I was recently reading an article about Ray Dalio’s “All Weather” portfolio. (https://www.theoptimizingblog.com/leveraged-all-weather-portfolio/ )
@awenig, thanks for sharing! Article author here. Pretty fair points from @Jeremy but I figured I’d chime in with my 2 cents.
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Risk: The 3X S&P 500 leveraged ETF he mentioned is UPRO. Between February and March it lost 77% of it’s value. If the Covid crash had been a little worse, it could have been 99%+. It’s still down 37% off its YTD high, whereas the S&P 500 is only down 5%. If it’s a 3X leveraged fund, why are we down way more than 3X the loss?
We’re not talking about UPRO or any leveraged ETF held in isolation, but instead alongside uncorrelated assets. This is somewhat of a straw man.
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Leverage decay: Those violent leveraged swings don’t come for free. Somewhere baked into that fund is borrowing money at a cost. That gives us the 3X ups and downs, but also a (possibly not so) slow leak on the value, gain or lose. The longer you hold, the more damaging the leak to your financial future.
Common misconception and mostly fearmongering like I pointed out in my blog post. That same “decay” works both ways. It’s not as big of a deal as it’s made out to be.
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Expense ratio: They’re generally about 1%. Where as VTI is 0.03%. So you’re paying 33X more to Wall Street every year to hold that fund. Fees are the enemy of the investor.
We’re implicitly assuming the enhanced returns will more than make up for the ER. Obsession over lowering ER can lead to suboptimal performance. If expected returns are greater than the ER difference, then it’s of no consequence and is still likely cheaper than using margin.
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Complexity: I’ll be honest. I don’t fully understand how these leveraged funds work, or what is happening internally to get those violent swings. If I had to guess, there’s all sorts of fees and inefficiencies that hurt the individual investor. One of PFC’s principles is that “Simple is better than complex”. Simplicity favors the individual investor. Complexity favors the wall street firm that cooked up the nonsensical investment to line their own pockets. I put this in the “complex” column.
This is a decision for the individual investor. I’m definitely a fan of a simple strategy like an unleveraged Bogleheads 3 Fund Portfolio. But one’s lack of understanding of a particular product does not mean that product isn’t suitable for someone else. On the scale of lazy buy-and-hold investing to active day trading, I would argue my proposed idea would still be on the relatively lazy and simple side.
And to be clear, that article isn’t written BY Ray Dalio. I suspect Ray Dalio would hate the idea of using leveraged ETFs in his portfolio.
Dalio’s All Weather Fund at Bridgewater employs leverage. One of the primary purposes of using a diversified mix of uncorrelated assets is to allow for the use of leverage.