A long-time reader sent a link to an article from Forbes titled Leverage Your Way To A Richer Retirement. The article considered research done by Jason Scott at Financial Engines which looked at completely revamping the 4% rule (the 4% rule pertains to the optimal withdrawal rate for a retiree take from their portfolio without exhausting their funds).

Scott’s portfolio is called the floor leverage rule and the basic idea put forward is to put the vast majority of the portfolio into bonds or perhaps TIPS to guarantee some minimum level of income from the portfolio. The suggested allocation was 85%.

Scott views the fixed income allocation in an interesting way. Based on prevailing yields how much needs to be invested to generate $1000 in annual income. Per the numbers cited $25,000 would generate $1000 per year from TIPS and that $19,000 would buy $1000 of income from a zero coupon ladder. Obviously then, $1 million in the bond bucket would generate $40,000 from a TIPS portfolio (again these are numbers cited in the Forbes article).

Scott then avers that the remaining 15% goes in to 3x levered ETFs tracking a broad equity index. As the market rises the idea would be to regularly and frequently rebalance excess from the equity portion into the fixed income to buy more zeros or TIPS thus increasing the portfolio’s income. If the market is headed lower then “you simply watch it go down and hope it recovers.”

If the concept sounds vaguely familiar that’s because you’ve probably read about something similar from Boston University professor Zvi Bodie and also from Nassim Taleb. The bigger idea from all three is that high risk is concentrated in a very small portion of the portfolio. They all have different ideas about how to take that risk.

To the Jason Scott portfolio, read the article to get a sense of the work involved in back testing the idea and also to get a handle on Scott’s chops having gotten a doctorate from Stanford.

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