Life-cycle investing and leverage: buying stock on margin can reduce retirement risk

Abstract

Standard retirement investment strategies are fundamentally flawed because they fail to diversify equity risk across an individual’s entire working life. Investors should utilize leverage, such as buying stocks on margin, during their early working years to increase market exposure when their liquid savings are small relative to their discounted future earnings. This approach shifts the portfolio from a leveraged position when young to an unleveraged, more conservative allocation as the individual approaches retirement. Historical simulations using market data from 1871 to 2007 demonstrate that a strategy employing a 2:1 leverage ratio early in the life cycle stochastically dominates both traditional 100% stock portfolios and conventional life-cycle funds. The application of this temporal diversification increases expected retirement wealth by approximately 90% compared to typical target-date funds and 19% compared to constant 100% stock investments. Such gains facilitate retirement nearly six years earlier or sustain a post-retirement standard of living for over two decades longer than current practices allow. Despite the use of leverage, the strategy reduces long-term retirement risk by preventing an excessive concentration of market exposure in the final years of employment. – AI-generated abstract.