Gyroscopic Investing

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Wow.

Does this simulation account for expenses?  Leveraged funds tend to have some pretty high expense ratios.

Stay far away from leveraged investing. There is a lot more risk involved than any possible extra gains.

Past performance does not equal future performance!

I highly doubt that leveraged instruments can be used to achieve this over longer periods of time, due to degenerative decay, etc. (see http://seekingalpha.com/article/104703- ... raged-etfs) and high fees.

kka wrote: I highly doubt that leveraged instruments can be used to achieve this over longer periods of time, due to degenerative decay, etc. (see http://seekingalpha.com/article/104703- ... raged-etfs) and high fees.

kka points out what I've also seen with these leveraged investment products. They behave in very unpredictable ways and can cost investors a lot of money. I kind of put these things into the category of: "Investments made to be sold and not bought."

There really is no need to use leverage for investing and plenty of reasons to avoid it. I know several people who used leverage in the past thinking that all the risks were controllable. Yet it almost wiped them out when the markets turned. It's just not worth the risk.

Would a HB purist advise against this type of investing (see Rule #7) or should we consider the 2xPP to be an improvment on the otigional thesis of safty and security?

It's a great idea, but I sense a deviation from HB's PP. That said it seems like a fine VP concept.

SmallPotatoes wrote: Would a HB purist advise against this type of investing (see Rule #7)

Investing with leverage is not something you should do in the Permanent Portfolio or Variable Portfolio. IMO. Risks are amplified with leverage always.

Leveraged Exchange Traded Funds (ETFs) such as FAZ, FAS, and SKF are designed to multiply the DAILY PERCENTAGE change of the underlying index by factors of 2 or 3. They are thus toxic to your wealth and must not be held. Here’s a simple explaination of why. Take the FAS which is the 3X of XLF, the Financials fund. When XLF rises 1% in a day, the FAS is supposed to rise 3%. When things are going your way, everything is fine. But when the XLF drops, very bad things happen to FAS.

Have a look at this table:
XLF% ChangeFAS (3X)% Change
Start$10.00$10.00
Day 1 Close$11.0010%$1330%
Day 2 Close$10.00-9.09%$9.45-27.27%
TOTAL Change$0.000.00%-$0.65-5.45%


On day 1, XLF rose 10% so FAS rose 30%. Great, you’re in the money.

But on day 2, XLF dropped back down to its starting price of $10.00, a decline of 9.09%. The bad news is that FAS declined 3X this amount or -27.27%. This takes its share price down to $9.45 instead of the $10 that you might expect.

So whereas XLF is unchanged after 2 days, FAS is down 5.45% after those same two days.

Why? The power of daily compounding instead of cumulative compounding. The leveraged ETFs are structured in a way that they compound on daily percent changes, not cumulative price changes. The day 2 decline of FAS should only be 23.08% to take it back to its original $10.00 per share price. But because it is 3X of XLF’s daily change, instead it declines 27.27%.

Said another way, the leveraged ETFs operate on the daily percent change not on the price of the underlying index.

Definitely not a buy and hold type of ETF! Not even for one day. Traders: set tight stops!

Originally posted at http://madmoneymachine.com/2009/04/20/l ... heres-why/

Clive wrote:Brownian Motion rules tell us that on average it will take the square of 10 (i.e. 100) random steps for the person to reach/breach the circumference.

The problem though is that the market does not move according to a set fixed set of rules. So these swings in leverage cannot be relied upon. Further, the leveraged products out there have their own significant problems (which MadMoney talks about) and may not perform as expected.

I understand what you're trying to do, but I've just seen leverage cause far more problems than it has ever helped investors.

I'm enjoying this discussion and by no means wish for investigation of the 2x or 3x PP to cease. I can't help but think, though, 'the enemy of a good plan...'

Clive wrote: In using 2X ETF's however there is some negative compound loss effect, however compared to a conventional PP that has 25% in each of the four assets the additional 25% stock exposure in the 2X ETF based approach might counter those negative compound effects.

It might, or it might not.  That's a big might.  Here's a simple test.

1. Go to http://www.etfreplay.com/combine.aspx

2. Plug in
DGP 12.5
SSO 12.5
TLT 25 (UBT hasn't been around long enough)
SHY 50

Custom date range 28-Feb-2008 (longest all ETFs available) thru today

Total return: 5.3%

3. Plug in
GLD 25
SPY 25
TLT 25
SHY 25

Custom date range 28-Feb-2008 thru today

Total return: 8.6%

So the 2X including UBT would probably be < half the return of the non-leveraged.

Ok, how about going fully leveraged?

DGP 25
SSO 25
TLT 25
SHY 25

Custom date range 28-Feb-2008 thru today

Total return: 1.4%

Extend this a couple more years and you will really be feeling the pain.

I'll take the "might not".  HB's advice is still correct: Don't use leverage.

I'm not convinced that time will be kind to this strategy.  Since inception (June 2006), SSO has lost 48.5% vs. SPY down 6.7%.  Since inception (Feb. 28, 2008), DGP has gained 29.5% vs. GLD 26%.  Even if GLD gains another 26% in the next two years, it's unlikely that DGP will end up ahead for the entire span.  There might be some benefit to more frequent rebalancing, but I don't think it can overcome the negatives over the long term.  It smacks of too good to be true.  But revisiting this thread in a few years will be interesting.  A rebalanced backtest of only SSO from June 2006 might also be enlightening.

This is my first post, and first I would like to thank craigr for all the good work he has done educating so many people on the PP phylosophy.
I did come accross the PRPFX fund a few years ago but I never heared about HB and the basis of the fund.
Thank you and to all who are sharing their wisdom.

I have also been folloing the last few posts of Clive and I have a couple of comments about the 2XPP strategy.
It seems to me the assumption that "However in the PP's case we anticipate one asset being up as another is down with overall near neutrality." Might not be true, since at least two of the 4 asset classes usually move in the same direction so the net effect is always a slight bias towards the prevailing trend, while the cash is always neutral and one asset mostly counter trend. In strong down trends the PP will also go south but less so than full exposed strategies.

Now, given the above in my opinion you cannot benefit from any fundamental neutrality when deploying the 2xPP strategy. What is also worse in my judgment is that if the prevailing trend is a trading range bound then the decay factor of losing more than you gain every time the direction turns will steadily eat away on the portfolio.
It seems to me re-balancing is the key in this strategy, however that might involve timing the bands which are futile in the long run.

I think Harry and the PP will always have a place in my heart and my portfolio. The solutions presented here such as the 2xPP and the 50/25/25 are indeed in-line with what I think Harry was after: fail-safe investing.

Harry told us the future is uncertain, yet his PP certainly relies upon The Market much as does Bogle's 500 Index. In many ways Harry hasn't told us anything new, but has shown how a conservative investing approach can succeed.  Bogle had us buy & hold, humbly taking our fair share of each year's growth (if there was any at all).

There are no guarentees, but if I may: the past has been indicitive of the future.  Browne didn't say this though he wagered on it. Bogle did as well and both did very well.


   

I have thought about running the numbers on the PP with 2x ETFs myself. I think the approach has merit, the biggest drawback would be if a sizable physical gold holding were left out. There are costs/risks associated with the 2x products such as:

1) constant leverage trap
2) reliability of the ETFs performing as designed
3) counter party risk

The benefits are that increased returns can be sought, or the maximum loss can be capped - essentially cutting off the left tail from future returns. When people think of the risks of leverage, what comes to mind is the possibility of losing more money than you put in. ETFs including the 2x type, stocks, corporations, etc. all offer the advantage of not capping losses at the amount you invested. Margin, options, and futures accounts offer losses larger than your investment, but 2x ETFs do not.

Here is an interesting look at different ways to generate leveraged returns besides 2x/3x etfs:

http://www.automated-trading-system.com ... -leverage/

Just buy VFINX and hold it if you're after greater returns and alright with greater risk.