These are my assumptions

  1. A stock + bond portfolio over the long term has better risk adjusted returns than stocks alone.

  2. A person who is not comfortable with 100% equities would simply maintain a leverage ratio of 1 and some combination of both stocks and bonds.

  3. A person who is comfortable with 100% equities should still construct a stock/bond portfolio. They’d simply increase the leverage until it roughly matches the same stdev as 100% stocks instead of going 100% in stocks.

You folks probably already know all of this. But everytime I ask a financial adviser they do not recommend leverage at all.

But it seems like the reasoning is sound. As long as the cost of borrowing (LETFs, box-spreads, future etcs...) is lower than the average returns, a levered stock/bond portfolio would actually be the more rational thing to do rather than be in 100% equities.

  • 10
    $\begingroup$ Congratulations you have (re)discovered (one form of) Risk Parity Investing! In 1996 C. Asness published a paper in JPM suggesting leveraging up a 60/40 portfolio to achieve the same risk as a 100% stock portfolio. You can download the paper here aqr.com/Insights/Research/Journal-Article/Why-Not--Equities (download button on right hand side) $\endgroup$
    – nbbo2
    Apr 3 at 10:49
  • 4
    $\begingroup$ "everytime I ask a financial adviser they do not recommend leverage at all". Even among institutional investors there seems to be a reluctance to use leverage, which Asness calls "leverage aversion". (He blames it for the lack of widesread adoption of his idea LOL). $\endgroup$
    – nbbo2
    Apr 3 at 10:57
  • $\begingroup$ Publicly traded vehicles which follow a risk-parity approach include the ETFs: RPAR, NTSX and AQRRX/AQRRIX/AQRNX. They have relatively limited history, but will be interesting to watch IMO. $\endgroup$
    – nbbo2
    Apr 4 at 9:26

1 Answer 1


I think @nbbo2 nailed the answer to this question in comments (upvoted). But, to answer the question solely by its title:

One reason you would not run a levered portfolio with matched volatility is that correlations are quite unstable.

All the mathematics that one uses for running this kind of levered portfolio requires correlation/covariance, and

  • The correlation you should use is the future correlation, obtainable only through time travel,
  • The correlation you will use comes from some historical estimator, which converges as $O(1/\sqrt{N})$ and has uncomfortably high error sizes for practical sample counts,
  • Asset correlation is actually rather unstable. In particular intra-equity correlations increase greatly in a crisis. Equity-bond correlations change a lot in crises also, with the direction depending on the type of crisis.

Thus in practice the levered portfolio has a good chance of failing to meet its purpose, while adding significant operational complexity.

I don't think any financial advisors are thinking about the disadvantages of leverage on this quantitative level, but a long conversation with a smart advisor might reveal that he/she has instincts along these lines.


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