In a paper titled Life Cycle Investing and Leverage: Buying Stock on Margin Can Reduce Retirement Risk (paper available here), Yale University economists Ian Ayres and Barry Nalebuff recommend that young investors should employ leverage to increase their exposure to stocks to 200% of their capital.
Our recommended investment strategy is simple to follow. An investor who targets a single percentage or a single present dollar value follows three phases of investment. The worker begins by investing 200% of current savings in stock until a target level of investment is achieved. In the second phase, the worker maintains the target level of equity investment while deleveraging the portfolio and then maintains that target level as an unleveraged position in the third and final phase.
The expected gains from such leveraged savings are striking. With increased longevity, people need to save more for their retirement. The expected gains in retirement accumulations relative to the traditional 90/50 life-cycle strategy would allow someone to finance an extra 27 years of retirement (well past age 100) or to retire at age 59.5 and still finance retirement through age 85. Or, to the extent that current savings are inadequate to maintain pre-retirement standards of living, this can boost retirement consumption by 90%.
At first glance, it sounds like a crazy idea but the economists explain the problem the strategy is designed to address in this interview with TIME magazine:
Another way of saying it is, we believe in stocks for the long run, but most people, when they have lots of stocks, don’t have the long run, and when they have the long run, don’t have lots of stocks. People seriously underinvest in the market for the first 25 years of their working life.
In my opinion, the strategy sounds fine in theory but is likely to run into problems in practice. The typical response of a young investor who purchased stocks on 2:1 margin and experienced a 50% stock market decline (and got wiped out) would be to abandon stocks altogether. It would be a rare investor who sticks to the strategy in the face of such a decline.
