Using margin in retirement: the magical year of 1968

Last time we saw an intriguing result…

Using margin never hurt (well, other than psychologically) and it sometimes helped. And for someone who retired in 1968 it helped so much that you ended up with an extra $4.6 million. Instead of just $137,000 left in your portfolio when you died, you actually have $4.8 million. That’s a staggering difference. What leads to such a staggering difference?

First a reminder: I’ve said this many times but it bears repeating. We’re talking about massive amounts of debt when you use this strategy. Over 40% of your networth in debt starting in 1982 and going until 1996 (when the bull market finally took off). And often closer to 50%. At the peak in October 1996 you have $1.8 million in debt. If you retired in 1968 at age 65 you are 93 years old with nearly $2 million in debt. From November 1986 to July 1997 you have over $1 million in debt.

None of that strikes me as something a real world retiree would be willing to do. So this remains an academic exercise. Still, academic exercises can be fun, so let’s see what we find.

Unfortunately what we find isn’t really that interesting. It is just a story of tiny differences that compound across several decades.

The divergence starts in June 1970. After a few years of withdrawals, inflation, and bad equity returns the portfolio has fallen to $773,000 which flips the “time to start to using margin” trigger. You need $3,815 that month but you have $2,728 in dividends, so you actually only need to borrow $1,095.

That trend — borrowing around $1,000-$1,500 a month — continues for a few months until February 1971. (At that point our portfolio has recovered enough that we stop using margin and go back to using normal portfolio withdrawals.) Since you’ve done this for 8 months we can guess that our portfolio will be around $10,000–$15,000 higher. And that’s exactly right, our portfolio is $12,023 higher but our net worth is about the same in both cases. After all, our portfolio is $12,000 higher but was also have $11,000 in debt.

Yes, the market has gone up slightly over those 8 months but, so far, the effect is small.

January 1971: +$1,418 net worth; $10,125 of debt (by using debt)

Over the next 3 years we don’t need to use margin: the market doesn’t have any big drawdowns. Of course, it also isn’t doing so well that our portfolio has totally recovered. We are still below where we started (in inflation-adjusted terms). So we aren’t in a position to pay down our existing debt; we’re still paying interest on it. But at least we don’t need to take on any new debt.

The market was pretty flat over this period, so our use of leverage (via debt) didn’t really help (or hurt) us.

At this point we are 6 years into retirement (if we retired at age 65, we are now 70) and so far this whole “use debt when the markets are down” feels like a wash. It isn’t hurting us but it sure isn’t helping us. And it means we have a monthly interest adding up, which is mentally annoying even if the amounts aren’t material.

December 1973: +$181 net worth; $12,529 of debt

The year 1974 is the darkest hour for the “use debt” strategy.

The markets have been flat but your monthly withdrawals keep going up (thanks to inflation). Eventually you hit the “time to use debt” threshold again.

At this point your monthly withdrawals are $4,582, your monthly dividends are $2,715, so you need to borrow close to $2,000 a month to make up the difference.

Four months after you start this — in April 1974 — the markets really start tanking. By December your portfolio is down to $651,000. That’s better than the $623,000 you’d have if you didn’t use debt. But you also have nearly $40,000 in debt. So overall, you are actually $10,000 worse by using debt right now.

You spend a lot of time wondering whether you’ve made a terrible mistake.

You’re now 7 years into retirement (age 71) and the “use debt” strategy has left you with a lower net worth. You spend a lot of time wondering whether you’ve made a terrible mistake.

Remember: it isn’t just your portfolio that looks bad. 1974 was the height of Watergate. On August 8, 1974, the Wall Street Journal joined other newspapers is calling for President Nixon to resign. The Energy Crisis was in full swing. The New York Times ran a headline, “Stock Market Plunges 14.55 Points To Lowest Level in Almost 12 Years” which included quotes like

Most brokers and investment advisers interviewed yesterday were pessimistic over the market’s future. They said they expected the 600 level of the Dow to be breached shortly and added that it could go much lower before recovering.

Inflation was near double-digits and Treasury Secretary William E. Simon was saying it would stay that way through at least the end of the year. And you have nearly $40,000 of debt, worrying that interest rates might go from 9% to something even higher…

The stock market crash of 1973–1974 saw many things drop 50%.

December 1974: -$10,274 net worth; $38,687 of debt

Over this two-and-a-half year stretch the “use debt” strategy slowly recovers from the 1973–1974 bear market. Your portfolio grows relative to the “no debt” portfolio but your net worth doesn’t. In other words: all of the portfolio gains are offset by increases in debt. Your portfolio is still under the “use debt” threshold.

Here’s a quick snapshot of the growing gap between portfolios…

Image for post
Image for post
Gap between Debt Portfolio and No Debt Portfolio

…along with the changes in net worth, which increase much more slowly (and begin reversing)

Image for post
Image for post
Gap between Debt Net Worth and No Debt Net Worth

You are now almost 10 years into retirement. The bear market has been over for almost 2 years. You are closing in on 75 years old. You have $132,000 of debt. And your net worth is almost exactly the same as if you didn’t do this “use debt when the markets are down” strategy.

August 1977: +$258 net worth; $132,408 of debt

Did I say that 1974 was the “darkest hour” for the “use debt” strategy? Ha ha. Just kidding. This stretch of almost 3 years saw your net worth trail by $26,000 at one point…at the same time as you piled on $300,000 of debt. Keep in mind that the interest on that debt peaked at almost 20% in April 1980. That’s $5,000 a month just in interest at one point.

Is your faith in this strategy tested? How much do you believe in it?

It is true that your portfolio is higher. The Debt Portfolio is $1.1 million while the No Debt Portfolio is $820,000. Both of those are far below where you started. Your original portfolio, adjusted for inflation, is $2.4 million. So the Debt Portfolio is at 45% of where you started and the No Debt Portfolio is at 34% of where you started.

The Debt Portfolio is clearly better but it doesn’t exactly seem awesome. You’re still down over 50% from where you started.

Still, the gap between the two portfolios has steadily increased. There have been a few set backs along the way but the overall trend is clearly upward.

Image for post
Image for post
Gap between Debt Portfolio and No Debt Portfolio

At this point, though, you are 12 years into your retirement. You are in your late 70s. In theory, your strategy will pay off. You have way more equities, so once equities have a good streak you’ll be way ahead. Except you’re getting close to the mean life expectancy according to the Social Security Administration. (The mean is around 17 years.) There’s actually a 27% chance you’re already dead. A 1-in-4 chance that you died before this strategy started to pay off.

June 1980: -$361 net worth; $292,830 of debt.

You thought you were out of the woods. You had lots of debt & leverage, sure. But you have all those equities. You just need a big runup in equities and you’ll be sitting pretty.

And there is a big runup. Between May 1980 and November 1980 equities went up over 30%. That’s huge!

But your portfolio is still way below where you started. You’re still way under the “use debt” threshold. So even though your portfolio is increasing, you keep using debt. Between those new debt-based withdrawals and the high interest at the time, you total debt explodes up over $500,000 during the same period. Your loan-to-asset ratio goes from 26% to almost 50%. You’re dangerously close to getting a margin call from your broker.

If you died right now, would you call this a winning strategy?

The net result is that your net worth relative to not using debt is trailing by $126,000. Meanwhile, there’s a 33% chance that you’re dead by now.

We can see the change in relative net worth over this time period…

Image for post
Image for post
Gap between Debt Net Worth and No Debt Net Worth

August 1982: -$126,000 net worth; $530,701 of debt.

If you died right now, would you call this a winning strategy?

The market begins a rally in September 1982, saving you from a margin call. It also means your net worth starts clawing its way back to parity. Because you are using so much leverage this point market changes have a large impact on your net worth. You are essentially at 140% stocks.

This time they said you need to come up with $39,044 in 72 hours.

This 2 year stretch is up & down. Your relative net worth goes from a deeply negative $126,000 in September 1982 to positive $66,000 in July 1983 (a nearly $200,000 swing!) before heading back down to negative $53,000 in July 1984 before improving back to negative $17,620 at the end of 1984. That’s a total combined swing of $347,000 up and down over the course of 20 months.

In July 1984 you got a margin call from your broker. You were riding right at the limit and the market moved a little bit. They called you up and said you need to come up with an $17,144 in 3 days.

The next month it happened again. This time they said you need to come up with $39,044 in 72 hours.

Of course, to meet those margin calls you need to liquidate some equities. Which pushes your portfolio value down. Which means that you trigger the “use debt” threshold again. Luckily, the market starts moving up, so you don’t get any more margin calls.

At this point you are almost 20 years into retirement. You are in your early 80s. You’ve been running the strategy for two decades. Theoretically you are placed for huge future gains. The Debt Portfolio is $500,000-$700,000 higher than the No Debt Portfolio. But your net worth is being held back by the tremendous amounts of debt you are carrying.

December 1984: -$17,620 net worth; $757,571 of debt.

Things have finally turned the corner. At this point the “use debt” strategy pulls ahead of the no debt strategy and never looks back. Of course, it took us 17 years to get to this point. There’s a 45% chance we died already.

In November 1986 you go over $1,000,000 in debt for the first time.

All of that leverage starts paying off, though.

Image for post
Image for post
Gap between Debt Net Worth and No Debt Net Worth

At one point we are $732,253 ahead thanks to using debt. Of course, it isn’t all smooth sailing. 1987 had that big crash. We got a voice message one day from our broker telling us we needed to come up with $50,960 to meet a margin call thanks to the market declines.

December 1987: +$227,144 net worth; $1,123,457 of debt.

The next five years is a story of the leverage paying off. There are a few set backs. In September, October, and November 1990 you face three margin calls. $89,000; $154,000; $90,000. That wasn’t fun. A sudden $333,000 missing from your portfolio. 12% of your total portfolio value gone. Despite that, your net worth is still $414,760 higher than if you hadn’t used debt. It stressful but you convince yourself that you’re still ahead.

You won’t know it at the time, but October 1993 marks the first time since 1974 that your portfolio has “recovered” enough that you will no longer have to use margin. Here’s a chart showing your portfolio relative to where it started out at the beginning of retirement.

Image for post
Image for post
Percent of original portfolio remaining

There was a very brief spike in 1986–1987 during a short bubble but it isn’t until 1993 that your portfolio has recovered and stays that way. Mind you, it still isn’t back up to 100% of where you started. But it is above the “use debt” threshold and will stay that way.

In fact, it is hard to convey just how often you need to use debt.

Here is a chart showing all the months. An “up” bar means you withdrew from your portfolio and “down” bar means you had to use debt.

Image for post
Image for post
How often you needed to use debt for you monthly expenses

In fact, a full 40% of the time (144 months out of 360) you needed to use debt, including a very long stretch from 1974 to 1983.

October 1993: +$1,251,260 net worth; $1,602,753 of debt.

Keep in mind that $1.2 million net worth on top of $1.6 million in debt means your portfolio is actually $2.8 million bigger than then No Debt Portfolio. The massive amount of debt obscures that to some degree.

Here’s a chart of the two portfolios in these later years.

Image for post
Image for post
Red is the Debt Portfolio; Blue is the No Debt Portfolio

The Debt Portfolio just needs to overcome the drag of debt & interest…which is eventually (though it takes a long time) does.

December 1997 is the end of the 30 year retirement. Our debt stops growing in these years and eventually our portfolio has grown enough that we can even start paying down our debt (somewhat).

From November 1996 until December 1997 we are actually able to put $1.3 million towards paying off our debt.

Image for post
Image for post
Monthly debt repayments

These are truly staggering numbers. I think we’re in a realm that normal people struggle to comprehend. Paying $100,000 in debt in a single month. And then 30 days later putting another $220,000 towards that same debt? Paying almost $500,000 towards debt in a single 60 day period over June & July 1997?

In any case, the net result is that by the end of the 30 year time period debt has been reduced to a “mere” $545,000. The portfolio stands at $4.8 million, even after that huge debt reduction. No doubt if we extended things another year or two, the rest of the debt would be eliminated.

To show how exponential the gap in net worth is, let’s look at the last 10 years of retirement. (Of course, there’s a 57% chance you died before this happens.)

Image for post
Image for post
Gap between Debt Net Worth and No Debt Net Worth

You can see that it goes from negligible to multiple millions, with the bulk of the increase coming in the short period from 1995 to 1997.

Having gone thought that (very long) exercise, what are some of my takeaways?

Even though the debt strategy worked in the end, when we dove into the details we found very long stretches that would have tried the faith of many. It isn’t until 17 or 18 years into the retirement that the strategy really starts paying off. The big benefits don’t come until 20+ years in. Along the way you end up with stupendous amounts of debt and interest payments that amount to $60,000 a year.

If you happen to die before the 30 years (say, of a heart attack just 18 years in at age 83) then never live long enough to see those eventual benefits and have only lived with the stress of managing debt.

We also saw that it can take a very, very long time for a portfolio to “recover”. Well over a decade. So any strategy that relies on portfolios to “recover” needs to accept that such a recover may be a very long time coming.

It seems unlikely that any real person would have the confidence to stick with this strategy over such long time periods. So while the strategy (eventually) works on a spreadsheet, I don’t think it would work in the real world.

Written by

Learn how to enjoy early retirement in Vietnam. With charts and graphs.

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store