A deep value stock

Rohit,This is not the correct place to post..But interesting article.Borrow now, while you’re still young. Sometimes the cleverest ideas are the ones that initially seem the most preposterous. Such was the case with a paper I recently heard presented by Yale Law Professor Ian Ayers, coauthored with Yale Business School professor Barry Nalebuff.These authors contend that the typical young person should invest 200% of his net worth in stocks. That is, buy everything on 50% margin. This is because far too little is invested in stocks by individuals when those individuals are young, resulting in very poor diversification across time. What? You’ve never heard of inter-temporal diversification? Well the intuition behind it is obvious once you mull over it for a while. For me it was one of those “yeah-I-never-thought-about-like-that” moments. We all accept that exposure to only certain asset classes is risky, but what about the differential exposure to stocks that I have in 2007 (when I am young and less wealthy) and 2040 (when I am older and, of course, wealthier)?Ever heard of the traditional wisdom by which you subtract your age from 110 and then invest that percentage of your wealth in stocks? Well as Warren Buffett might say, traditional wisdom is often long on tradition and short on wisdom. In this case, there is no theory behind the advice at all. It is just made up. Sure, it’s convenient for the investment adviser who needs to create the impression he is following some sort of strategy, and is a great marketing tool for the life cycle mutual funds that actually practice the principle. But why should we believe this is correct?Ayers and Nalebuff argue that this rule is too conservative and actually provide theoretical support for their notion through a simulation of the strategy. Investors should leverage up significantly in their early years and then reduce their leverage over time. This gives them equivalent exposure to the stock market when they are young and when they are old and this diversification reduces the overall risk to their savings.If you are like me, you can understand the intuition but nonetheless have some gut-level objection to the idea. The authors are prepared for this and address the issue directly.There is definitely an aversion to borrowing to invest in our culture. Individuals have no problem borrowing to purchase a home, car or education. But borrowing to invest is taboo. Is this justified? Most folks will point to the ’29 market crash, when margin calls perpetuated an unstoppable slide. While this point is valid, the type of margin borrowing that occurred at that time was done for the purposes of speculating in the short-term. What these authors are suggesting is far different, with a time horizon for the borrowed funds several decades in length.Margin calls are usually thought of as portfolio-destroying, but in this simulation the authors show that margin calls actually have no meaningful effect, since they assume that performance of the market after a margin call is as likely to be positive as it is negative. So sometimes a margin call will result in forgone profits, sometimes forgone losses.And what about those high margin interest rates? Well in real terms they are still considerably lower than even conservative estimates of the equity premium, so the young investor still stands to benefit. But in fact margin rates should be much lower anyway. A loan secured by highly liquid assets with positive expected returns over which the custodian has power to liquidate at a moments notice is far from risky to the lender. Nonetheless margin rates are often double that of mortgage rates or student loan rates. That they persist at levels so high may, in fact, be further evidence of the cultural objection to margin investing. The perceived risk is far higher than the actual risk.I hope I have accurately portrayed these scholars’ proposal. It is fascinating to me, both because I am a victim of the natural margin-aversion that many others are, but also because it suggests that aggressive investing, when done responsibly, can reduce risk.Whether or not new ideas such as this prove to be wise, I think it’s always good practice to question the traditional wisdom. For instance, Warren Buffett’s assessment of diversification, and how lower diversification can actually reduce risk by increasing the deliberation made over any single investment, has always seemed a counterintuitive proposition. But there is certainly truth to it. Likewise, the idea of borrowing when young is counterintuitive and there may indeed be truth to it as well.

hi vishnu / ranjiti think there are some unstated assumptions in the article which are not explicit- assumption 1 : you know what you are doing. Being 200% invested with margin will work only if you invest well. if one is wrong, then margin call will wipe you out. i dont know about others, but investing is rarely a skill one is born with. it takes time and effort to learn and if you leverage in the begining , then the risk is even higherassumption 2 : margin interest is not high if it exceeds equity risk premium. i dont think one can be sure about this. equity risk premiums are not cast in stone. even if i earn 5% extra and use 3% extra margin cost, why take risk of a wipeout for 2% extra returnsI have read the reverse opinion in a lot of places like- losing money in early years reduces the time your money can compound and hence the terminal value is reduce- per warren buffet any returns*0 is equal to 0. So personally i would never favor an approach which has even a 1% chance of a wipeouti have slighlty non convential approach to equity allocation. it may sound strange, but personally for me how much i invest in equity depends not on age or other factor but on the confidence (based on actual results) with which i can pick stocks. As i have improved, i have increased the allocation to stocks.so much for my short answer !! :)regardsrohit

Hi rohit/vishnuThere is some sense to both the views but Rohit’s conventional approach is the best according to me. Read the following famous article by Richard russell on Compounding and you will know that “Losing money early in your life, is not a good thing” http://ww1.dowtheoryletters.com/DTLOL.nsf/htmlmedia/body_rich_man__poor_man.htmlBut when you find a very high probability event, you need to bet on big. You can take that chance.Regards,Ranjit kumar

“But when you find a very high probability event, you need to bet on big. You can take that chance”Wrong statement.This is what I sometimes find a bid odd. People who consider themselves Value Investors decry quantitative finance.Kindly refer to Kelly’s theorm (on communication) where he tells what to bet and how much to bet to maximize profit.I know I have a holier than thou attitude, but I am a quant guy.

http://www.thinkmentalmodels.com/this is a good site to access similar information!This is a great book!