Best empirical evidence on better than SP500 investment returns?

For buy-and-hold strategies: leverage (borrowing to invest) can be used to increase returns.  The Sharpe ratio of a portfolio is a measure of it's risk/reward trade-off; there's a theorem that given a set of assets with fixed known distributions and ability to borrow at the risk-free rate, the Kelly optimal allocation is a leveraged version of the portfolio with highest Sharpe ratio.  You can calculate that optimal leverage in various ways.

In practice, we don't know future Sharpe ratios (only the past), we don't have assets with fixed known distributions (to the extent there is a distribution, it likely changes over time), and there's other idiosyncratic risks to leverage.

Using past data, however, is highly suggestive that at least some leverage is a great idea. For instance, a 40/60 stock/bond portfolio has higher Sharpe ratio than a 100% stock portfolio in almost all historical models since bonds and stocks have low correlation. It's not unreasonable to assume that low correlation will hold going forward.  If I leverage up a stock/bond portfolio to the same volatility as the corresponding 100% stock portfolio, I see a 2-4% increase in yearly returns depending on time period.  This is easily achievable by buying leveraged ETFs.

Naive Kelly models will usually recommend more risk than the stock market, so if your risk tolerance is even higher the (potentially naive and misleading) math is on your side. Be careful if you might need the money soon: these models assume you're never withdrawing!

My opinion: ~1.5-2.5x leverage on stock/bond portfolios looks reasonable for long-term investors, although it really depends on the assets -- short term treasuries for example are so stable that even 10x leveraging isn't crazy.

In the real world, you can leverage by:

  • Buying leveraged ETFs.  These work just like buying stocks or regular non-leveraged ETFs.  Vanguard doesn't allow these, so I use Fidelity.  I might recommend SSO and TMF, along with international + extended market diversification.  Since the leverage on these is set daily, they eliminate some of the tail risk of leveraging. Downsides: volatility decay in sideways markets and ETFs can simply fail to track their (leveraged) index.
  • Using margin accounts.  This is where your broker lends you money, using your other investments as collateral.  Rates are often really bad/not worth it -- be careful.  Also they'll sell your other investments if you become overly leveraged due to a downturn (a "margin call") -- which means forced selling during a downturn, which can cause you to miss out on any recovery.  I don't like this.
  • Directly taking on debt / counter-factually not paying off debt.  If you take out a mortgage instead of paying cash for a house, the money you saved can be considered to be "on loan" at the mortgage rate.  Investing it is then a form of leveraging.  This is bad if the rate is too high, but mortgage rates are really low right now.
  • Futures.  These allow higher leverage than ETFs and adoption of various strategies if you're willing to monitor them daily -- for instance, you can leverage/deleverage on a daily basis with no (additional) tax penalty.  Great for getting really high leverage, e.g. for stable investments like treasuries.  Downsides: your positions will be closed if you run out of margin -- which means you can be forced out of the market during a bad enough downturn, potentially missing the recovery.  For high-leverage strategies, this means you probably need to monitor daily and de-lever as appropriate.  Gains from futures are immediately taxed at 60% short-term 40% long-term capital gains, introducing tax drag that you wouldn't have with ETFs.
  • Options.  I don't know much about these.  Here's a book talking about passive indexing approaches using options, which I haven't read:
  • Other stuff (box spread financing?)

You can kind of backtest various strategies for yourself using e.g.:

Keep in mind that the past doesn't predict the future, and naive back-testing might not track historical reality perfectly or may be missing some idiosyncratic risks of leveraging certain ways.

For your maximal laziness, here's an ~1.9x leveraged ETF allocation I made up just now that's around 40/60 world stock market/long-term bonds: 36% TMF, 16% SSO, 8% VXF, 40% VXUS.  Full disclosure: Lots of people would think this is a terrible allocation since "everyone knows" the bond market is due to crash due to current low interest rates.

For increasing salary vs investing: do these really funge against each other?  Why not both?  Generically I'd think income should dominate before you have a lot invested, and then investment strategy becomes important once your yearly average investment returns become similar in scale to your yearly income.

A No-Nonsense Guide to Early Retirement

This is mentioned in the "don't screw up" section.  By market cap, crypto was 1.7% as big as the world stock market, and Bitcoin 1% as big, so those seem like good starting points -- adjust from there for your desired level of risk vs reward.

IMO, self picked stocks are dumb.  You give up diversification benefit for no reason, unless you think you know better than the market (which you don't).

A No-Nonsense Guide to Early Retirement

Great point; I agree.  Also a great example of missing an obvious risk; I hadn't noticed that before linking.

The calculator here allows simulating withdrawal rates by asset allocation, although it only has data back to 1970 so is a bit limited.  I get the same safe withdrawal rate (4.3%) for 30 year retirees using either 100% US or 50/50 US/ex-US over that time frame.  100% Japan had a 1.5% safe withdrawal rate.

A No-Nonsense Guide to Early Retirement

Learning about the existence of state guaranty associations has decreased my sense of how big I think the counter-party risk is; thanks for sharing this.

Re: running out of money, I've added a section on the risks of retiring too early to address this concern in more detail.  I now agree that annuities might be a good idea to address this if you are old enough, and I was probably overly worried about counter-party risk.  

Re: the 4% rule, it is indeed more of a guideline than a guarantee.  More details are available here:  The link shows a 100% stock allocation with a 3.5% withdrawal rate has a historical 98% success rate over 50 year periods starting from 1871 -- if you are never going to generate income again and are never going to increase real expenses, you may be able to buy quite a bit of safety by going to 30x instead of 25x and holding a 100% stock portfolio.

A No-Nonsense Guide to Early Retirement

I would worry about the counter-party risk with annuities; if a single company goes out of business, you might be bust.  Even if you distribute across many companies, I'd think it's more likely that the whole sector goes bust than that your portfolio devalues to 0 in some other way.

For that reason I'd lean toward not putting too much of my assets in annuities -- but maybe it works out so that the counter-party risk is smaller than the risk of running out of money otherwise.

A No-Nonsense Guide to Early Retirement

For posterity's sake: I became convinced this is practically doable (using either treasury futures, leveraged ETFs like NTSX, or maybe options which I don't understand as well) and probably a good idea/not very dangerous if done correctly.  I think that fact is slightly info-hazardous for a couple reasons:

  • You shouldn't trust most people to correctly advise you on financial products, to not be delusional, or to have your best interests at heart.  So it's hard to figure out exactly what to do.  Index funds overcome this problem through the sheer size of their giant pile of empirical evidence and expert consensus; basically everyone agrees that they work as advertised, and no one reports getting accidentally burned using index funds -- except when the whole market crashes, where they behave as expected.
  • If you learn that it's probably a good idea when done correctly, you might feel obligated to go do it, and then you might do it incorrectly and foreseeably lose a bunch of money.
  • Because the pile of empirical evidence is less giant, it might not turn out to be such a good idea in retrospect, so it's fundamentally riskier (even taking into account the risks people calculate).  I'm sure someone would argue the pile is giant, but even if true that's probably only the case if you're sufficiently expert to judge more obscure evidence piles which most of us are not.

So I'd STILL recommend you not do this unless you're extremely curious in this area, have no hang-ups, feel competent and trust your own judgment around things like intimidating financial products, have no track record of unwise gambling behavior, and have a stable enough life that if you fuck up you won't be in a bad situation.

Here's some resources.  If you're not interested enough to read and enjoy stuff like this, probably avoid doing this:

But I'll probably do it myself and might write a blog post about it.

A No-Nonsense Guide to Early Retirement

After reading around for half an hour, I think there's a decent chance that some form of leveraged investing via e.g. ETFs might be a good idea.  The basic idea makes sense to me.

This is currently completely out-weighed by my "being too clever in markets is a great way to lose all of your money" prior.  But I'll probably look into it more and see how convincing I find the numbers and historical evidence.  If I'm pretty convinced I could see myself allocating 10-20% of my investments in a leveraged strategy at some point in the future.

A cursory look at box spreads makes me think it's the kind of thing with so many caveats that I'd never feel certain I'd eliminated enough tail risk from it.

A No-Nonsense Guide to Early Retirement

Re 1: This is a good point; I did the math on this at some point for myself and ended up still landing on traditional by a large margin (even though I wanted it to turn out pure Roth for simplicity).  But it'll be dependent on your expected tax rates, opportunities for low-tax conversion, and your retirement timeline (more tax-advantaged money dominates on longer timelines).

Also yeah, I skipped backdoor and mega-backdoor to keep things simple.  The goal was to give people a linkable 90/10.  The outcome I was aiming for is that people read, get the important parts of the memetic package, and then some of them will dive in more to find things like that for themselves -- for instance, they're mentioned in the flowchart I linked.

Re: tax advantages of homes, yeah .  Homes are probably a better long-term expected value than I make them sound for this and other reasons.  Still, transaction costs suck, and I think they stop being a good idea if you buy/sell them too often -- I've heard you need to hold ~5 years on average to break even on transaction costs vs mortgage advantage, but haven't done the math myself.  I am biased toward the flexibility of being able to change my physical location in order to take better jobs, decrease my commutes, decide to decrease my expenses, etc.  If you do buy a home, you can ameliorate these concerns by just buying a small home so that you can more easily decide to eat the proportional transaction costs if necessary.

Re: financing things at low interest rates to instead invest in the market, I agree this is correct to maximize expected value but 1. it's not all that big of an impact for things smaller than a house or new car and 2. I think most people would do better by avoiding the over-spending tendency that credit brings, and the negative psychological effects of future spending obligations.   If you're buying a house or new car regardless and can get a low interest rate, I agree you should take out low interest debt instead of buying it with cash.

A No-Nonsense Guide to Early Retirement

The intent isn't to neglect these advantages; rather, I (probably wrongly) assume that everyone is familiar with these advantages -- this is my intent in noting the psychological difficulty of dropping from a 500k home to a $1k/month apartment.

The intent is instead to bring to attention the nature of the financial trade-off.  I use a pretty simple model, but you can dive into the counterfactual yourself: what's the price you're paying for owning your home instead of owning an index fund and renting?  How low could you go on rent, and what would be the impact on your financial life?  Is that tradeoff worth it to you for the advantages

The answer can certainly be "yes" -- but I think people are biased toward assuming yes when they haven't actually examined the issue.

A No-Nonsense Guide to Early Retirement

I roughly agree with this.  My biggest concerns around buying housing are:

  1. The transactional friction of buying/selling homes causes opportunity costs.
  2. People tend to buy too much due to low-interest credit.

But you correctly point out upsides that I don't dive into.

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