This latest pitch from Julia Guth is an ad for the Oxford Club Communique, their “entry level” newsletter, and she’s selling us on the idea that there’s an “Ideal Retirement Booster (IRB)” that can help you reduce risk and extend your standard of living during retirement by 27 years.
Which sounds almost magical, right? That’s what huge numbers of people need — particularly the younger baby boomers, the first people who’ve been mostly expected to fend for themselves when it comes to retirement savings (and who in many cases are far short of the savings they need for the comfortable retirement they envision).
Coincidentally, these folks in their 50s and 60s are also the prime market for investment newsletters.
So what is Julia Guth actually talking about? What is this “IRB” technique for boosting your retirement savings? Let’s look at some snippets from the ad, then explain:
“A study conducted by Yale reveals that people’s ‘expected retirement wealth is 90% higher compared to life cycle funds’ if they use this secret early on before switching to more conservative strategies, and that doing so would allow people to add 27 years’ worth of cash to their retirement fund.
“Another study by the Wharton School of Business proved that this ‘can decrease the time to retirement by over 10 years.’
“And a report published by JPMorgan concluded this is ‘a powerful but often underutilized way to enhance wealth.'”
So that sounds good, right? We know that Yale is full of smarties, so Ms. Guth can’t be just making this stuff up.
But what, specifically, does this “IRB” do? Is there some special technique or trading strategy? More from the ad:
“I call it the ‘Ideal Retirement Booster’ – IRB for short.
“Simply put, it’s a way to add decades’ worth of cash to your retirement fund… with one simple change to the way you invest.
“I will show you how you can implement this in about 20 minutes.
“It’s really not all that difficult.
“The problem is most people have virtually NO CLUE this exists.
“One of my contacts – a prominent financial advisor who formerly worked at Deutsche Bank – can’t understand why people don’t use IRB. He says, ‘none of my clients – or any other clients I know of’ use this.
“That’s a pity. Nothing I’ve ever encountered allows people to accumulate so much cash in so little time.”
Wow, sounds incredible!
So how do we accumulate all this cash in a short period of time?
What, oh please oh please, is this fantastic IRB?
More from Ms. Guth…
“We have over 73,000 Members – most of whom are in or near retirement age.
“The biggest concerns we hear over and over again are…Are you getting our free Daily Update
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- I haven’t saved enough for retirement.
- I don’t have enough income to enjoy retirement.
- And worst of all, I might run out of money….
“I’m not here to talk about how bad retirement can be.
“I’m here to give you a real solution…
“A chance to ensure your retirement is comfortable and secure…..
“I’ve never encountered anything that gives you more of an “upper hand” to build long-lasting wealth than the underlying approach to the IRB strategy.
“Dr. Dean Foster, professor at the Wharton School of Business, says that this simple approach ‘can decrease the time to retirement by over 10 years.'”
There are several examples given in the spiel, of individuals who turned their small savings into much bigger nest eggs using the “IRB” — and then we get into the other details that the Oxford Club uses to tantalize us:
“‘It’s Like Adding Rocket Fuel’
“In short, IRB is a way to potentially increase your returns by as much as 100% to 200% on every investment you make.
“It works just like normal trading where you buy and sell stocks… However, unlike regular stock trades, you increase your market exposure so that for every dollar you make in profit, you get an extra $1 or $2 more than you could have otherwise.
“Think of it like a 401(k) account. Many companies offer a 50% match on whatever you save. It’s a lot like that, except in this case, if you play it right, you can get a 100% to 200% match!
“Now, don’t worry, this doesn’t involve futures, options or other high volatility investments.
“In fact, the Yale School of Management conducted a 135-year, in-depth, back-tested study on this retirement booster.
“It found that for people who use this strategy correctly, and at the appropriate times in their lives, it could ‘extend their standard of living during retirement by 27 years.'”
So… didja guess what it is?
Don’t worry, we fed all that excitement and “rocket fuel” into the Mighty, Mighty Thinkolator, and we can tell you exactly what the IRB is. It’s leverage.
And if you’re not using options or futures, then leverage means margin. Which is what a broker will call it when they lend you money. Margin accounts generally allow borrowing up to 100% on non-retirement accounts, meaning that you can use your investments as collateral and borrow up to their value to buy more investments. You pay interest on that margin, which varies dramatically by broker, and you subject yourself to their risk assessments (if they think your net investment value is falling too far, they will sell off your stocks to make a “margin call” to reduce the risk of their loan to you).
But yes, investing on margin does improve your returns. The problem with this pitch is not that margin is bad, the problem is that “IRB” is a hugely risky endeavor for people who are nearing retirement…. that “at the appropriate times in their lives” bit that’s glossed over in the ad is perhaps the most important point. The very people who are most likely to be seeing this ad and finding it appealing, the people who are close enough to retirement that they’re very worried and might be inclined to make risky bets to “catch up,” are those for whom the quoted academic studies are pretty much meaningless.
So what’s the story, and why the references to those academic studies?
Well, the quotes from scholars at Yale and Wharton are real — margin and leverage have been studied closely by academics, and some models have been developed that substantially improved returns and either led to much bigger investment nest eggs or lower long-term risk of running out of money (or a shortening of the time it takes to get to retirement).
So what’s the catch? Well, all those studies find that the real value comes from having a levered exposure to the broad market over a long period of time, starting when you’re young. And the most-discussed study, the one that Ian Ayres and Barry J. Nalebuff published in 2008 (Life-Cycle Investing and Leverage: Buying Stock on Margin Can Reduce Retirement Risk), is specifically posited as a way to diversify across time — helping to average out the contributions you make to your retirement portfolio by borrowing to increase them early on, when the actual savings tend to be smaller.
The basic model that’s cited, the Ayres/Nalebuff model, is similar to conventional strategies in that it reduces your risk exposure (what percent you allocate to equities versus govt. bonds or cash) over time, but it starts out with dramatically more risk exposure because they want to allocate a larger share of your eventual accumulated wealth to equities when you’re young, but most of that wealth hasn’t been accumulated yet.
They would have young people starting out go to 200% exposure to equities (because that’s the maximum for most margin accounts), and then gradually step that down (in their models in the original paper, “maximum leverage” ends in your 30s, all leverage ends by 55 at the very latest). In practice, you’d probably have to do this with in-the-money LEAP options if you’re using a tax-deferred retirement account, because such accounts prohibit borrowing on margin, but the authors indicate that the performance of LEAPs and margin is similar over time.
So what does that mean? Well, Julia Guth is teasing leverage as a way to boost returns — and it will. But if you want to get those kind of dramatic returns compared to “lifecycle investing” (roughly speaking, the standard kind of “60/40” stock/bonds portfolio for a 50 year old, for example) without markedly increasing the long-term risk (in face, they say standard deviation — one measure of risk — is lower), you have to start early. I would assume that the average age of Oxford Club subscribers is probably 55 or 60, and for them this model really has no meaning at all.
Which doesn’t mean that older investors can’t use leverage — it’s just that it’s not necessarily a way to increase returns unless you’re also ready to deal with a substantial increase in risk. And not theoretical “risk” like the talking heads talk about when they say that it’s a “risk on” market — actual risk, as in “there is a possibility, perhaps unlikely but with a non-trivial probability of happening, that your full investment could be wiped out.”
A slightly older study, the one from Dean Foster at Wharton that is quoted in the ad, came out in January of 2007 and was entitled “Early Retirement Using Leveraged Investments.” That did model the likelihood of cutting ten years off of your working life by using margin, though in this case they weren’t as specific about stepping down the margin — my quick scan of the paper indicates that they used a steady 200% equity exposure during all the working years.
Which is all well and good — I see the point, and the papers and the book are worth looking at particularly if you’re a younger investor interested in a long-term strategy. This all caused a bit of a stir a few years ago, partly because it came out just when young investors were in the process of losing all risk tolerance — the paper came out in 2008, a year with a memorable market crash, their book on the strategy, Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio, was published while wounds were still raw in 2010).
But the ad then goes on to cite some individual examples of stocks on which you could earn double your returns by using “IRB” — like Cerner (CERN), which could have given you a 1,022% return over five years by using “IRB” (ie, using 100% margin) and turned your $10,000 investment into $112,200. I don’t think there are any academic studies suggesting that people should speculate on individual stocks using margin, because most people are bad at choosing individual stocks and wouldn’t typically be “levering up” to hold an individual stock for 20 or 30 years. But sure, if you buy on margin and the stock goes up, your profit is much larger.
She also cites Icahn Enterprises (IEP) as an example, which has been another hugely successful investment and had a very good year in 2013 with a 135% gain — she says that, had you levered up with “IRB”, you would have had a 270% return. Which is possible, of course, but requires both that you choose the right stock at the right time and that your investment doesn’t quite tick the “margin call” at your broker — it doesn’t fall so much that you are forced to sell at the bottom. IEP probably would not have caused a margin call that year for you, unless your broker has a very high maintenance margin, but it might have come close, particularly if you had bought in February of 2013 instead of in January.
What is a margin call? If you’ve never traded on margin before or used this kind of leverage, this is important: There are two kinds of limits on what you can borrow from your broker — the first is the initial margin, which is usually 100% leverage (or a 50% margin), which means you can put in $1,000 and borrow $1,000 and buy $2,000 worth of stock. That makes intuitive sense to most people.
The second is the maintenance margin, which is more complicated. This is how much cushion the broker will give you before they worry that they’re not going to get their loan back — the minimum is usually 25% as set by regulators, but often it’s higher at specific brokers, or for smaller or newer accounts. That would mean that your equity in the investment, after removing the full margin loan amount, has to equal at least 25% of the total current value of the investment at any give point in time.
To illustrate, assume that your $2,000 investment (for which you put up $1,000) climbs by 50% — that’s fantastic, you can sell the stock for $3,000, repay that margin loan of $1,000 plus whatever the interest is (this is automatic, usually) and keep roughly $2,000 in profit for a 100% gain on your initial investment.
For a margin call scenario, assume that you’re wrong or the market turns against you and the stock falls by 30%. The $2,000 investment is now worth $1,400. You still owe the $1,000 you borrowed from your broker, so your share of the equity is $400. That’s a 60% loss for you, at least on paper, and you’ve decided not to sell it because you are convinced the stock will come back because it’s of such high quality and is misunderstood. If it were your money, that would be your choice — but most of it is not your money anymore. If your broker’s maintenance margin is 40% (that would be fairly high, but not unheard of), they’re going to issue a margin call to protect their $1,000 loan (if their margin is 25%, which I think is the minimum, you’d escape a margin call until the stock falls to an overall loss of 37.5%).
What is a margin call? A margin call might be a polite phone call where they say that you have to transfer more cash to your account to get the margin number up, or it might just be that they sell the stock (or other stocks in your account) to raise cash for you — they don’t necessarily have to ask you what you’d rather sell or give you a chance to deposit more cash, most margin agreements give brokers a lot of leeway. Now, it might be that they’re doing you a favor if you’re wrong — it’s like a last-ditch stop loss sale where your broker is helping you protect a little sliver of your equity — but maybe not. And it’s also possible to lose more than you invested — if the stock drops by 80% overnight because the CEO is discovered to have been secretly clubbing nuns and using them as test subjects in the company lab, then that $2,000 investment is now worth only $400. Your broker will almost certainly liquidate it for you, but you’ll also still owe your broker another $600 — you’ll have to send them that cash, or if there’s anything else in your accounts with them they’ll probably liquidate that to raise the cash. Margin makes it possible, if not necessarily likely (stocks don’t fall that fast very often, but we’ve all seen it happen on occasion), to lose more than you originally invested.
This has historically not been a big deal for folks who are simply levering up exposure to the market — according to the studies quoted in the ad, there would have been very few margin calls on the broad market for most cohorts who used this strategy, and in those cases the margin call wouldn’t hurt the end results because it would have hit those investors very early on, when they had plenty of time for the leverage to help them out of it during the recovery. But if you’re talking about buying individual stocks on margin, the chances of a substantial loss are obviously much greater.
So you can forgive us for being a bit snarky in noting that although the ad cites that on page one of their special report “you’ll find out the ONE CHANGE you must make to potentially add 27 years’ worth of retirement cash to your account…”
… we might add that the ONE CHANGE that would be most helpful would be, of course, not just the use of 100% leverage but the acquisition of a time machine so you can go back to your 20s and use 100% leverage.
And, as you might have realized by now, all of this assumes — even if you are the person for whom these academic studies are a good fit, a young worker making a retirement plan — that you can be quite dispassionate about your investing — if you’re 25 years old and you get a margin call that wipes out 60% of your retirement portfolio because the market crashes, are you sanguine about following the path and getting right back in with full leverage again a week later?
The ad also claims that they have the “six best companies” to use with this “IRB” strategy, the stocks they are effectively saying that you should buy on margin… and while they don’t go into detail on what all those stocks are, they do tease us about one specific one.
Which we really ought to name for you, right? OK, we’re getting a bit long today, but we’ll give it a shot. Here’s how Guth teases this stock that she thinks you should buy on margin:
“The first stock in the report absolutely belongs in everyone’s portfolio…
“Why You Should Own This Revolutionary Biotech
“After heart disease, cancer is the leading cause of death in the industrialized world.
“Yet this pharmaceutical is taking the lead.
“It’s in perhaps the perfect position to grow substantially in the coming year. For one, it has eight exciting new drugs in the pipeline, mostly for cancer and viruses… which could lead to blockbuster sales in the coming months.”
Hoodat? We’re going to need some more clues:
“Three of its major drugs currently on the market are among the world’s most effective treatments of cancers, including blood, breast, stomach, and colorectal cancer. And that gives this company a steady, reliable revenue stream to pass on to shareholders. In the last 12 months alone, sales surpassed $52 billion. And it’s earning a massive 60% return on equity.
“Now, it’s important to note: This type of stock is what I call a steady climber. It’s safe and it tends to outperform the markets. But you won’t see spectacular gains by investing in this stock the ‘normal’ way.
“That’s what makes it ideal to use with IRB. With this approach, you’ll have the chance to magnify your gains in this stock by twofold to threefold.”
Well, there are not that many companies who generated between $50-$60 billion in revenues over the past twelve months, and only a few of them are pharmaceutical firms (Bayer, Pfizer and Roche)… and only one really comes close to matching the hints, with leading cancer drugs Rituxan (blood), Avastin (colorectal), Herceptin (breast), among many other products, is Roche (those three are all Genentech-developed drugs, Genentech was a partner/subsidiary of Roche for many years before the two fully merged about five years ago). So I reckon they’re teasing Roche Holding (listed in Switzerland, but RHHBY is a very liquid ADR for trading Roche in the US).
The description of the pipeline doesn’t necessarily match up exactly, but is awfully vague anyway — Roche does have some phase 2 drugs for viruses, particularly Hepatitis (B and C), but their late stage pipeline is overwhelmingly focused on cancer and immunotherapy. Roche is obviously a fantastic copmany, if perhaps a little bit richly valued at about 17X next year’s expected earnings (that’s not really any worse than many large pharmaceutical stocks, though their dividend payout is smaller and they’re not listed in the US, so they’re not as adored as some).
And yes, if you’re going to get a 50-100% gain in Roche over the next two or three years, it’s probably going to have to be because you lever up your investment — this is a huge company ($250 billion market cap, Johnson and Johnson is the only larger pharma stock), and analysts are only forecasting that they’ll grow their earnings by 7% a year going forward, which doesn’t lend itself to a stock doubling in short order. I’m not saying you should buy Roche on margin, to be clear, or that it couldn’t have phenomenal returns even without margin, just that even if it does “grow substantially in the coming year” the stock isn’t likely to provide wild returns unless you use borrowed money to juice it.
So there you have it — another case of an appealing idea, one that does indeed make at least some sense in the academic literature (using leverage to boost returns while you’re young and starting to build retirement savings), being used to sell something entirely different (buying individual stocks on margin, perhaps when you’re within a decade of retirement or even to “save” your retirement).
There’s lots of different kinds of margin and leverage, and lots of different kinds of risk, just make sure you know what you’re doing if you buy risky assets using someone else’s money — they’re going to get their money back, whether you’re right or wrong.
P.S. I just noticed that there’s a Warren Buffett reference in this ad, too, so I couldn’t resist checking it — here’s what Guth said:
“In fact, a study conducted by the National Bureau of Economic Research concludes that Warren Buffett’s stellar returns come from ‘neither luck nor magic, but, rather, reward for the use of [IRB].’
“And Warren Buffett’s former daughter-in-law, Mary Buffett, seems to agree. She says, ‘It’s like adding rocket fuel’ to your portfolio.”
Which is true — that NBER paper entitled “Buffett’s Alpha” is here, and the quote is:
“…we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks.”
Or there’s a longer quote that I found interesting in the paper here:
“If his Sharpe ratio is very good but not super-human, then how did Buffett become among the richest in the world? The answer is that Buffett has boosted his returns by using leverage, and that he has stuck to a good strategy for a very long time period, surviving rough periods where others might have been forced into a fire sale or a career shift. We estimate that Buffett applies a leverage of about 1.6-to-1, boosting both his risk and excess return in that proportion. Thus, his many accomplishments include having the conviction, wherewithal, and skill to operate with leverage and significant risk over a number of decades.
“This leaves the key question: How does Buffett pick stocks to achieve this attractive return stream that can be leveraged? We identify several general features of his portfolio: He buys stocks that are ‘safe’ (with low beta and low volatility), ‘cheap’ (i.e., value stocks with low price-to-book ratios), and high-quality (meaning stocks that profitable, stable, growing, and with high payout ratios)….
“In summary, we find that Buffett has developed a unique access to leverage that he has invested in safe, high-quality, cheap stocks and that these key characteristics can largely explain his impressive performance.”
So the moral of the story? Yes, if you can use leverage like Warren Buffett you should definitely use it — but do keep in mind that his is indeed “unique” — most of his leverage isn’t really “borrowing” except in the strictest