For the few who follow this blog, I started to implement the last step of my portfolio adjustment as planned at the end of 2021
I plan to migrate 50% cash to 50% bond in the coming years. The pace of the migration will follow the pace of Fed's rate hikes. My target is to reach 50% TMF when Fed slows down or pauses rate hikes.
Here is the timeline of my portfolio migration:
2. Jan 2022: Apply for HELOC as emergency fund - (Prepare for enduring 4~5 yrs downturn w/o any major lifestyle or portfolio change)
3. Feb 2022: Say Goodbye to W2 - (Retire when my W2 makes no difference as planned in 2012)
4. Mar -June 2022: 50% cash => build a bond ladder using 1~1.5 yr treasury - (I didn't go long duration to avoid the problem similar to what brought down SVB).
5. Mar 2023 ~: As my bond ladder reaches maturity, I started to convert them to TMF (and maybe buy some FAS opportunistically)
Once the migration is done, I plan to hold the position for a while. I won't rebalance unless TMF spikes or UPRO outgrows TMF by a large margin.
Best of luck and wishes for your successful future. Again thanks for sharing.
ReplyDeleteIn your opinion, at what interest rate will UPRO be too risky as an investment? Given that UPRO (and any leveraged ETF) leverage cost has risen significantly due to the fed increasing interest rates I think they are now too risky to invest in. Currently these ETF pay a funding fee of fed funds rate + ~.03%. I got this number from the semi annual report for UPRO. This means if the fed raises interest rate to 5%, then UPRO is paying ~5.3% on the swaps. Add in the expense ratio of ~1% and you get ~6.3%. If the expected return for the S&P is ~7%, then that is a relatively small gap between the UPRO funding costs and the expected return. What are your thoughts?
ReplyDeleteI meant ~.3% in my original comment. Also the link to the UPRO semi annual report that details it's borrowing rates are below: https://www.proshares.com/globalassets/proshares/documents/semi-annual-reports/prosharessemiannual.pdf
DeleteHi Isiah, thanks for posting the references to the borrowing rates of UPRO. I wasn't able to find the official numbers but fed funds rate + 0.3% aligns with what I found by fitting the historical returns.
DeleteRegarding funding costs vs. expected return, I guess it shouldn't matter if you believe the canonical theory that equity expected return = risk free return + equity risk premium. But I would also like to hear what OP thinks since I think OP is more pragmatic about the market.
IMHO, It's already pretty risky now. Just one and a half year ago, IB margin interest rate was negligible for large investors. Now it's > 5.3% for all:
Deletehttps://www.interactivebrokers.com/en/trading/margin-rates.php
Somewhere in the market was under tremendous stress around 4/20/23. The drop in the very short end of the yield curve was not seen in 2008. Some highly levered players were probably forced to buy liquid assets (1~2M T-bill) as collaterals at very high cost.
https://www.ustreasuryyieldcurve.com/b/gijBzu
Fed' interest hikes should have caused trillions of dollars mark-to-market loss for various bond holders. Most losses are still hidden by the held-to-maturity accounting. Some smart players may dodge the bullet, but the losses must be bear by someone, who might have hard time in the next 2~3 quarters.
I'm inclined to believe that SVB marked the first tremor of an incoming earthquake not the end of it (more like Bear Stearns).
My equity position is the lowest since 2008. I still hold some UPRO not because I believe the downturn is over but because I could be wrong in my judgment. I don't respond to daily or even monthly events, and my investing clock ticks at a very slow rate :-). When I said that I started migrating to 50% URPO + 50% TMF, what I actually mean is that I started a process but the process may take quarters to execute.
BTW. The historical 7% for S&P is a geometric mean over long time horizon, and the actual return series are fractal. Also, the interest cost varies, Fed will push it to a level that hurts the real economics, but once there're bloods on the main street, they have to reverse it. It's a dynamics system and we cannot expect these two numbers remain still.
DeleteI think margin interest cost is a relatively minor issue. I'm not super-worried about the cost over long time horizon, but I'm fearful of how individual ETFs manage their margin calls in extreme conditions. When the market is under stress, institutional investors and all players start to worry about their counter-party risks, they all jerk up margin requirements, which could increase leverage cost to prohibitively high level. It's how leveraged ETFs go bust:
Deletehttps://www.reuters.com/article/us-credit-suisse-gp-notes/credit-suisse-volatility-fund-liquidated-after-market-selloff-idUSKBN1FQ256
https://www.etf.com/sections/features-and-news/leveraged-etf-closures-piling
ES mini requires only 3~5% margin in calm environment. If I recalled correctly, the requirement went up to 15~20% after the collapse of Lehman Brothers. The brokerage firms added their extra margins. No one lent each other, and every one wanted to hold treasury and drove down its yield. The margin cost could shoot up many times in a few days. Most leveraged ETFs were tiny or non-exist in 2008/9, These ETFs are not battle tested yet.
Now, many ETFs grow their AUMs to billions of USD. e.g. TQQQ >$14B. If the margin requirement spikes, the leveraged ETFs industry will have to post billions of dollars in a short notice. They may be unable to find counter-parties or the cost may be just too high. I think this is the existential risk of using leveraged ETFs to construct your portfolio.
First I will like to thank you for being so transparent with your investing journey over the years. I enjoy this blog and your boglehead posts. I hope you post even more now that you are retired.
DeleteI would argue that the interest rate is a major issue/component for any leveraged ETF (including UPRO). If interest rates are high enough the AUM of the ETF will decrease because interest expenses are taken out of AUM. This can lead to a scenario where the underlying asset has positive returns, but AUM decreases which causes the leveraged ETF to have negative returns.
I would outline an extreme exaggerated example to illustrate my point. If interest rates were at 10% for a decade and during that time the S&P500 returned 9% each year during that decade, the UPRO ETF would lose AUM every year because it is paying more in interest expenses then it gets from its underlying holdings. It would lose AUM and see its price fall even though the underlying S&P index was positive.
If we look at the theory of your strategy its betting that the S&P500 or the QQQ will average positive returns over the long run. You then leverage that bet by using leveraged ETFs. But with leveraged ETFs you are really betting that the underlying index will have higher average returns than the average interest rates + ~1.3% for a given time period. Interest rates are minor issue as long as leverage is cheap. But, there is a point where the price of leverage will could a major issue.
Does there exist an interest rate where you would sell the leveraged ETFs and just buy the underlying asset? Or are you taking the view that interest rates will be low over the long term so you are not concerned with interest rate?
I personally don't try to time the market or interest rates. I believe leveraging up the market only makes sense in low interest rate environments. If rates get back below 3% I would get into leveraged ETFs, until then I will just own the underlying asset.
RE: whether to sell the leveraged ETFs and just buy the underlying asset.
DeleteYes, when my overall leverage ratio is lower than 1 and no need to incur leverage cost/risk. But, the decision will be based more on the change of my lifestyle and/or the stage of a business cycle, and less on absolute interest rates.
Why do you use leveraged bonds still? If you want to focus on preserving wealth seems like intermediate term or t bills would be safer. After all the risks of TMF were dramatically demonstrated in 2022.
ReplyDeleteIf you read my blog at the end of 2021, I started to lower my leverage ratio to plan retirement, but I didn't go TMF directly because the interest rate was close to zero at that time. It's obvious that the rising interest would hurt both stock and bond. There is no point to be a dogmatic Boglehead and jump right into the hell when you can see it clearly.
DeleteI've been holding short term bonds in the past year. These bonds start to mature now. I plan to switch them to longer term and higher leverage. It's relatively safe to do so because the current hiking cycle approaches the end, and bond should have limited downside.
More importantly, stock and bond start to show negative correlation. I'm not sure whether or when stock market crashes. But, if it does, I hope that something in my portfolio will spike so that I can seize once-in-a-decade opportunity to buy more stocks. To prepare that the market might take years to recover, I opened a line of credit to cover my living expense for 4~5 years even if I don't need it now.
In case that the market doesn't crash and keeps going up. Life will be dull and I will do absolutely nothing to manage my portfolio. But, I should still have a decent chance to beat the market because of the leverage.
Vagabond, thank you for sharing your journey and your thinking process. Super helpful. One question, when you said Dec 2021 "100% UPRO", it is still only part of your portfolio, right? Because by looking at the numbers you shared on Bogleheads threads, you should still have other underlying asset in retirement accounts, right?
ReplyDeleteAgain, congrats on the retirement, and great life example of taking the (statistically) calculated risk of making your own fortune with an immigrant background.
100% means 100% of my investable asset, which account for ~80% of my total asset. The other 20% are my primary residence and 2 rental properties, which are largely paid off. The rental income is kind of inflation hedge used to cover my basic living expenses. I don't intend to touch them in the foreseeable future.
Delete80% of my investable asset is in traditional IRA, 10% in Roth IRA, 10% in taxable account. I have too much in traditional IRA. It's probably a mistake because they will be taxed at the highest possible rate.
Thank you so much for the reply!
DeleteLike you mentioned in your May23 post, LETF faces creditor risks and geopolitical impacts. Looking back, your 10+yr journey was incredible. Do you think it is repeatable (e.g. Fed rate hike peak now and might start lowering it for a new cycle)? If not, would you still hold 40% (50% of your 80% investable) as UPRO for foreseeable future?
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ReplyDelete版主好，我對您的投資組合調整有一些疑問
ReplyDelete1.50%部位的UPRO去年下跌超過60%，等於總資產虧損接近30%，理論上應該要重新再平衡，但因為您主觀判斷下，現金部位似乎未進行重新平衡，錯過了今年UPRO接近40%的反彈，等於總資產接近20%的上漲
2.原本50%短期債券部位轉換TMF，將原本固定收益的部位轉換為長期債券的曝險還加上槓桿，雖然未來停止升息甚至降息的機率很高，對長債有利，但畢竟跟原本短期國債保本的性質有差別，等於未來是100%持有風險資產，大幅提高投資組合的風險。
而且槓桿債券ETF的漲幅很難克服波動的耗損，夏普值也比股票槓桿ETF低，如果想在投資組合增加風險部位的曝險，似乎直接增加UPRO或TQQQ才是更好的選擇。
除非未來又出現經濟大幅衰退而且降息，那或許債券才是最佳的選擇，但如果過去一年主觀預測事後看效果不如預期，為何有信心未來可以預測成功?反過來說，如果對未來判斷有信心的話，那似乎現有50%UPRO部位也應該開始轉換為TMF才對。前後邏輯似乎有矛盾之處。
單純理性討論，提供不同意見跟版主交流，如有冒犯還請見諒，謝謝
Hi Clueless, do you have any updated opinions on TMF and/or TQQQ/UPRO? Thanks,
ReplyDelete