I try to read the Freakonomics blog in the NY Times when I can find the time. I still remember when the first book came out, and how I felt like everywhere I went people were talking about the book and the ideas it contained. At the time, I think it was something unique. Lots of similar books have followed suit. People slap -onomics on the end of all kinds of things (it’s marketable). Malcolm Gladwell‘s books are similar. He has his own style, of course, and he’s more sociologist than economist. Freakonomics demonstrated that there’s a market for challenging conventions and thinking about things in different ways. But, as usual, I digress.
The blog does (or attempts to do) the same thing that the books did. One of the contributors on the blog is Ian Ayers, a Yale economist and law school professor. Ayers, in tandem with Barry Nalebuff, recently wrote a book called Lifescycle Investing.
I have not read this book, but I’m intrigued by the idea, which is, basically, that people do not diversify well enough over time. What they mean is that people have large amounts of money invested over too short of time periods. Most people would agree that it is advantageous to invest early to take advantage of long time horizons. Ayers points out that the problem with this approach is that the time when you have the longest time horizons is also when you have the least amount of money. Most of your capital when you’re young is tied up in untapped human capital. The paradox of a long time horizon is that you either have a long time horizon or the money to take advantage of it, but not both. The authors offer a solution: borrow on margin to finance investing more earlier.
They argue that using their approach actually decreases rather than increases risk – because of the increased time. Part of their reasoning is that you can borrow cheaply right now in order to invest on margin (around 1% according to the video below). Their recommendation is that you diversify less as the costs of diversity rise.
To use their example from this post:
“Yes, we do propose that young investors invest with leverage. But, as we explain below, this is fully in keeping with Samuelson’s own prescriptions. The reason for leverage isn’t that this is a way to double your bets and make quick money. Rather, this is the way to get around a constraint that prevents young investors from getting their desired exposure to equities. To put some numbers on this, take someone whose lifetime wealth is $1,000,000 and who would ideally like to expose half of that wealth, or $500,000, to stocks. The key point, and the source of confusion, is that we aren’t proposing that this person invest double their wealth, or $2,000,000, in stocks. No, we propose that the person invest something like $50,000, with leverage, in order to get exposure of $100,000 to stocks.”
More in their own words:
My thoughts:
Aren’t we already doing this in a sense? By this, I mean tapping into our human capital by taking on all sorts of leverage early in our lives and spending time trying to get even. I have money in stocks and retirement, but I still have student loans and two mortgages (one on the house I live in and one on a rental property).
Still, I like the idea. I don’t think it’s one that I will attempt in practice. I especially like the idea of automating this – forming mutual funds that do this for people at the prescribed levels. Obviously there are lots of funds out there that employ leverage, but I think the preference would be to see this done using index funds in exactly the way the authors have described. I’d love to hear/see some intelligent criticism of this idea, if there’s any out there. Anyone out there planning on trying this out? Anyone out there already doing this? Has anyone read the book? Good luck and thanks for reading.
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