The typical 60-something investor has much more money in the stock market than he did his late 20s, mostly because young people don’t have as much money to invest. Ian Ayres, an economist and Yale Law School professor, proposes that retirement savers should invest more in the stock market when young and less when old, even if young people need to borrow money to invest. In his new book, Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio with coauthor Barry Balebuff, Ayres makes the case that 20-somethings should make leveraged investments – going so far as to buy stocks with 50 percent down payments – in order to lower lifetime stock market risk. U.S. News asked Ayres to explain his controversial time diversification strategy. Excerpts:
How do you diversify your investments across time?
There are only two ways you can diversify: Across assets and across time. We’re trying to let you do both. To diversify across time requires you to borrow money, at least when you are young. For young people this means increasing their short term risk. If they have $3,000 and borrow $3,000 to invest $6,000 in the market, that money that they are putting at risk is a small proportion of their lifetime savings.
You say young people should have 200 percent of their retirement savings in stocks. What’s the best way to go about doing that?
Invest with a low cost online broker. Right now you can borrow at a 1.5 percent interest rate. Borrow at this very cheap rate and invest in stock index funds and ETFs. The lender doesn’t really care about your job or your personal approach, they just want to have the stock as security and that is going to be enough for them to lend to you at a very low rate.
What is a reasonable interest rate if you want to borrow money to invest?
It should be possible to basically borrow at about half a percent higher than the current rates on Treasury bills. That would be the competitive cost to borrow. If somebody is charging you interest more than 1 percent above the current Treasury rate, that is too much. Right now Treasury rates are close to half a percent. It’s not always going to be 1.5 percent is a good interest rate.
Can you make leveraged investments within your 401(k)?
You really need to be cautions here. Low cost service providers such as Vanguard and Fidelity do not charge low margin rates. The last time I checked 401(k) providers were charging their margin borrowers 7 or 8 percent interest, which is way too high. Usually you cannot do it through your 401(k) but you can do it through self-directed IRA accounts.
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Why isn’t putting 100 percent of your retirement savings in the stock market enough for a 20-something?
Putting a few thousand dollars in the stock market in your 20s doesn’t do enough to spread your exposure better across time when you are putting 6 or 7 figures in the stock market in your late 50s and 60s. The problem with just going 90 percent in stocks when you are young is that if you back off to 50 percent in your 50s you still will have 50 times more in the stock market in your 50s than when you were just starting off. If you cannot bring yourself psychologically to borrow even at a 1.5 percent interest rate to invest in stocks – even though you borrow money to invest in education and buy a house – at the very least go up to 100 percent in the stock market.
How should you shift your portfolio as you age?
People should maintain 2:1 leverage for about the first 10 years of their working life. For the next 15 years they should be less and less leveraged. By their time they are 25 years into working they shouldn’t be leveraged much anymore. People who are in their 50s, like myself, sacrificed years of diversification. The older you are the less personal benefit you can get from it. You might want to think about giving the gift of diversification to younger loved ones by exposing your kids from birth to the stock market.
Why are investors generally resistant to the idea of borrowing to invest in the stock market?
We have been programmed to think that borrowing anything to invest in stocks is risky. We don’t have the idea of people who borrow to invest in the S&P 500 or an index fund. Understanding the value of time diversification exposes one of the greatest benefits of buying a house. Home buying is one of the few ways that we trick ourselves into being well diversified over time. You save $30,000 and you go out and buy a $300,000 house. You keep $300,000 exposed to the housing market year after year. Compared to your stock exposure, your housing investments are much better diversified cross time, even though they are badly diversified across assets. The benefits of time diversification make the lack of asset allocation tolerable. For many people their house became one of their most valuable retirement assets. We’re just trying to get people to do a small step toward what they are doing with housing.