The True Cost of Leveraged ETFs

Under some circumstances, altruists might prefer to leverage their investments. The easiest way to get leverage is to buy leveraged ETFs. But leveraged ETFs charge high fees and incur other hidden costs. These costs vary substantially across different funds and across time, but on average, leveraged ETFs have historically had annual excess costs of about 2%, or around 1.5% on top of the expense ratio.

Given reasonable expectations for future returns, leveraged ETFs most likely have substantially higher arithmetic mean returns than their un-leveraged benchmarks. They also appear to have higher geometric mean returns than their benchmarks, but only by a small margin. Slightly more pessimistic estimates would find that adding leverage decreases geometric return.

Note: Many investors can get leverage more cheaply via other methods, such as margin loans or futures. Even if leveraged ETFs appear better than un-leveraged investments, other forms of leverage might be better still.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Past performance is not a guarantee of future results. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor.

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Can Investors Simulate Leverage via Concentrated Stock Selection?

Summary

Some altruists are much less risk-averse than ordinary investors, and may want to use leverage. But foundations and donor-advised funds legally cannot access most forms of leverage. As an alternative approach, leverage-constrained investors could buy concentrated positions in small-cap value and momentum stocks. For example, instead of buying an ETF that holds the best half of the market as ranked by value or momentum, they could buy the top 10%.

According to backtests, when portfolio concentration increases, both return and risk increase, while risk-adjusted return stays about the same. Adding leverage has a similar effect, so whether investors prefer leverage or concentration depends on the costs of each.

Large investors cannot hold concentrated portfolios without moving the market, so they probably prefer to use leverage if they can. For small investors, even if they can use leverage, buying concentrated investments might actually work better as a method of increasing risk and return.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Past performance is not a guarantee of future results. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor.

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Asset Allocation and Leverage for Altruists with Constraints

Summary

Altruistic investors differ from ordinary investors in that they don’t just care about their own investments, but about the investments of all altruists.

We can use our own investments to improve the overall altruistic portfolio in two key ways:

  1. Increase expected return by investing in high-return assets or by using leverage.
  2. Reduce risk by investing in assets with low correlation to the altruistic portfolio.

At the margin, we have to choose between either increasing expected return or reducing correlation. How do we make that decision?

We can extend the commonly-used technique of mean-variance optimization (MVO) to derive optimal asset allocations under various assumptions. We don’t know which assumptions apply to the real world, but we can draw some general lessons. The result suggest that we should try to both increase expected return and decrease correlation, but that we should prioritize increasing expected return.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor. Any asset allocation described as “optimal”, how an investor “should” invest, or similarly, is only considered such for the goal of maximizing geometric return under specific theoretical conditions, and may not be optimal for any actual investors.

Cross-posted to the Effective Altruism Forum.

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Uncorrelated Investments for Altruists

Summary

  • Altruists care a lot about finding investments with low correlation to other altruists’ portfolios. [More]
  • Altruists can probably decrease correlation by investing in under-utilized asset classes, most notably (1) commodities and (2) long/short equity indexes. [More]
  • But there’s a better way to decrease correlation. Some factors—such as value, momentum, and trend—have been shown to predict investment performance. [More]
  • We don’t know for sure if these factors will continue to work in the future, but evidence suggests that they will. [More]
  • There are publicly-available funds that provide concentrated factor exposure. [More]
  • Factor investing is psychologically painful for most people. We can do a few things to mitigate this, but ultimately it seems unavoidable, and this will prevent most people from investing in value/momentum/trend in practice. [More]

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions. Any given portfolio results are hypothetical and do not represent returns achieved by an actual investor.

Cross-posted to the Effective Altruism Forum.

Last updated 2021-02-08.

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If Causes Differ Astronomically in Cost-Effectiveness, Then Personal Fit In Career Choice Is Unimportant

Confidence: Unlikely

Longtermists sometimes argue that some causes matter extraordinarily more than others—not just thousands of times more, but 10^30 or 10^40 times more. The reasoning goes: if civilization has astronomically large potential, then apparently small actions could have compounding flow-through effects, ultimately affecting massive numbers of people in the long-run future. And the best action might do far more expected good than the second-best.

I’m not convinced that causes differ astronomically in cost-effectiveness. But if they do, what does that imply about how altruists should choose their careers?

Suppose I believe cause A is the best, and it’s astronomically better than any other cause. But I have some special skills that make me extremely well-suited to work on cause B. If I work directly on cause B, I can do as much good as a $100 million per year donation to the cause. Or instead, maybe I could get a minimum-wage job and donate $100 per year to cause A. If A is more than a million times better than B, then I should take the minimum-wage job, because the $100 I donate will do more good.

This is an extreme example. Realistically, there are probably many career paths that can help the top cause. I expect I can find a job supporting cause A that fits my skill set. It might not be the best job, but it’s probably not astronomically worse, either. If so, I can do much more good by working that job than by donating $100 per year.

But I might not be able to find an appropriate job in the top cause area. As a concrete example, suppose AI safety matters astronomically more than global priorities research. If I’m a top-tier moral philosopher, I could probably make a lot of progress on prioritization research. But I could have a bigger impact by earning to give and donating to AI safety. Even if the stereotypes are true and my philosophy degree doesn’t let me get a well-paying job, I can still do more good by making a meager donation to AI alignment research than by working directly on a cause where my skills are relevant. Perhaps I can find a job supporting AI safety where I can use my expertise, but perhaps not.

(This is just an example. I don’t think global priorities research is astronomically worse than AI safety.)

This argument requires that causes differ astronomically in relative cost-effectiveness. If causes A is astronomically better than cause B in absolute terms, but cause B is 50% as good in relative terms, then it makes sense for me to take a job in cause B if I can be at least twice as productive.

I suspect that causes don’t differ astronomically in cost-effectiveness. Therefore, people should pay attention to personal fit when choosing an altruistic career, and not just the importance of the cause.

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Donor-Advised Funds vs. Taxable Accounts for Patient Donors

Update 2021-01-15: While I still believe I identified the most relevant factors for comparing donor-advised funds and taxable accounts, I now believe my expected utility calculator has significant flaws, and it should probably not be used.

Confidence: Likely

A donor-advised fund (DAF) is an investment account that allows donors to take a tax deduction now and give the money to charity later. When you put money into a DAF, you can deduct it just as you would deduct charitable contributions. Then you can direct the DAF on how to invest the money, and choose to donate it whenever you want.

If you want to invest to give later, DAFs have some clear advantages, plus some limitations. Is it better to use a DAF, or to keep your money in an ordinary (taxable) investment account?

According to the assumptions made in this essay:

  • If I want to invest in a portfolio of stocks and bonds, then I should use a DAF.
  • If I have the ability to use leverage or to invest in assets with low correlation to stocks and bonds, then I should keep my money in a taxable account.

Disclaimer: I am not an investment advisor or a tax advisor. Nothing in this post should be construed as investment advice or tax advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment or tax decisions.

Cross-posted to the Effective Altruism Forum.

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The Risk of Concentrating Wealth in a Single Asset

Last updated 2020-11-25.

Some people hold most or all of their wealth in a single asset. A few examples of common situations where people do this:

  • Alice works at Google. A large chunk of her compensation comes in the form of Google stock.
  • Bob bought bitcoin a few years ago and the price went up a lot. Now, bitcoin accounts for 50% of his net worth.
  • Carol used her retirement money to buy a second house, and she earns income by renting it out.

This is usually a bad idea, and you should go to great lengths to avoid it. It’s bad even if you have high risk tolerance, because you can get a better expected return by building a diversified portfolio and then adding leverage.

Key points

  • On average, an individual stock provides the same expected return as the total stock market, but with 2-3 times as much risk. You could apply leverage to a total stock market index and get 2-3 times the expected return for the same level of risk as an individual stock. Or you could add leverage to the global market portfolio and get 3-4 times the expected return. [More]
  • The same principle applies to other types of individual assets, such as private company stock, rental properties, and cryptocurrency. [More]
  • If you hold a lot of money in a single asset and want to diversify, you may have to pay capital gains tax when you sell. The diversification benefits probably overcome the tax hit after about 3-10 years. [More]
  • You can reduce taxes by donating to charity, or by putting the money in a donor-advised fund or a foundation. [More]
  • If you’re a major stakeholder in an asset, you might depress the price by selling. You can reduce your market impact by selling slowly, or by paying your broker to manage the sale for you. [More]
  • An exception: Altruistic investors don’t just care about their own investments, but about the overall altruistic portfolio. If you hold an individual asset that other altruists can’t hold, such as equity in a private company, it might make sense to keep it. [More]
  • If the effective altruism community holds on the order of $10 billion in overly concentrated investments, then diversifying these funds could be worth as much as hundreds of millions of dollars in additional donations per year. [More]

Note: In this essay, I make some illustrations using historical market data. Future market behavior will probably look different, so the exact numbers I use won’t apply. But I expect the basic principles to remain true in the future.

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. Past performance does not indicate future results. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions.

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"Disappointing Futures" Might Be As Important As Existential Risks

Confidence: Possible

Summary

  • Perhaps the most concerning risk to civilization is that we continue to exist for millennia and nothing particularly bad happens, but that we never come close to achieving our potential—that is, we end up in a “disappointing future.” [More]
  • A disappointing future might occur if, for example: we never leave the solar system; wild animal suffering continues; or we never saturate the universe with maximally flourishing beings. [More]
  • In comparison to civilization’s potential, a disappointing future would be nearly as bad as an existential catastrophe (and possibly worse).
  • We can make several plausible arguments for why disappointing futures might occur. [More]
  • According to a survey of quantitative predictions, disappointing futures appear roughly as likely as existential catastrophes. [More]
  • Preventing disappointing futures seems less tractable than reducing existential risk, but there are some things we might be able to do. [More]
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Mission Hedging via Momentum Investing

Disclaimer: I am not an investment advisor and this should not be taken as investment advice. This content is for informational purposes only. Please do your own research or seek professional advice and otherwise take reasonable precautions before making any significant investment decisions.

Confidence: Likely1

Hauke Hillebrandt explains mission hedging:2

How should a foundation whose only mission is to prevent dangerous climate change invest their endowment? Surprisingly, in order to maximize expected utility, it might use ‘mission hedging’ investment principles and invest in fossil fuel stocks. This way it has more money to give to organisations that combat climate change when more fossil fuels are burned, fossil fuel stocks go up and climate change will get particularly bad. When fewer fossil fuels are burnt and fossil fuels stocks go down - the foundation will have less money, but it does not need the money as much.

But mission hedging has a big downside: it reduces diversification, which hurts your risk-adjusted return.

The momentum premium: “stocks with low returns over the last year tend to have low returns for the next few months and stocks with high past returns tend to have high future returns.”3 Investors can take advantage of the momentum premium by buying stocks that have gone up recently. The evidence suggests that it has persistently worked in nearly every financial market in the world, and there is a reasonable expectation that it will continue to work in the future.

In addition, momentum investing might provide effective mission hedging.

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Giving Now vs. Later for Existential Risk: An Initial Approach

Summary

  • This essay presents a variety of simple models on giving now vs. later for existential risk.
  • On the whole, these models do not strongly favor either option. Giving now looks better under certain plausible assumptions, and giving later looks better under others.
    • On the simplest possible model with no movement growth and no external actors, giving later looks better.
    • Higher movement growth/external spending pushes more in favor of giving now.
    • If our efforts can only temporarily reduce x-risk, we should spend a proportion of our budget in each period, rather than spending or saving all of it.
  • It has been argued that, because philanthropists are more patient than most actors, they should give later. This argument does not necessarily work for existential risk.
  • The probability of extinction has relatively little effect on when to give.
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