I’m skeptical of the closing claim that exponential growth keeps happening forever. Yes, you can grow GDP 2% for 200 years, that results in an economy 50x the start size. Expand it to 1000 years and you’re talking about an economy 400 million times as large. After 2100 years you’re up to an economy a QUINTILLION times as large.
At some point the exponential curve has to go S-shaped. Maybe we’re still in the happy exponential looking part of the curve. There are also signs we might be transitioning. Population growth has slowed, productivity growth has slowed, and the marginal return on capital seems to be somewhere around zero given modern interest rates.
> I claim that economic growth cannot continue indefinitely. [...] the Earth has only one mechanism for releasing heat to space, and that’s via (infrared) radiation. We understand the phenomenon perfectly well, and can predict the surface temperature of the planet as a function of how much energy the human race produces. The upshot is that at a 2.3% growth rate (conveniently chosen to represent a 10× increase every century), we would reach boiling temperature in about 400 years. [Pained expression from economist.] And this statement is independent of technology. Even if we don’t have a name for the energy source yet, as long as it obeys thermodynamics, we cook ourselves with perpetual energy increase.
The physicist says that per capita energy use has surged, but that is only true in the developing world. California's per capita consumption of electrical energy has not changed since 1975. https://www.google.com/url?q=https://www.nrdc.org/sites/defa...
Consider that are dealing with a bias metric. California's weather makes it the least energy intensive state. In 1975 about 50% of the homes in my state had air-conditioning. Now its about 95%. Similar story with heating modern systems. Even in the 70s, older generations dealt with a much colder home in the winter than most people would normally allow today. The days that require climate control in my state are something like 2-3x the average number of days in California and at a much higher intensity.
Additionally, California has exported much of it's energy use to other states and countries.
We're talking about the growth rate of energy usage. California's weather has not changed since 1975 in a way that would reduce per capita energy usage.
I'm not talking about the weather changing. I'm talking about the growth of climate control using electricity in states that aren't California has led to continued energy demands.
Honestly your reply is frustrating because you sound like you don't understand my point. Please re read my comment from before.
Even in your scenario, we wouldn't expect per capita energy usage to increase faster than population growth (as the physicist claimed) because now everybody who wants climate control has it. The whole point is that per capita energy usage isn't growing exponentially in the developed world.
The point I made was regarding electricity usage in california from 1975 until now and how that comparison to the rest of the country isn't valid because it's a bias measure. In 1975 everyone who wanted climate control didn't have it, and that slowly changed to everyone being able to afford year round climate control. That drove huge growth in energy demands in most of the country. In that scenario we would certainly expect per capita energy usage to increase faster than population growth.
Your original claim about California doesn't hold because it's bias.
> In that scenario we would certainly expect per capita energy usage to increase faster than population growth.
But it won't continue to grow now, which is what I showed with California. You have fundamentally misunderstood my example. The physicist claimed exponential per capita energy consumption growth, but California shows that isn't happening.
That study shows zero growth in resource consumption instead of the negative growth observed without their methodology. This does not match the exponential growth in per capita consumption that the physicist assumes.
> First, Tom Murphy is confused by what economic growth is. You don't need increased energy consumption for economic growth.
> Economic growth measures the number of ways resources (material and non-material) are used hence resources are like the universe; "finite but unbounded." Tom Murphy is a typical Newtonian in his mindset and this imperial reasoning is so pre-Planck.
> Even in a so-called steady state any substitution from one material to another would seen as a kind of economic growth simply because markets the place more value on the newer item.
> Second. He assume that exponential economic growth is tied to some physical exponential. It is not. What is the basis for the recent exponential growth of physical consumption. It is growing population. It has been shown that energy growth of consumption doesn't increase much beyond 150k dollars. So once population stabilizes the physical growth model switches from exponential to linear. Tom Murphy never makes a linear growth model and thus his short-term peakerism.
The stock market has grown significantly while demand for energy has widely declined in the last five months. Every energy long bet has been a disaster.
Economic growth may not be able to continue indefinitely, it’s inconclusive, your computers can create more economic value with declining watts even if you can’t. However accounting value, which is what a stock market is, can definitely grow indefinitely.
> The stock market has grown significantly while demand for energy has widely declined in the last five months. Every energy long bet has been a disaster.
The stock market isn't backward looking, or even short term future looking. Note that someone only watching the S&P 500 would know that the coronavirus broke out in early March but probably think the situation had been completely resolved by August. We can't be sure what the stock market thinks it is seeing (or if it is right for that matter).
And if energy bets didn't turn out well, notice that that correlates to the US losing its position as the world's largest economy. China invested a bunch in energy and now have a noticeably bigger economy [0].
> Economic growth may not be able to continue indefinitely, it’s inconclusive, your computers can create more economic value with declining watts even if you can’t.
This growth isn't going to involve more people because they need food and isn't going to involve more stuff because that needs energy. It'll be a very abstract form of growth.
Well, eventually what will happen is countries will disappear, wars will destroy things, and other events will wipe out economies, savings, or entire companies. The growth model will probably always be exponential, but from time to time things will reset to 0.
Those two nations still had the right culture and social structure to build blooming new societies. In this context, with "culture" I don't mean political views or such, but work ethic, and things like literacy, education, etc.
The German car industry wouldn't have been thinkable hadn't the Germans invested a lot of research into building machines in a mass produced way, motor research, etc. Sure, the factories themselves were destroyed, but the engineers together with their knowledge remained.
In fact, there are theories that disruptive events are even helpful for economic progress in the long run because they filter out the lazy elite of rich people while giving opportunities for new ideas to be tried out, and hard working people to rise to wealth and influence.
Sure, but that filtering out means wealth is destroyed and you have to start over. The account resets to $0.00.
Also, these events "filter out" a lot more than just "lazy elite rich people". Plenty of productive rich people and regular every day people are filtered out as well.
Wasn't food rationed and life quality lower in general during the wars? I'm basing this on seeing propaganda of making daily sacrifices for the war but not exactly sure. My general image was that collectively it was an extreme low point in many countries.
> At some point the exponential curve has to go S-shaped.
In principle yes, of course.
In practice, you are imagining a world in which we never expand our civilization into space and across the galaxy, because otherwise you would be looking at the S curve and thinking "wow, this thing has only just gotten started" and marveling at what lies ahead.
Our space-ward expansion has some hard physics limits. And we've not yet eclipsed what was already done decades ago. And even settling Mars will require more sustainable lifestyles than most first world citizens now enjoy.
We're talking about hundreds and thousands of years though. A few hundred years ago, the mere thought of airplanes and cell phones would be considered witchcraft. I don't think it's a long shot to be reasonably optimistic about where humanity can get in terms of technology.
It's not supposed to be all easy. A big part of advancement is creating technology that enables us to reach higher with less effort. Sustainability is a big issue now that a lot of people are working towards. Once we unlock more efficient techniques of capturing solar energy, energy becomes almost a non issue until we reach another barrier that's orders of magnitude away. Space travel will reduce resource limitations too.
>I'd guess we're very close to the peak of attainable technology.
Not many people, and pretty much no research scientist, would agree with that statement. I can personally think of several technologies I'm 100% certain will exist in < 40 years that will drastically alter everything about day to day life.
European global expansion also had hard physics limits. The age of sail grew the global GDP tremendously. I wouldn't discount multi-year asteroid mining trips/etc. from having the same impact in 50-100 years.
If I had to bet on which happens first out of the end of growth-driven capitalism or humans leaving the solar system I wouldn't be putting my money on spaceships.
Imagine a world with 1 trillion people on it. A new Einstein is born every 10 years. Better access to information, the ability to augment their minds with computers makes them 10x smarter than Einstein was. Is it so hard to imagine that the economy would be 50x bigger in that situation?
It’s not just Einstein being born, it’s Einstein being born in a place where the person has access to education, funds, and an environment conducive to a civilization changing breakthrough.
Overall I’m pessimistic that another Einstein is possible in the timeframe that we need them and that they would have the motivations to solve the problems that we need solved.
My cynical view is that realistically another Einstein would probably just get sucked into figuring out how to use big data analytics to get users to click on ads all so they could buy a $2M three bedroom house in the Bay Area.
It is unclear if the Earth’s carrying capacity reaches a trillion, that’s certainly in the high side of forecasts. It does not look like we’re on a trajectory to hit anywhere near that.
I also question the value of genius at driving GDP growth indefinitely. Eventually you run into natural laws that are insurmountable; you can’t genius your way out of entropy.
That said, the GDP wall could well be millennia away and we still have tons of room for growth. Maybe we finally bring cheap fusion online, solve asteroid mining, and terraform anything remotely habitable around us. Or maybe we don’t, investment as a vehicle for income fails, and no one gets to retire in 50 years.
It’s been pretty clear for some time now that inability to inhabit anything besides earth is a huge failure mode for the species. It might possibly be the unifying goal for the species to put aside its petty differences and come together on a grand project.
I gotta say though, the chances seem extremely slim and it’s more likely that climate change would trigger a reduction in the production capacity of humanity triggering political changes that may make it impossible to solve these problems.
Unless more of the world falls out of economic development, the opposite of the trend we've seen for decades, the Einsteins born in areas that can empower them will increase in number proportionally. In fact, our current accounting of Einsteins is limited to the ones that were empowered, so if trends continue we should expect a larger than proportional increase.
"In the long term we are all dead" so why would it even matter if over 2100 years your perfect 5% compounding hasn't happened as expected? No place on earth experienced nothing short of complete societal overhaul in that span -- most often multiple times at that.
I threw out some numbers to set a baseline of “this can’t go on forever.” I don’t pretend to know when it starts to transition, or the speed of the transition.
The fact that the rate of growth will someday slow means assumptions you make about your 401k may or may not hold if we happen to be at the wrong point on the curve.
But humans also don’t have infinite demand on production. If we have a sufficiently high amount of production per capita (ie we are post-scarcity) then growth becomes irrelevant (especially if overall population isn’t growing, which with current trends seems reasonable). At that point the only thing is to ensure that output distribution is sufficiently equitable. We can then have millions of years of stable happy humanity with zero growth.
I don’t agree. I don’t think we currently have enough stuff. As a techy in the US I make more than most, but there are still many material things that I can’t quite afford/have to limit myself. However, if production was 100x what it is now then perhaps I would be able to afford them. Post scarcity is at a production level far greater than current.
Also, higher production doesn’t mean higher natural resource consumption —- dematerialization is real. My phone satisfies my needs far more than a landline could but requires far less natural resources.
But don’t you think your desires would grow accordingly? To go back to my “medieval peasant” example, a simple shirt is something we take completely for granted and is arguably “post scarce”. But before industrialization, people would think of a shirt sort of like we think of cars today. It took months of labor to make one, and it cost orders of magnitude more what it costs today. So to those people “I would own a couple of really nice shirts” would have been a reasonable goal to aspire for. They simply could not imagine cars or iphones.
Your second point is an interesting one. I do think we’re gradually moving to a world of artificial scarcity (brand names, luxury goods, bitcoin etc.), plus some things will always be scarce by nature (access to important people, people’s time). So perhaps we’ll just discover that the connection between resource scarcity and human desires is accidental.
Yeah, my point rests on the idea of dematerialization going forward. I think people have finite capacity of desire for natural resource limited products and it is possible that we are not too unreasonably close to “peak physical stuff.” I can get better more “intelligent” clothing but I will never need 100000 unique clothing items simultaneously. On the other hand, immaterial needs may continue increasing, my desire for AI assistance, computer-human interfaces, and augmented reality may be massive, but those have low marginal cost.
I do also agree that certain things that are scarce by design or by their nature and will continue to be so.
The rich will not give away their stuff. You’d probably have to give away 90% of your wealth to be level with the rest of the world. Also it is communism and it doesn’t work in practice.
Current world is not post-scarcity. However, there is a point where marginal value of “extra” stuff is essentially zero. When everyone can be at that level is what I mean by post-scarcity.
Over that time, you could populate a good portion of nearby systems. It would only take 1m years for humans to populate every possible planet in the galaxy:
Sure, but then your economy is still constrained to grow at the speed of light. A shell of some thickness expanding at the speed of light. The volume of that shell increases parabolically, not exponentially.
So it still needs to slow down growth, although growth can still occur indefinitely. Well, billions of years until stars naturally start burning out, in which case you get a slowing of growth and degrowth until you're huddled around red dwarfs for a trillion or so years and then harvesting energy from black holes until like a quadrillion years.
Consider the last 2000 years. The global market went from nothing to outlandish emperor-level luxuries available to multiple billions of humans + all the stuff that we have that even emperors didn't imagine. I think quintillion times growth in "actual value to humans" is not that off. And thinking about the next 2000 years, I don't see any hard limits there too.
A quintillion is larger than the ratio of a synaptic refractory period and a human lifetime by a factor of about 1.5 million. Even with my optimism about transhumanism, I’d be very surprised if that was accurate or will ever be.
With the world’s population projected to severely contract in the coming centuries, I wonder how that will effect the possibility of exponential growth.
General artificial intelligence, once we figure it out, will cause an increase in the annual economic growth more extreme than even the industrial revolution caused. Either that or a disaster, but hopefully the former.
Anyone who thinks we will run out of things to create just lacks imagination. There's so much stuff we'd really, really like to have but haven't been able to economically create yet. Medicine, body modifications, automation of all that's boring, cheaper manufacturing of everything, entertainment, recreation, transport, space habitats and almost anything else you can imagine.
Parking my comment here to be part of the dense club.
Why would you even need forever growth? Is it good enough that old companies die and new companies replace the old? In that process, there's always growth to find and invest in?
There's always winners and losers. We hope the market provides us with ever improving options, which could be a win for everyone. Some may lose by taking down zombies, but the market overall improves. </overly simplified and probably wrong answer>
The article is kind of fluffy. Not everyone should save and invest the same way. Someone who's closer to retirement shouldn't necessarily be investing like an "optimist" (i.e. more risky long-term portfolio), and they'll probably want more liquid assets than someone who's in their 20s with very limited obligations.
Having an emergency fund can benefit everyone but beyond that your portfolio should ideally be driven by your goals and their timeline. If you have no goals and you're just trying to make as much money as possible in the stock market like a lot of new retail investors, this definitely should be given some thought.
I think most could be better served by learning and applying goal-based investing and modern portfolio theory to achieve what this article is clumsily trying to suggest.
My takeaway from the article was actually matching exactly what you're saying. You understand that investment in the long term should be profitable, but can be negative in the shorter term. And that's exactly why when you're younger you don't need to worry too much about bumps along the way, because you have a longer horizon. When you're older, your horizon is shorter and you have to adjust accordingly.
Unless you have more invested than you’ll plausibly need to withdraw, in which case your investment horizon can be longer than your lifetime. (My investing horizon is ideally more based on my future grandchildren’s lifespan than my own.)
You can also be thinking about trying to set your grandchildren up with a small inheritance (e.g. down payment on a moderate home). I wouldn't consider that dynastic wealth (they will still need to work) but it goes a long long way to making your grandchildren's life much, much easier.
Exactly. My parents gave me $10K towards my first house down payment and I plan to do similarly for my kids. I’m nowhere near on track to need to talk to a estate trust advisor, but I’m planning to have saved up more than 25x my annual income requirement in retirement; as a result, I’m very likely to die with a positive balance in my accounts.
Don’t worry too much: My kids will 100% have to work if they don’t want a sucky life.
I'm totally philosophically aligned with this article and enjoyed reading it, but I'm just interested to hear whether anyone else has this problem: More and more stuff I read seems to be name-droppy like this. For instance, I've been reading "The Psychology of Money" recently, and I'm enjoying it, but its style is a lot like this article; an endless series of anecdotes about famous and semi-famous people, with insights from the author tying them together. Is this a new trend of some kind, or has it just become more obvious to me lately?
Edit: Ha! I did not catch the part at the end where this is the same author as that book. Ok then!
> Is this a new trend of some kind, or has it just become more obvious to me lately?
It is a classic trend. Anyone writing a book or trying to reach a wide audience has to cater for the fact that the audience has none of the skills required to assess complex claims. Most of the readers aren't going to be good at maths, are not going to have a grasp on the nuances of human behaviour and incentives, struggle with science, don't read history, etc, etc.
What most people are good at is copying successful people. So it is extremely common for people with large audiences to converge to a "Here is an example of a famous person, here is what they did. Here is another famous person, they did the same thing" style.
It’s not a new trend, it is common in non fiction writing. Everything Malcolm Gladwell writes is in this style, and the same for many non fiction business / self help type books.
"There’s this writing style in popular non-fiction that I’ll call the ‘Malcolm Gladwell method of shoving-a-story-in-your-face’. It substitutes argumentation for storytelling and anecdote, and in so doing sidesteps the difficulty of making a case, since the reader is too distracted by narrative to comprehend the point the author is actually attempting to make.
Whenever this happens, I take care to pay special attention, because often the point is banal, or flawed, or too inconsequential to stand on its own. (I happen to know this because I’ve used this technique a few times on this very blog, and I know from reader feedback how effective it is)."
It is annoying though when it get voted to the front page. You are expecting something that is interesting or insightful and it is just generic, repackaged investment insights/aphorisms/advice that is used as an indirect sales pitch to promote a likely equally mediocre investing service.
Honestly it’s every business/investing/self-improvement/etc book. Clever anecdotes and analogies turning what should be a few paragraphs into a couple hundred pages. I can’t remember the last time I read a good book in one of the aforementioned categories!
Collecting these stories and weaving a narrative around them is basically productizing survivorship bias and many people have made a career of it. Just browse the bookshelf at your local Fedex Kinkos. E.g. Malcolm Gladwell, as was mentioned elsewhere in this thread.
One question that's been top of mind lately for me is how optimistic you should be in your investing strategy.
IBK currently allows retail investors to trade on margin with an annual interest rate of only 1% (yes, really). You can borrow up to 2x your principle at this rate.
If you were extremely optimistic, you would borrow 2x your principal and expect to 3x your annual return.
If you were optimistic but wanted to avoid risk of ruin, you would borrow between 0-1x of your principal.
Curious if anyone here has considered this or has a strong opinion on it.
Side-note: I'm assuming my "principle" in the above scenarios is the remaining cash I have on hand after my rainy day fund (i.e. the saving like a pessimist part).
One should target volatility, not leverage. Without leverage, you can usually only take the most risky of strategies in order to get a return. If you're willing to take on leverage, you are much more likely to find a good strategy.
Source: work at a small prop firm that takes on around 10x leverage. Even at this leverage ratio, we are considerably less risky than the S&P 500. Even at 10x, our volatility is somewhere between 1/2 to 1/3 of the S&P.
If you take on very little directional risk and are doing stat arb like us, there's nothing wrong with taking on a lot of leverage. Even at 10x, we are safer than the vast majority of retail portfolios in existence.
Leverage (through futures, options, shorts, or borrowing) is the cornerstone of almost all active outperformance in the industry. Without leverage, you will be forced into high beta names that trade at a premium compared to their risk adjusted return. See the "low beta anomaly" for more information.
Shit happens and even the smartest people can get fucked, just look at the LTCM blow up. So of course it's possible.
It's impossible to eliminate all risk, regardless of the leverage ratio. I'm just saying that leverage isn't a reasonable proxy for risk. You have to dig deeper.
That sounds reasonable at first glance, but it would be really interesting to see a proper study of leveraged investments throughout the modern era, and their tendency to blow up compared to the volatility of what would be the reasonable alternative.
The book Lifecycle Investing by Nalebuff and Ayres, both professors at Yale, argues fairly convincingly that trading on margin is optimal for young people, especially those expecting high-earning careers (e.g. software developers).
The calculations in the book use much more pessimistic annual interest rates than the 1% you quote, too.
I'm too risk averse to actually do this, even though I believe their arguments. However, it has convinced me that at least 100% stocks, 0% bonds is optimal, if we avoid margin (for a young person expecting a good job).
path dependency is the main problem with margin trading. S^P 500 fell 60% in 2007-2008. So that should give you an idea of how much of a cushion you need to give yourself for the worse case scenario.
if you have have 100% margin and the market falls 50%, the broker will close out all your positions at a large loss to protect its own assets (often well before the 50% target), at which point it will not matter how much the market rebounds after that
I personally don’t invest on margin. It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead.
In short, there’s no set of circumstances where my decision tree comes down on the side of taking the loan.
I actually have a somewhat controversial opinion (that shouldn’t be controversial because it’s all math, but it still is regardless) that, after you save 5-6x your emergency fund, you don’t need an emergency fund at all and you’re better off investing it all in a total market index fund. The reason being that even if there is a market crash, you’ll still be able to afford the emergency since you’ve saved multiples of it already, and in general in the long run having stocks instead of cash or T-bonds in an EF will be better. Various blogs have done the math and it all checks out, but people still push back at me for this. Having an EF if your net worth is a few multiples of your emergency fund, is entirely psychological. Which is fine. But people should just be aware that it’s a bias they have.
Perhaps investing on margin is the same. I have personally taken the leap and got rid of my emergency fund. But I haven’t looked at investing long-term on margin yet. I did see a test from HEDGEFUNDFIE on bogleheads forums about this. But I haven’t looked into it. I definitely think taking out a margin loan while simultaneously having an EF in cash makes no sense though.
You have $100k. Put 80% of it in the stock market. The stock market drops by 40%, your investment is worth $48k and you withdraw nothing but spend your entire emergency fund. The market recovers and now your portfolio is worth $80k.
You have $100k. Put all of it in the stock market. The stock market drops by 40%, your investment is worth $60k and you withdraw $20k.
The market goes back to 100% and now you have $67k in your portfolio.
If the market dropped by 80% your portfolio would be gone entirely. Meanwhile if you had enough emergency funds you would have kept everything.
The worse the emergency, the higher the ROI of the emergency fund. Since there is no upper bound for how bad an emergency can be the theoretical ROI of an emergency fund is also unbounded.
In this comment the definition of an emergency is a stock market drop combined with unexpected unemployment.
You've just given a cherry picked example to show that yes, withdrawing during market downturns is bad. I don't disagree with this? I'm merely saying that, on average, over the long-term, it makes more mathematical sense to ditch the EF if you're a high net worth individual. For example, you have literally just picked the worst case scenario and used that to justify why the strategy is bad. What about all the times your emergency doesn't coincide with a total market crash? My all stock "emergency fund" will actually grow larger than yours, on average. You probably have several emergencies over the course of your life.
Honestly your example is about as useful as me saying investing in stocks in general is bad, because sometimes, they go down. So what? We're talking about broad long-term averages here, nothing more.
It's fine to argue about personal psychological preferences, but as I say, this purely a mathematical statement I am making here. It should not be controversial, but it always is.
Yeah, I mean there's also some practicalities involved like having cash to withdraw from an ATM or paying rent, but yeah pretty much I'm fully invested.
I know. I get the exact same push back every time I mention this. I don't know why? I'm literally saying, on average, over the long-term, it's mathematically better to ditch the EF. This is a mathematical statement, but always someone says ""but what about 2008!?" as if I havn't considered it. It's quite bizarre. I suppose an EF is an emotional issue for a lot of people maybe.
I mean honestly, using a credit card for a month before interest hits is usually fine too? My credit limit is like 50k or something ridiculous across all my cards. Not to mention when all in on stocks you can sell for better long-term capital gains tax treatment or even tax loss harvest losses too, which you can't do with a savings account. And ETFs are actually pretty liquid: I can sell and withdraw in a few days if I wanted to anyway.
Yes, but then you need cash to pay off the credit card, which is cheaper to pull from your margin available than to let the credit card charge you interest.
I'm not suggesting to pay credit card interest. I'm saying you can cover any emergency expense with a credit card which buys you a month, and then you might have ordinary salary or time to sell your stocks before interest is due.
No offense but I'm pretty surprised you commented what you did. Literally my first sentence says "... before interest hits...".
I’m perhaps equally surprised that you’d consider anything an emergency that would covered by your ordinary salary within a month’s time. I mean, that’s just normal credit card use, right?
Maybe we’re talking cross purposes here because I generally save a large % of my paycheck. So if an emergency came up (and I was still employed) I would just save a smaller % of it.
But regardless I’m just saying you can use a credit card to buy time interest-free before you pay off the emergency with your salary/stocks/whatever. It’s better than taking a margin loan, no?
> So if an emergency came up (and I was still employed) I would just save a smaller % of it.
i mean that's not really an emergency.
An emergency is one such that if you weren't prepared for it, you can't handle it. For example, losing one's job can be considered an emergency (a short one, if you're in high demand).
A medical emergency is a good example of an emergency - to which you prepare for by purchasing insurance.
So by saying that a person's portfolio would perform better by ditching the emergency fund is just the same as saying 'take on more risk and get more return'.
You’re kind of nitpicking here. It doesn’t matter how much the expense is: the point is that you can use a credit card to buy time interest-free before you pay off the expense with stock/paychecks/whatever. Regardless of what the expense is, this is clearly better than taking out a margin loan immediately.
I’ve thought about this too, and came to a different conclusion. The primary reason is just because the markets haven’t collapsed more than 85% over a months long period before, doesn’t mean it won’t in the future. And, my marginal utility for money gets so high below a certain level, that it’s not worth risking this outcome when the marginal utility of more money is relatively smaller.
Yeah, it’s essentially just estimating the probability of you getting an emergency which coincides with a total market collapse so horrific it reduces your semi-liquid net worth to less than your emergency. I’m at a point where I’m ok with that risk. At some point you would be too: 85%? 90%? 99%? Clearly we agree Jeff Bezos doesn’t need 6 months cash on hand at all times. So the limit is somewhere. I think a total market collapse reducing the Dow Jones to like 3,000 is pretty unthinkable at this point. Or rather, if it did happen, there are bigger problems than my cash, like the zombie apocalypse which caused this horrific stock market collapse.
1. To have enough money to survive an emergency no matter what.
2. To maximize long-term net worth on average.
I was only talking about 1. You are talking about 2. But, to address your point: yes, stocks can indeed go down, but on average they go up. Sometimes your emergency will coincide with a good stock market. You're literally choosing the worst possible situation and then saying "see, this strategy doesn't work!". But I'm actually being very careful with my words here. I am saying: mathematically, backtesting with real data and with monte carlo simulations, you will maximize your long-term net worth on average if you forgo the EF after a certain net worth level.
Consider also the original comment I replied to talked about investing on margin while simultaneously having an EF. Which, if you're against me forgoing an EF, you must really be against investing on margin while having an EF: That's kind of the same to what I'm currently doing, only paying interest for it!
People don’t keep EFs to maximize their expected net worth. They do it to keep worst case scenarios within reasonable bounds.
You argue keeping stocks is ideal for 2 (sure) and it doesn’t hurt 1 (assuming your net worth is significantly higher than what you’d keep as EF). Agreed.
An EF is for
3. Maximize long-term net worth in x th percentile of outcomes (where x < 10)
EDIT: “ you must really be against investing on margin while having an EF”. Yep.
Makes sense. 99% sounds about right for myself. But, how do I estimate the degree of downswing that I'm 99% confident will never happen in my lifetime? Or, is there a way to buy options to protect against this outcome that would economically make sense? Thanks!
Yeah it’s hard. There is about 200 years of stock market data so I would look at the biggest crashes to get a sense of what the biggest of them all could be. I guess that’s the German tank problem. It seems very unlikely we’ll get a crash relatively twice as bad as the Great Depression though
It seems very unlikely since there's 200 years of data to show that was the biggest crash ever. So a crash twice that size is very unlikely. You could do the math to calculate the exact probability given the sample size of stock market years.
Right, and at some point you have to choose to live your life assuming there isn't an undetectable asteroid about to wipe out all human civilization, even though you don't know the probability of it happening.
I keep roughly 10% of my net worth in cash... That equates to several years of expenses. It may be excessively high but it lets me sleep at night. You joke, but the past year shows something like a zombie apocalypse is a possibility.
Yeah as I say, it's fine to do whatever you want with your money to provide emotional comfort. I'm merely saying it's a psychological bias you may want to be aware of.
I mean, you chose a 10% figure. Why 10%? Why not 20% or 5%? I think it's helpful to really think through the math sometimes.
Yes, you're right... Mathematically, I know I can be fine with less, it just makes me feel uneasy. I was actually trending towards a lower percentage, but I got scared and depressed earlier in the year. I sold off some poorly performing stocks and ETFs, giving me some more cash cushion. It felt like the sh*t was really hitting the fan. It still does, in many ways, just not for my investment accounts. When (if?) things "go back to normal" I will re-assess...
I suspect if you know not to trust yourself to stay the course when the sky is falling, then you are in fact probably better off in the long-run with a less risky asset allocation. There’s plenty of evidence out there to show that the more you buy/sell/tinker, the more likely you are to get worse returns. Literally the best investors are dead people. So if you need some % of cash or bonds to stay the course and do nothing, that’s good. Which shows some self awareness and maturity. Ideal would be to dispassionately follow the math, but your strategy is the next best thing.
> You joke, but the past year shows something like a zombie apocalypse is a possibility.
For me the past year shows that the economy has been more resilient than most people expected, that the Fed is willing to drop rates to zero in order to keep it that way, and that the stock market actually goes up when that happens because it is the only investment that might return more than a fraction of a percent.
If you are going to keep that much in cash, I might suggest putting some of it in inflation-protected securities like I-bonds. They are backed by the US government, and I can't forsee a situation where the government could default on them without the value of the dollar also tanking. They are better protected from inflation than money in a savings account.
I agree with what you say about the economy. I am also impressed by the resilience there. My apocalypse comment was more in reference to the non-economic aspects... sickness, death, isolation. I put on the news and it's awful. Working-from-home has also really worn me out. Many nights, I have trouble sleeping.
I will look into something like the I-bonds more seriously.
In the very worst scenario, you’re going to need guns, source of food, land, and most importantly a network of people who you can call to help defend you (or go on offense with you to acquire necessary resources).
The dollar is only useful as long as the US government continues to perform as an organization. However, as the US approaches dissolution, I would expect the value of USD to approach zero as the government increases the supply of money and prospective owners of the currency lose trust in its ability to retain value in the future.
>or go on offense with you to acquire necessary resources
Are you seriously suggesting, on a hacker forum, to be prepared to use the proceeds of your emergency fund to violently steal life-critical resources from other people in a crisis?
I really hope I've misunderstood, and you're using the phrase "go on offense" as a euphemism for deer hunting.
No, I am suggesting that in a worst case scenario, an emergency fund full of cash is useless (on a multiple year timescale, of course how many years is subjective).
It’s conceivable to imagine a scenario where resources are so limited that acquiring them becomes a do or die situation, which is what I imagine the previous poster meant by “zombie apocalypse” scenario (or more realistically, war). Or I erroneously assumed “zombie apocalypse” to mean worst case scenario.
I also forgot to include a less drastic measures of also owning assets in a different country and the rights to live there in case you need to immigrate.
This is true. However, I think there are a variety of scenarios, less extreme than total societal collapse, where it still may be useful to have a large emergency fund. It may not be rational.
Do we all agree with that? I feel like I'd probably still keep 6 months of cash on hand if I were Jeff Bezos... But presumably that's one of the many reasons I'm not.
This sounds true if you only optimize for (hedge against) one risk only - stock market crash.
To me, an emergency fund is a hedge against various different risks like these (I am guilty of not being prepared for all of them):
1. A pandemic. For this I was ready even before we thought it's indeed possible - I have funds in several different banks (debit cards) that allow me to not have to visit a bank physically for several years (even if some of the cards expire in the meantime, or one bank suddenly goes bust)
2. AI glitch, identity theft, a bank holiday (this happened to me actually some years ago) that blocks you from accessing banks (and investment brokers if you have nowhere to withdraw your funds) for several weeks/months - for that you hold paper cash, physical gold and cryptocurrencies stashed at different physical locations.
3. Natural disasters - again some combination of diversified physical and virtual funds
4. Legal trouble - yes, even if you are not guilty you could get your funds blocked.
I presume you are from the US, hence the purple goggles ;) (I hope I'm not offending you)
You won't necessarily have to, but yes, no risk no reward. Doing this is what people who have retired have to do whenever there is a market crash.
Really this shouldn't be that controversial. It's super simple: Which does better long-term? Stocks or cash? That's pretty much all I'm saying. There's a ton of data to back up what I'm saying.
Leverage allows the execution of strategies that have a high Sharpe but low natural return.
I work at a small prop trading firm and we run 10x or even more leverage most of the time. Without leverage, we wouldn't be able to run the vast majority of our strategies.
Basically, leverage is immaterial: what matters is the risk of the strategy. A leveraged strategy could be less risky than an unleveraged one.
Things that you should consider when deciding leverage: beta exposure, correlation to the market, volatility of the strategy, and the risk adjusted return of the strategy.
A classic example of this is risk parity: risk parity uses high leverage but is often safer than a classic 60/40 portfolio.
To be honest, what you just said went right over my head, but I really want to learn more. Can you recommend where to start given that the strategy I'm evaluating is akin to levering up 1x and investing in index funds?
@smabie: Thanks a lot for the post. I am for the first time understanding concepts that in words were very hard to process. The math connection you make really helps, as basic calculus as statistics are part of an engineering background.
I really appreciate it! Finance can be a really opaque topic and there's a lack of rigorous yet straightforward material about the subject.
Most information about trading either falls into the total bullshit camp designed for idiot retail investors, or complex papers/books designed for academics or professionals.
My blog tries to straddle the two: providing rigorous material but geared to those without a background in finance.
> It just feels weird to take a short-term loan (whatever the interest rate) when I have the cash to cover the loan. And if I don’t have the cash to cover the margin loan, I should be working on increasing my emergency fund instead.
I see. Would your thinking change if your emergency fund was sufficiently large but much smaller than your investable cash?
For example, let's say your rainy day fund was $10, and you have $100. You have $90 to invest. In this case, the short-term loan you're taking out could range from $0-270 (the majority of cases would not be covered by your rainy day fund).
I like the OP don't use margin. Long term it will lead to trouble, it may work for a little while but long term the trend is against you. Especially when you have a larger account they will give you 4x margin, this is a great way to loose a lot of money quickly if the market makes a quick turn against your positions. To be clear the market invariably at some point will quickly turn against you!!
In my opinion, and practice, emergency funds should not be used for investments ever, this includes covering the losses from investing. Yes it can feel like you are not maximizing your returns on that amount of money but its job isn't to generate returns, it is your help smooth out the bumps in the road of life for you. In my experience life can punch hard and it never throws just one punch, it is usually a 1,2,3 combo. That emergency fund is merely there to help raise the chances of you standing on your feet after the vicious flurry.
If you want leverage and you are in the US or have a US based brokerage account use options. By using options your all in is basically the cost of the option and this ensures you will not ever lose more than you paid. PLEASE note the previous sentence is predicated on the golden rule of NEVER WRITE an uncovered/naked option, seriously do not do it!!!! I also use the 5% rule, which no one trade is more than 5% of my portfolio so no one trade will destroy me.
No. If a margin call came in a down market, it would wipe out my emergency fund; that’s the exact opposite of “saving like a pessimist.” If I have $90 to invest, then I have $90 to invest; I’m not going to gamble with someone else’s money whatever the odds.
Let's say you found a strategy that had 10% return and 1% volatility. you really wouldn't leverage this? Even after 4x leverage is applied, it would still be considerably less risky than the S&P 500.
They're not too good to be true. it's just the people making those kinds of returns aren't taking retail investment.
For example in crypto, market makers are commonly making 100% return. You haven't heard of these firms and they aren't interested in your money.
Market makers usually do quite well for themselves, but are capacity constrained: they can earn stellar returns on tens of millions of capital, but maybe not hundreds of millions or billions. You probably haven't heard of most of these firms and they would prefer to keep it that way.
of course if you want a public example, look at RenTec. They are unique in generating eye popping returns with such a large amount of capital. This is extremely uncommon. However generating comparable returns on 500-1000x less capital is significantly more common. These returns often don't compound tho, as they are severely capacity constrained.
It sounds like people who invest the time to properly learn finance can make a pretty good living at it. If that’s you, I wish you the best of luck.
But I’m a retail investor, and will almost certainly remain one— Not only do I not have the training to come up with these strategies, I don’t have the knowledge to judge the veracity of anyone claiming to sell them to me either. I’m content with my suboptimal portfolio that I don’t have to think about more than once a year, and have more important things to spend my time on.
Few cryptocurrency holders are using it for payments or building anything that creates value. It’s just zero-sum speculation and FOMO.
Equities are different because their connection (however tenuous) to actual earnings gives them a very steady long-term uptrend. The hard part is just staying in during a crash so you don’t miss the recovery. Half of S&P 500 returns came on its ten best days.
I myself also don't trade on margin, but I don't disagree with it. An optimal trading strategy should be positive and often could include some amount of margin trading that beats interest rates as well as accounting for additional risk. The reason I don't trade on margin is that I don't put so much effort into it to optimize to such a level.
I think the answer is more philosophical than a formula that applies to everyone: in that sense i would say: save like your pessimist self would save and invest like your optimistic self would do. Like a grandpa would say, "To Each Their Own"
My optimistic self will probably always invest way more conservatively than someone investing on margin...
Absolutely not because of risk of ruin owing to path dependency. I would recommend 2-3x ETFs instead because there is no risk of ruin but there are still possible path dependency issues.
I'm a foreigner that's lived in the US since college. Half of my friends and family are american and the rest foreign. There's a huge cultural difference between both sides' approach to wealth.
My american f&f (outside of silicon valley) think of wealth in terms of "saving for retirement." 401ks, tax strategies, etfs, stocks etc. It's very passive, probably "correct", and very unambitious.
The foreign side is totally different. They have very little interest in saving for retirement--they think in terms of investing in businesses. They don't buy etfs or stocks. They buy (small, then larger) businesses. It's very active and after age 40 or so takes up most of their time. The goal is to never retire, but rather to build a series of cash producing entities for ever.
Part of this is certainly cultural. In lots of the world, being a boss is higher status that being an *employee", regardless of the actual income each activity generates. The owner of a business with 200k in revenue is higher status than a McKinsey employee with a 500k salary.
This cultural difference is reflected in a desire to escape "wages" as soon as possible, not necessarily "save for retirement".
> This cultural difference is reflected in a desire to escape "wages" as soon as possible, not necessarily "save for retirement".
I don't think it has to do with that necessarily (at least in my cohort), it's just that many immigrants come from nations who haven't had stability in their financial systems, if they even had one to begin with. A business has tangible roots in a community and can generate revenue when there's a monetary collapse, which is much easier for someone to trust if they haven't grown up in a stable economy. My old country doesn't even have 30 year mortgages, for example. If it did, mortgages expiring now would have been signed right as the iron curtain was coming down, which drastically changed the Eastern bloc's financial systems almost over night.
This isn't that unusual and is sometimes driven by available opportunities. If you live in a developing economy, the number of $500k equivalent jobs is likely not high, and at least for the countries I've visited, they are often roles at multi-nationals with foreigners at the top (and not all that accessible to locals).
Similarly, your potential investments for retirement savings can be quite limited. We're quite spoiled in the west to have massive stock markets with tens of thousands of stable, profitable companies. And a regulatory framework which means the chance you buy a stock and find out the entire company is a fraud is relatively low. I've heard from folks in some developing countries that they'd never put money in their own stock market - the chance of losing everything is way too high.
For developing countries, you often have a young, expanding population, and 7% GDP growth in one year wouldn't be seen as abnormal. Small businesses become a great way to get in on the growth (the market is often highly fragmented, so competition isn't that fierce) and businesses are a much more accessible way to wealth than any corporate job. The other avenue I've seen is real estate. In the SE Asian countries I've been in (the ones growing quickly), real estate is even more of a ticket to wealth than in the US. Seems like they can never build enough and in the big cities, prices aren't that different than non-coastal US ($100k+ USD), which is shocking considering the median salary is 1/10th that of the US.
Status is weird like that. Different cultures assign status differently. In many parts of the world--certainly in LatAm--status is about power and independence more than it is about money.
If it wasn't clear, I'm not disagreeing, I'm looking for examples, or other reasons for that belief
Edit: The note I think about it, the more I'm inclined to disagree after all. A $500K McKinsey employee is not an entry level consultant. They are likely leading a large team and working regularly with C-level executives at enterprise businesses. They are going to have presence and gravitas because credibility is a huge part of their job.
What kind of business does $200K in revenue per year? It's very likely to be a sole proprietorship, maybe 1-2 employees at most.
I realize that there may be cultures and subcultures that truly believe the independence of the business owner makes them more respectable (although I personally believe that independence is a bit of an illusion), but I think more people would subconsciously assign a higher status to the first person and that it probably wouldn't be close.
This is more a function of your successfulness and competence than whether you happen to have an incorporated business wrapping your daily operations.
A successful and competent employee has built relationships with colleagues, supervisors, and reports. He knows them, and they know him. He won't be asked to subjugate his principles to the company in an inappropriate way, in part because others know that he will go above and beyond within his principles to do well for the company.
For a business owner, the exact same thing, just replace colleagues et al with customers, suppliers, shareholders, and other partners.
On the other hand, a weak business and/or business owner will be very vulnerable to principle-based compromise. Out of the need to keep customers, suppliers, et al happy, he is subject to whim and every demand. Walking away from his business means the collapse of his reputation, failing his employees, and failing his family. He is no more free than your average entry level employee.
>He won't be asked to subjugate his principles to the company in an inappropriate way, in part because others know that he will go above and beyond within his principles to do well for the company.
I respectfully disagree. Your team may not, your direct reports won't and your management hierarchy may not, however, your business will. If you have certain principles such as support for LBGTQ+, anti-military contracts, or a conservative in tech for example, and your company signs a contract to work with another organization that doesn't care about the cause or are completely against it, what happens? I know CEO's who can't fire bad clients because they don't own their own company.
>Walking away from his business means the collapse of his reputation, failing his employees, and failing his family.
Walking away from bad business can make you so much money it's hard to imagine. I've had conversations about doing business with shady people, which resulted in me making a deal with the person who had the same experience with the other individual.
>On the other hand, a weak business and/or business owner will be very vulnerable to principle-based compromise.
Growing pains, but an employee who is competent or incompetent will face the same dilemma because of what I suggested earlier.
I call it being a slave earlier, to intentionally raise alarm. I don't know of a way to define it but you don't have to go to sleep at night thinking, well, I didn't like that decision and now I need to change my entire life or deal with it. I.e. find a new job, change my commute, change my schedule, acquaint yourself with a new environment, meet new people and so on. An owner, is doing this on a daily basis already.
> If you have certain principles such as support for LBGTQ+, anti-military contracts, or a conservative in tech for example, and your company signs a contract to work with another organization that doesn't care about the cause or are completely against it, what happens?
I guess things are changing, but historically refusing to serve customers based on political differences would be considered intolerant. You can disagree with someone without refusing them service. I don't see any ethical dilemmas in serving someone you disagree with. You are free to disagree with that principle.
For any business owner, making a decision to walk away from business on grounds of political disagreement is a huge luxury. I don't think it's commonly exercised, and for good reason, imo. This is very different from walking away from a "bad customer", one who may cost you money over the long run while sapping your soul. Empowered employees also feel capable of walking away from these customers because they understand the business so well that they see the issues coming, and they've earned to decision making respect for their choices to have weight.
> Growing pains, but an employee who is competent or incompetent will face the same dilemma because of what I suggested earlier.
This is exactly what I'm saying. The two are more similar than I think most people make them out to be. You will have differences in freedom, but those are often determined by your competence and success, more so than whether you have a business license.
The way you talk about a business owner sleeping well at night makes me wonder if you know any. Owning a business is extremely stressful. The buck stops with you, and while in theory you are free, your entire business depends on your decisions. You think it's hard to change jobs? How hard do you think it is to move on from a failed business? In a capitalist society, business owners are as much slaves as anyone else. The difference is, you take so much risk on that if you succeed, you end up making a return that does buy you a good deal of freedom. But that's not intrinsic to the business you own, and it is determined as much but what you need as what you have. It's a freedom derived from being a human being that has "enough".
>I guess things are changing, but historically refusing to serve customers based on political differences would be considered intolerant. You can disagree with someone without refusing them service. I don't see any ethical dilemmas in serving someone you disagree with. You are free to disagree with that principle.
Let's not separate a single example, the entire example list is as a whole, i.e. any of the situations listed are that to the person involved. Sure for you it doesn't, however, someone else will have a different opinion with respect to dealing with other political stripes. There are people who won't deal with other religions in this day and age.
>> Growing pains, but an employee who is competent or incompetent will face the same dilemma because of what I suggested earlier.
I typed this in a way it was not clear. The growing pains will heal. The competent and incompetent employees will always be slaves, their competence won't help them.
No I was a wage slave. It is why I'm saying you can't succeed as an employee without compromising your principles. Even CEOs of Fortune 500s don't have the ability as they have a board to report to. Well except Zuck.
I think it's worth considering that, just because you didn't do it, does not mean it can't be done. Perhaps your personal growth was as big of a difference as the format of your labor relationship.
>Compounding is easy to underestimate because it’s not intuitive, even for smart people. Michael Batnick once explained it. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8x8x8x8x8x8x8x8x8, your head will explode (it’s 134,217,728).
what does this have to do with anything. no kidding that multiplication is harder than addition (it requires many additions).
Using Microsoft and Bill Gates as an examples is major example of survivorship bias. What about the hundreds or thousands of other companies and founders that tried such an approach and still failed. Yeah, in hindsight anything Microsoft does will look like genius given how successful Bill Gates and Microsoft are. if Bill gates had policy of tying his shoes at work instead of at home, people would probably read into that as part of his success.
> You could tell three things about Bill Gates pretty quickly. He was really smart. He was really competitive; he wanted to show you how smart he was. And he was really, really persistent.
Of course he was also a lier (vapor ware). And a cut throat business man.
You might like nowadays Bill Gates philanthropist, but there is a reason people hated him for decades. I don’t understand why retrospectives on him ignore this side.
The author is quoting Paul Allen about his first impression of Bill Gates. How is him being a cut throat business man relevant at all ? This is a pointless comment.
>"Of course he was also a lier (vapor ware). And a cut throat business man."
You could say the same thing about any business person. And the bigger the business the bigger are the qualities you mentioned (or should I say they just cause bigger effect). It is obvious. Also it is not reserved specifically for business person.
‘Bankroll management’ concepts in the poker community were a fantastic learning tool about concepts such as variance and risk of ruin. The ‘tldr’ recommendation is to keep 20 x buyins of a cash game or 100 x for tournaments, but inside the nitty gritty, as Opponent skill increases proportionally to your own, Winrate decreases, meaning more buyins are required to offset risk. ‘Running bad’ can last hundreds of thousands of hands too - 100-year disasters happen every few hundred hands in what mentally seems mathematically improbable is actually likely to happen at an unexpectedly high frequency. Even if you have a 10,000 buyin bankroll, there’s no guarantee you won’t go bust even with a significant skill edge. Be a slight losing player and you will forever appear to be ‘running bad’ but just turns out you suck.
Applying this to real world business concepts is interesting too - corona was a great example, and for all we know next year could be unrelated total world war, past has some indication of future trends but only when the sample size is substantially large (in the case of geopolitics and disasters, all known global history is an insignificant sample)
Is there any way to estimate the total amount of investments that are vulnerable to a margin call or similar mechanisms that can force a sale during a downturn?
Dow dropped 90% in great depression, so even trading the dow with 10% leverage would've wiped you out.
Dow also dropped >50% in GFC, so 2x leverage would've ended you.
Taking ultra risky bets when you are young is sensible because it isn't actually risky. This is because for a 30yo with good career prospects, your future career is probably worth an amortized $5 million dollars. If you have $200k in savings, that is only 4% of your true net worth. If you lose it, you still really have $5 million dollars. Therefore playing loose with it is pretty reasonable.
If you're 63 and will retire in 2 years, your amortized future career earnings are probably $200k and your assets $5million, and then you should be conservative.
"Save like a pessimist, invest like an optimist." Beautiful! Just what i was looking for. So simple and reasonable. How did I not think of this before?
At some point the exponential curve has to go S-shaped. Maybe we’re still in the happy exponential looking part of the curve. There are also signs we might be transitioning. Population growth has slowed, productivity growth has slowed, and the marginal return on capital seems to be somewhere around zero given modern interest rates.