Who Can Use Stock Pledging and Leveraged Funds: Understanding the Risks, rev 1.0

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First, determine whether you plan to live on pledged borrowing after retirement.

If you do not plan to use securities-backed lending for living expenses in retirement, then you should not and cannot invest in leveraged funds.

Only if you plan to live on pledged borrowing in retirement do you need to follow the steps below.

If you are currently 100% in 00662 and later want to build a leveraged position, whenever you have new money, use half to buy 00670L directly and half to buy 00864B.

By the time you retire, you should immediately adjust your asset ratios to match scenarios 1 through 3 in video 00454 and the handout examples.

For example, suppose you choose to use pledged borrowing for living expenses and choose scenario 1, and suppose you already have pledged borrowing.

After Setting Up Pledged Borrowing, You Can Borrow 2% Per Year for Retirement Spending

First set aside twice the amount already borrowed. Put half of that in cash through 00864B and half in 2x leveraged 00670L. This part has beta 1.0 and cash equal to the amount already borrowed, so even if the market falls to zero, you will not be forced into liquidation.

After removing the assets above, allocate the remaining assets as 60% 00662, 20% 00670L, and 20% 00864B.

After setting up pledged borrowing, you can borrow 2% per year for retirement spending.

00670L and 00864B should use smart rebalancing every year.

Smart rebalancing method:

In an up year, move half of the appreciation in 00670L into 00864B. In a down year, move an amount equal to 2% of assets from 00864B into 00670L.

The following article explains who can invest in leveraged funds.

https://docs.google.com/file/d/1XwfB3Z9rnw0uVmb5YLVqPqVF0MDZ0lHT/edit?usp=docslist_api&filetype=msword

• Understand the risks of pledged borrowing and leveraged funds.

• Who can use securities-backed lending: people who will never sell their assets, have enough assets, and understand how to combine leveraged funds with cash. In Taiwan this means people with more than NT$10,000,000 in stock assets. In the United States it means investors with more than US$1,500,000 in a taxable investment account. US retirement accounts cannot be pledged, and leveraged funds cannot be pledged. If investing in leveraged funds, it is recommended to hold them in retirement accounts. You must always keep cash far greater than the pledged loan amount to avoid bankruptcy risk.

• Who can invest in leveraged funds:

• People who are still working and have more than ten years before retirement can consider a small leveraged fund position. Leveraged funds can be paired with cash to reach Beta 1.0, with the cash position serving as an emergency reserve. Using lifecycle investing, younger investors can let beta be slightly above 1.0. If assets are still limited and retirement is more than twenty years away, time can reduce the risk of slightly higher Beta and may lead to higher long-term returns.

Who Should Not Use Securities-Backed Lending

• People using pledged borrowing must prepare enough cash, and the cash must be far greater than the borrowed amount. Pairing it with leveraged funds can keep beta at 1.0. Enough cash, which does not fall when the market falls, is what prevents forced liquidation.

• Who should not use securities-backed lending:

• Anyone who has not watched videos 00004, 00452, and 00454 and does not understand what we are saying should not use pledged borrowing.

• Anyone who does not use leveraged funds with cash and keep cash far above the loan amount should not use pledged borrowing.

• If your cash is not far above your pledged loan amount, you should not use pledged borrowing. Always keep free cash far above the pledged borrowing amount. When the market falls, cash does not fall, so you will not be forced into liquidation.

Who Should Not Invest in Leveraged Funds

• To avoid forced liquidation when the market falls, you need a large cash reserve. That makes beta far below 1.0 and lowers investment returns, so leveraged funds are needed to bring beta back to 1.0. Anyone who cannot use leveraged funds while keeping a large cash reserve should not use pledged borrowing.

• Who should not invest in leveraged funds:

• Retirees who do not use pledged borrowing and need to withdraw retirement spending from assets should not invest in leveraged funds. When the market falls quickly and you are withdrawing from assets, retirement assets can be depleted very quickly.

• Leveraged funds shrink very quickly during rapid market declines. If your assets are shrinking sharply and you do not have pledged assets available, you must sell assets. The leveraged fund position can shrink close to zero, leaving you without enough assets.

• During a market decline, leveraged funds fall and shrink very quickly. If you do not use pledged borrowing and must sell assets to live, your assets can go to zero.

Draft: James

• It is like raising chickens during an epidemic: only a few are left, yet you still have to kill your own chickens to eat. Eventually you will eat them all.

Draft: James.