Investing With Leverage (Borrowing to Invest, Leveraged ETFs)

TL;DR

Leverage can increase expected returns for aggressive investors, but it comes with risks and should be used carefully.

Transcript

• Investors who are concerned about volatility in their portfolio might add in a bond index fund to their asset allocation in a proportion that matches their risk preferences. An allocation to bonds reduces expected returns but it also reduces expected volatility. But what about investors who are not concerned with volatility and are willing to tak... Read More

Key Insights

• ↩️ Leverage can increase expected returns for aggressive investors but should be used cautiously due to the risks involved.
• 👪 Borrowing against a home or using a margin loan can provide access to leverage, but both options come with their own considerations and risks.
• 😘 Leveraged ETFs offer easy access to leverage, but their long-term performance can be affected by volatility and their expected returns may be lower due to embedded leverage.

Questions & Answers

Q: What are the two options for investors who are willing to take on more risk than the stock market offers?

The two options are reducing diversification by focusing on the riskiest stocks or using leverage to increase expected returns.

Q: Why is leveraging a well-diversified portfolio a better approach than concentrating in risky assets?

Concentrating in risky assets reduces diversification and increases exposure to specific and uncompensated risks. Leveraging a well-diversified portfolio can lead to better expected outcomes.

Q: How can young investors use leverage to their advantage?

Young investors with limited cash can borrow to invest in stocks, gradually decreasing leverage over time. This strategy provides more consistent exposure to stocks and better expected outcomes.

Q: What are the drawbacks of using leveraged ETFs?

Leveraged ETFs are designed to match the levered returns of an index for a single trading day. Holding them for longer periods can result in less amplification of returns due to rebalancing effects and time decay.

Summary & Key Takeaways

• Aggressive investors who are comfortable with risk can consider reducing diversification and focusing on the riskiest stocks for potentially higher returns.

• Another approach is to maintain a well-diversified portfolio and increase expected returns by using leverage, which involves borrowing money to invest.

• Leverage can be achieved through borrowing against a home, using a margin loan, or investing in leveraged ETFs, but each method has its own risks and considerations.