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j7ake

I don't really understand the equation.

Plugging in an average stock market performance (over last 20 years):

Return: 8% Standard Deviation: 17.72% Risk free rate: 3% (guess)

This gives f = 1.59.

This means the optimal strategy is to be putting 159% of your money in an ETF index?

This strategy is in stark contrast with the typical 70%-30% allocation of investments. How do we reconcile this? Intuitively, the function of your age needs to be included in this equation (I think somebody commented on this already).

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Maximum expected value isn't the same thing as best distribution of results. The levered portfolio does better in expectation, but at the cost of being in for a really bad time in a bear market.

Plus, many investors can't stomach the losses of a 100% equities portfolio, let alone something levered up.

>How do we reconcile this? Intuitively, the function of your age needs to be included in this equation (I think somebody commented on this already).

Age is a proxy for funding amount. A lot of investment goals aren't just "maximize the amount of money I get". They often care about things like "I need to spend $X/yr in retirement". So your investment goal should also put some weight on how likely it is to sustain that, and a higher bond percentage at higher investment amounts will do that.

It also doesn't take into account the cost of that extra 59%.

It includes risk-free rate, the cost of financing. And it's 259% of funds, 159% borrowed + 100% of own funds.

For a consumer, the rate of funding would be higher, however.

Isn't risk-free currently more like 0%?

Alternatively, where can I get my 3%? No ICOs please ;-)

yah, 3% is a high assumption for the risk-free rate. but if it were 0%, you'd be losing money to inflation over time (treasuries are only proxies for the theoretical construct that is the risk-free rate).

no single security provides the risk-free rate but perhaps a (small) portfolio of securities could get you the risk-free return.

You can find FDIC insured bank accounts at 1.25% nowadays. There's also I-bonds at 1.9% inflation-linked, with a purchase limit of $10k/yr and a 1-year redemption lock-out.

3% is more accurate for the cost of margin loans or the opportunity cost of pre-paying a mortgage.

Risk free rate = treasury bills (1.43%)

Putting 160% would mean using a leveraged S&P 500 ETF.

meaning, the investor just buys the leveraged ETF, rather than borrowing money at the t-bill rate to purchase SPY. Amiright?

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