exposure to stock market.

  16. 16. Brian

    This has to be one of the dumbest things I’ve read in quite a long time.

  17. 17. Sam

    @ Brian,

    Everyone has their view point and you have too. I value it. But leaving a vague comment like this does not help. Can you elaborate why you think this is dumb? Thanking you in advance.

    Sam

  18. Ed,

    Borrowing to invest is a personal choice. One of the topics not discussed or reviewed by many is disability coverage. Most group coverages only pay 60% of a person’s wage (Bonuses Excluded). Many people could not live on 40% less income… add a loan and a disability may result in selling RRSPs, TFSA, or the investments themselves at a loss or gain.

    See: http://www.milliondollarjourney.com/risk-management-via-insurance-disability-insurance.htm

    The other thing to consider is Critical illness insurance. Here is some stats
    on disability lasting longer than 90 days.

    Incidence of Disability and Death at Various Ages – source: Education Committee of Academy of Life Underwriting (2007)
    Age Disabled greater than 90 days Disability vs. Death

    32 8 per 1,000 8 to 1
    37 9 per 1,000 8 to 1
    42 11 per 1,000 6 to 1
    47 13 per 1,000 5 to 1
    52 17 per 1,000 4 to 1
    57 21 per 1,000 3 to 1

    cheers,

    Brian

  19. If the insurance proceeds are tax-free, a lot of people could live on 40% less income and some might even make more :) Though I’m sure there’s some limitation to ensure no one makes more when they’re disabled.

    Borrowing as much as you’re saving when you’re young is an extreme move unless you save as little as the average young person. And it’s difficult to do unless you get a very low interest rate. I would be interested in seeing how Ed arranges loans to get a good long-term rate.

    But the general idea of pulling stock investments forward is still valuable. As I wrote about on my blog, it shows that the idea of paying off your mortgage first and then starting to invest after will increase your investment risks. Going in the other direction there might be a lot of things you could delay to invest in stocks sooner, and then spend later while your investments grow and diversify your risks.

  20. 20. Ed Rempel

    Hi Winn,

    A couple comments on your strategy. It sounds to me like it would make retiring more difficult for several reasons:

    1. If you restrict your investments to income producing investments, then your investment return would probably be lower than with equities (without restrictions).
    2. If you want to retire on only the dividends from your investments and not tap into the actual investments, then you need a much larger portfolio to retire on.

    With retirement income planning, we normally plan on a sustainable income. How much is sustainable depends on many factors, but we looked back 150 years and found that almost anyone retiring 100% equities and withdrawing 5%/year of their portfolio would have had a sustainable income for more than 30 years. (The only exception was people that retired right before the 1929-32 crash.)

    My point is that 5%/year is probably sustainable. However, if you restrict yourself to dividends from your investments, your income would be much lower, so you would need a much higher portfolio. If you sell shares periodically, you should be able to have a $50,000/year income with a $1 million portfolio. If you only want to use dividends (say they average 2.5%), then you need a portfolio close to $2 million for the same retirement income.

    There is a common misperception that selling a bit of your stock market investment each year cuts into your capital, but taking dividends does not.

    To clarify this, if you rather have a company that grows at 10%/year or one that grows at 7%/year and pays a 3% dividend (excluding tax effects)? The truth is that they are essentially the same. Remember, the company that pays a dividend is reducing the capital inside the company in order to pay the dividend.

    If you take a company that grows at 10%/year long term average and sell 5%/year, this is sustainable forever exactly the same as if that company paid you a 5% dividend.

    Dividends and regularly selling shares are like rainfall and snowfall. Both are precipitation.

    Ed

  21. 21. Ed Rempel

    Hi Value,

    Borrowing to invest when you are young is not that extreme or that difficult.

    There is risk, of course, but “extreme” is probably exaggerating it.

    For investors with a long time horizon, comfortable with market fluctuations, discipline to avoid all the common errors made by most investors, and with a sound investment strategy, borrowing to invest may make sense.

    If you buy and hold a quality, diversified portfolio for 20 years or more, your chance of success with borrowing to invest is very high.

    Borrowing the amount that you save, as the Lifecycle Strategy suggests, is one arbitrary amount. You can borrow much more or much less than this.

    It is not difficult. There are all kinds of strategies. Here are some common ones:

    1. RRSP replacement – If you plan to invest $5,000/year into an RRSP, you could instead take an investment loan that has payments of $5,000/year. In both cases, you get a $5,000 tax deduction, but with the loan, you may have $125,000 in investments vs. only $5,000/year with the RRSP.

    2. Smith Manoeuvre – This is usually an automatic borrowing to invest every 2 weeks with each mortgage payment. There may or may not be larger amounts.

    3. Investment loan – Just borrow an amount to invest.

    I find most people know all about mortgages and other types of loans & credit lines, but don’t know about investment loans.

    Today, you can get an investment loan at about 4%. The most common types are 100% loans (no money down) and 3:1 loans. If you use mutual funds, you can borrow with no money down and no fees. The limit is usually between 50-100% of your net worth.

    The qualifications for 3:1 loans are much easier than with 100% loans. With a 3:1 loan, if you save up $17,000, you can borrow $50,000.

    My point is that, if done right, borrowing to invest is not “extreme” or difficult.

  22. Hi ED
    sorry to reply you so late.I hope you have a wonderful new year.
    In regards to you comment, what I am saying is that for instance if you plan to retire on $50,000 a year it would last 30 year like you say. However as inflation keep going up you may need more money to sustain your life style. My point is that if I use the same amount of money to build a portfolio for 3-4% dividend stock that would give me $40,000 a year in retirement, but most of the time if you pick high quality dividend stock. Those stock will grow its dividend at the rate similar to the growth rate of EPS. If you build a portfolio that pass out 3-4% dividend per year that growth at a rate of 10% per year which mean that in 7-8 year you would have like 6-8% dividend income on your investment of 1million dollar. The good thing about high quality dividend stocks is that they appreciate in value over time and the dividend grow rate would greater than inflation most of the time. One of the advantage for investing in dividend stock is that you don’t rely on the market in order to receive income if you invest properly. Unlike non dividend portfolio, it is highly rely on the market performance. In some case like we had experienced on 2008-2009, with a non dividend stock portfolio you need to sell more share on lower price in order to sustain a $50,000 life style.Which mean that if the market come back as always a non dividend portfolio would end up with less value. Then the 1 million portfolio may not last 30year.
    One of the reason I am in favor of dividend stock is that it is more secure because in order to pass out dividend they need to make money to sustain their payout if for some reason they cut their payment you know that the company is in trouble. While you are building your retirement you can reinvest the dividend to buy more shares. In the end, you will have more dividend income and stock. Dividend is like profit sharing from your investment you can choose where to invest your money, as you know company managers sometime make stupid financial choices, in my opinion I like to invest my corporate earning to financial products that i like.
    In regard on building a stock portfolio I am not saying that I only pick dividend stocks, I do pick high quality stock on my portfolio. My portfolio would be mostly dividend stock, the ratio would be like 80/20.

    ps: thank you for your time to reply me ED, by the way I just start to blog come by and give me some advise, I am a novice on bloging.
    Sincere,
    Winn

  23. Thanks for the comment Ed! It sounds like the borrowing approaches come in two categories:

    1. Increasing the amount of your mortgage by investing more instead of paying it off (SM).

    2. Targeting a repayment amount instead of an investment amount.

    The risk for someone who is young, borrows a lot, and doesn’t have a high tax rate in the first place, seems to be in the interest rates. If you’re planning to pay back a loan over 15+ years, a high interest rate might take away the benefits of diversifying more. And it’s hard to get more than a 10-year guarantee even with a mortgage. Are investment loans typically at a floating rate?

  24. 24. Ed Rempel

    Hi Winn,

    I agree with you. Dividends make a lot of sense, dividend stocks have performed well long term and they also tend to promote the right investor behavior.

    My only concern with dividends now is that the are the current “flavour of the day”. In the 90s, it was tech stocks, then we had an income trust bubble, then it was gold and now it is dividend stocks. In general, investors are willing to overpay for dividends today, because the stock market has struggled the last few years.

    I’ve been around long enough to see that there are cycles. There will obviously be another bull market at some point and dividend stocks will likely lag.

    The mistake many investors will make is to buy dividend stocks today when they are priced higher, and then sell them during a future bull market when they are out of favour and something else is outperforming them.

    When we talk with our fund managers, they look at many factors in deciding which companies to invest in. Dividends is one of the factors, but not one of the top 10. More important are many other factors, such as the how profitable the company is, how sustainable that profit is, how fast it is growing, how competent the management is, competition factors, etc.

    My advice is that if dividend stocks is going to be your strategy, commit now to always focusing 80% on dividend stocks. Do not change this strategy in the future, especially during the inevitable next bull market when they will probably lag.

    In short, dividend investing is a very sound strategy. But switching between different strategies whenever they are the “flavour of the day” is not a good strategy.

    Ed

  25. 25. Ed Rempel

    Hi Value,

    I don’t understand the first part of your post, but I can tell you we are not really worried about higher interest rates.

    Investment loans are usually at variable rates, such as prime +1%, but they would have to go very high before they would be a major problem.

    In general, if you leverage for the long term, say 20 years or more, the return you need to make on your investments to break even is about 2/3 of the interest rate. I can still remember doing leverage 20 years ago when investment loans were at 9%. To be worthwhile, we would need to invest to make a long term return of 2/3 of that, or about 6%, which is still easily achievable with good quality fund managers.

    Today, investment loans are about 4%, so our investments would only need to make a long term return of about 2.7% to break even. That is a very low hurdle.

    Many people remember the sky-high interest rates of the early 1980s. We believe they happened for a specific demographic reason (baby boomers getting into the housing market) that will not happen again, so interest rates are likely to remain reasonably low for the next few decades.

    The other point to keep in mind is that stocks tend to make up for higher interest rates with some time. Higher interest rates generally result from inflation. During inflation, companies are able to increase their prices and their profits faster, which is why stocks tend to keep up with inflation.

    In the investment classic, “Stocks for the Long Run”, Jeremy Siegel looked at long periods of time (50-70 years) and found that the stock market consistently made about 7% over inflation, with higher returns during periods with higher inflation.

    We would only be worried about interest rates if they rose a lot, and certainly not if they are under 10%. We don’t really expect interest rates to be high enough to be a problem in the foreseeable future.

    Ed

  26. Interesting – that’s good to know. Thanks for the information!

  27. 27. Ivan

    Do you think Greek soon-to-be-retired people feel pretty safe with their bonds now? Until governments learn not to spend more than they earn, there is no safety in bonds.

  28. 28. Ed Rempel

    Hi Ivan,

    Good point. Bonds are actually much more likely to have a 99-100% loss than stocks. In the last century, a few developed countries have had their government bonds go to zero, but none have had their stock market go to zero.

    Countries where their government bonds fell to zero or near zero in the last century include Germany, France, Italy, Japan and Brazil.

    Stocks tend to eventually recover from essentially anything, but bonds get massacred in high inflation.

    Ed

  29. 29. Troy

    I’m a bit of newbie here, and I’m wondering if interest payments on investment loans are tax deductible?

    If not, are there other types of loans (e.g. against an existing life insurance policy), for which the interest payments would be tax deductible?

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