Recanting a Small Part of Lifecycle Investing

On page 9 of?Lifecycle Investing, Barry Nalebuff and I write:

“[B]efore you invest in stocks, first pay off all your student loans and credit card debts.”

On reflection, we were only half right.? You should pay off your high-interest-rate credit card loans before investing in stock.? But in this post from?our Forbes blog, Barry and I show why young investors need not pay off their student loans before investing in stock.

Our new result that you shouldn’t wait to pay off your student loans substantially expands the number of young investors who should start buying stock on margin.? Most young college and professional school graduates have amassed significant student loans, and many more take on home mortgages.? But Barry and I now believe that many of these savers would be wise to expose themselves to leveraged?stock risk rather than merely use any savings to pay down existing debt.? Our mistake was in thinking that the cost of investing in stock was the added interest that must be paid on the student loan.? That is,?the cost of investing in stock on an unlevered basis.? But?our Forbes post shows that the cost of investing on a leveraged basis can be much cheaper:

Imagine you are 26 years old and you owe $40,000 on student loans. You’ve managed to save $10,000. Should you use that money to pay off part of the loan balance or should you invest the money in the market?

If the student loan carries a 5.5% interest rate and you expect the stock market return to be 5%, this question seems like a no-brainer.? You should use your savings to pay off the student loan and implicitly earn 5.5% on your money (by saving that amount in accrued interest) rather than invest the money in stock and just earn 5%.? Indeed, by paying off part of your student loan, you areguaranteed a 5.5% return, whereas with a stock investment you’re taking the risk that your return might be much smaller.

But it turns out that there is a third option, another way to invest in stock that may be more attractive that either of the foregoing alternatives. You can use the $10,000 as collateral and invest $20,000 in stock by buying on margin at 2:1 leverage.? Today, it is possible borrow (directly atInteractive Brokers or indirectly through?ProShares UltaS&P500 or?Barclay’s leveraged ETNs) at less than 1.7% interest. The market return only needs to exceed 3.6% [= (1.7 + 5.5)/2] in order to produce a better result than paying off your student loan.? When you buy stock on margin, you incur two different kinds of cost.? The opportunity cost of not paying down your student loan is 5.5% on first 10k and the margin interest cost on the 10k that you borrow is 1.7% (or less!) – so that the average or blended cost of investing on margin is 3.6%.

This is a case where the pushback we received from readers (for example,?here and?here and?here) led us back to the drawing board.? Thank you, Freakonomics nation, for pushing us to this new idea.


more debt... just what all new professionals need...


Ian, levered ETFs are in no way suitable for a long term investor - they are designed only to replicated levered returns for a one day period, not over time - crazy things can (and will) happen to returns in periods of excessive market volatility.

Justin James

Sorry, but buying on margin is the last thing I'd suggest someone with only $10k be doing. You've got no reserves left if something goes south. The last thing a 26 year old with a mountain of student loan debt (and perhaps a marriage coming up or just behind them, maybe a kid of the way, and probably in the middle of their first mortgage) needs is to be facing a margin call with their entire $10k saving tied up in stocks which are now underwater and they are leveraged on.


Ian Callum

This conclusion only makes sense if you assume that it is possible to ignore stock market volatility. If a young investor sells out at the bottom of the market, then they'll suffer huge losses due to their use of leverage. Studies of realized mutual fund returns indicate that selling at the bottom happens frequently enough to be a real concern.


someone will need to purchase stock from the baby boomers.

Steven Bearden

The math of this article and the Forbes article make sense. The only trouble is that most people in their mid to late twenties (I'm one) don't. I would think that this might be a dangerous course because of people investing incorrectly.


It's a strange world where somebody charges 1.7% to lend to a 26 year old to buy stock but charges 5.5% for (likely subsidized) student loan debt.

Eric M. Jones

As my tax guy says, the world looks quite different when you, , "Ask yourself: What would Richard Nixon do?"


Lifecycle investing seems like something that is good for people (in the aggregate) but seems dangerous for individuals. Don't underestimate the Black Swans.


First, why would any sane person ever buy stocks on margin? That's like taking out a cash advance on the credit cards to play the tables at Las Vegas. Admittedly the odds in the stock market are better, but it's still gambling.

Second, I can't understand why anyone would want to spend the time & energy needed to pick individual stocks. My time's more valuable to me (and to my clients, if I choose to spend the saved time on work rather than fun) than that.

Unless you're into researching stocks as a hobby, I say just find some good mutual funds, and have the sense not to bail out of them near the bottom of the down swings.

Jim C

What an excellent idea. The S&P500 has a 10-year annualized return of negative 1.2%, so the new graduate who practiced this in 2000 (when the market had a 17% annualized 10yr return and and this seemed like a no-brainer) would be just as far in debt, but with his/her savings wiped out from a margin call.

Don't forget that even a momentary downswing can trigger a margin call, right at the bottom of the trough when you're in the hole the most - giving you no chance to ride the recovery.



I like the way Justin James responded, put into words exactly what I was thinking.

Your models might show this method to be a good idea, but a model is only as good as the variables factored in. Common sense, factoring more variables, says this is a bad move. It could end well, it could also end very, very badly.


The math in this article has absolutely nothing to do with being in debt. The math proves that you can make more if you lever up. Everyone knows that.

What the other commenters have pointed out is that this also increases volatility. The increased volatility is a bad idea for nearly everyone, and the people least equipped to deal with that volatility are those in debt.

David L

I agree with the consensus here--you are not appropriately addressing the risks inherent in margin investing. However, the same basic reasoning applies even without using margin. When I was a financial advisor (prior to the current debacle), many of my clients were young attorneys with tens of $thousands in federally-subsidized student loans with interest rates at or approaching 2%. They often were in a rush to pay off the debt, but I usually advised them to make their minimum payments and keep the debt as long as possible, because paying off loans where your cost of money is less than the risk-free rate is unconditionally a bad idea. Max out some manner of tax-advantaged retirement account instead. No need to invest on margin to make it worthwhile to carry cheap student debt.


I want to suggest something altogether different: Take care of your FUTURE...before you take care of the non-secured bills of the past.

Your future is a "bill" that demands payment far more urgently than paying off some credit card or student loan (unless those loans are secured and can lose your your house, etc.).

Some bills MUST be paid (e.g., your mortgage and car, etc.), for if you don't, they get taken away. But the only thing that gets taken away when you don't pay your credit card bills in order to take care of you and your family's future, is rating?

That's right. That mystical, black box number that financial corporations use to hold you in slavery. It keeps people paying endlessly on credit cards for years--skipping over saving for their own future, etc. Then comes an emergency...but having no savings, they are plunged right back into servitude to the the lenders.


Pay YOUR FUTURE FIRST! I'm not talking about buying a red Corvette. I'm talking about legitimate things such as savings, insurance, retirement funds (using Lifecycle Investing!), education funds for your children, emergency funds, and the such. THEN, AND ONLY THEN, pay your credit card payment.

If you don't have enough left over to pay the minimum payment, tell the credit card company what you CAN pay. If they agree, fine; pay them. If they don't (and they most likely won't), then stop paying them altogether until they come to terms. Really, what can they do to you--ruin your credit?


At some point--usually about 120 days out--the credit cards will then, benevolently, want to work with you. But now you hold the all the aces. Yes, if you can, pay them off. Otherwise, taking into account what you need for your FUTURE, make them a settlement offer of 20-30%. If you can afford it and they take it, fine (they did my offer). If not, keep working with them. In some states, they can do little but be snarky--and many, due to the economy, are now playing much nicer.

Again, you should pay your bills if at all possible. But they are not more important than what you owe to the future of your family!!! If they ask where your money is going, you can say, "I'm paying for my child's college education." No need to mention that your child is still five years or more from college--it does have to be saved for, does it not?

You get the idea.


College Student

This is a pretty irresponsible policy to be advocating, to say the least. Particularly on a blog like this, which has a fair number of college students/recent grads in its audience (at least I am) who might actually take your advice and get themselves into serious trouble because they don't completely know what they're doing. Your economic model is obviously predicated on the belief that "stocks never go down," an assumption that is obviously untrue. Especially considering the underlying fundamentals of the economy right now, I don't see how you could possibly suggest such a strategy when students like me may have massive amounts of student loans to pay off. Explain to me where the logic in taking out more money, incurring intolerable levels of risk, to pay off your large preexisting debts makes any sense? Sure, there is some potential for upside, which you seem to exaggerate, but the downside risks are enormous, and you never even really mention them! While models are useful for some things, a model that makes invalid simplifications and ignores the situation that your debt-laden students are in is dangerous and advocating such a practice is plainly irresponsible.



Have the authors taken a look at the succres rate of youung investors,not just the market as a whole ? Maybe better would be the distribution of success of young investors. I think it would be fair to warn them that xx% of them do worse than 1.7% return per yerar. If you can't even cover the margin cost, don't use margin.

I would avoid mutual funds- too many fees that kill rates of return. Go with index ETFs and get some education about asset allocation and portfoltio design for small accounts before committing to the strategy.

What about a 50/50 stock bond mix with rebalancing to mitigitate the downside risk ?

I think it might make more sense to find a quasi-optimal investing strategy that minimzes downside risk, then compare the volatility fo that result to what would happen if the money were used to pay off student loans.

I agree with most of the comments - this is a micro optimization that neglects some of the real world context of putting young adults in an arene in whch most of them have no experience (ie investing in the stock market).



This strategy is for investing your *retirement* assets. Not *all* of your savings. There is very little at risk with $10k of retirement assets: even if you can lose them all, they are dwarfed by your future income. Your future income over the next 40 years is already like a bond allocation (reasonably stable), so why would you add even more bond allocation? That's insanely conservative for someone young with money they are saving for retirement.

If you are saving for something near-term like a house or just a rainy day fund, then these techniques are not at all appropriate, as the authors would surely acknowledge.


I think most of the reader's concerns are answered in the book itself, which I would recommend to anyone in their 20s to think about.

My only concern, which you raise in the book in regard to paying of credit cards first is that you also have to pay taxes on gains which you don't have to pay on the interest payments.

That increases the amount that you have to comfortably expect to make. (Well, that and the fact that interest rates on student loans is usually greater than 5.5%, especially graduate loans for living expenses, which makes it even harder to accomplish.)

Also- GN (#7): At least you have collateral when buying on margin, with the ability of the banks to get their money back well in advance of losing everything with a margin call and forced sale. A lender can't foreclose on, margin call, or have much of any recourse in (other than the inability to obtain bankruptcy protection) a student loan.



This is terrible, terrible advice. The authors demonstrate a shocking lack of knowledge of the product they recommend, particularly to be bought on margin. SSO does not mimic the long term performance of the S&P. It tracks the DAILY performance of the S&P. These are not the same thing. Look at the chart of SSO over its lifetime versus that of the S&P.

This is a potentially extremely damaging recommendation, and one that I highly recommend against.