What are the options to beat the returns of an index fund, taking more risk?

In the current historical milieu, as a "civilian" investor (so, you and I are not part of the government-banking complex; you and I are not allowed to bet millions on massively leveraged derivatives) there's only one instrument where you or I are allowed high (roughly 10:1 or more) leverage, real estate.

For simplicity say this afternoon you have 100,000 to invest. You buy a $1m flat. In 10 years it is worth 2m, you have turned 1:20. In 30 years it is worth 20m, you have turned 1:200.

It's difficult to achieve those ratios in other investments.

{It's worth noting if the city you chose completely flops and the apartment is still worth only $1m in 10 or 20 years, you have "merely" turned 100k into 1m.}

The key:

With stocks it is a sheer fluke if you pick an Amazon at the correct time.

With real estate markets many (not all but many) markets grow tremendously over lifetime-periods (decades).

You can easily give many, many examples. Sydney, Aus. for example grew ridiculously the last decades of the 20th; don't even mention London, San Francisco etc.

If you happen to live in the place for 10 or 20 of the next 30 or 40 years, you get the huge, out-of-hand advantage that you don't have to spend the bulk of your (after-tax) income on rent. On top of that in most jurisdictions there are various tax advantages on interest, or "repairs" etc when you're renting it out. Don't forget too that real estate is the ultimate bankable asset. When the flat in question has gone up merely 10% or 20%, banks and everyone else will be throwing money at you, should you need some for some reason; as a property owner you'll save a small fortune on trivial minor stuff such as car loans as you go through life.

I would suggest "first" secure your toehold in real estate; and then aggressively munch on index funds, or as you ask find ways to do better than index funds on the markets.

What are the options to beat the returns of an index fund, taking more risk?

the answer is very simple, there are two choices:

1. Pick the right stock. (To put a number on this, you have a 1% chance of picking a massive winner.)

2. Pick the right real estate market. (To put a number on this, you have a, say, 25% chance of picking a massive winner.)

Any bank will loan you money to buy real estate with 10:1 (often higher) leverage tomorrow. If anyone knows a way to loan 10:1 money for buying index funds, please tell me!

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It's easy to find long term charts which consider these economics:

There's a good interactive one I googled: https://www.economist.com/graphic-detail/2019/06/27/global-house-price-index

It's critical to remember that you get that with leverage.

WTF!

If you bought the 100 at the start of one of those lines, you only put in, wait for it, 4 or 13 or 20.

In the current historical milieu, it's your only access to such leverage as a civilian. If one could buy index funds with 20% down and keep them for 30 years, one wouldn't mention real estate. But there it is.

The first option for most people to increase or decrease their level of risk to adjust the split between stocks and bonds in their portfolio. I'm quite a bit older than you so I have about 60% stocks and 40% bonds. Since you are young, a good aggressive strategy could be simply to invest 100% in diversified ETFs.

Anything beyond that gets complicated and you will have to do a lot of research to try to beat the market. Personally, I'd rather do other things with my life than try to beat the market, but some options are:

• Leverage (see SPUU)
• Selecting less diversified ETFs (e.g., one that is overweight in tech companies)
• Stock picking

You could leverage via call option LEAPs on the index of your choice. You could approach this several ways. Here are some:

(1) Use an ITM call LEAP as a 1:1 replacement for an investment in and ETF such as DIA or SPY, freeing up investment cash to deploy into your "low-fee investment funds." In terms of investment cost, for a two call LEAP 20% ITM, you'd pay a time premium under $15. That would be the cost of the reduced investment leverage if held for two years. Google "Stock Replacement Strategy" for an explanation of this concept.

(2) A variation of (1) would be to hold the two year LEAP for one year and then roll out a year back to two years out. Currently, the annual cost for that would be about $600 or 40% of the previous example.

(3) You could buy 2x the number of call LEAPs, achieving true 2x leverage. But understand that such leverage is a double sided sword. It provides a larger gain when it works and a larger loss when it fails.

(4) A way to leverage return without employing risk leverage is to utilize what is called a Repair Strategy, although in this case, you would not be using it as a repair. The idea is that if you are willing to cap your potential profit, you can obtain no cost 2:1 leverage between current price and a predetermined cap.

For example, you like the SPY. You buy 100 shares and along with a no cost one year REPAIR, you'd make $2 for every $1 the SPY rises between current price and that cap. Right now, with the SPY at $335, you could make as much as 60 points (18%) if SPY increased $30 (9%) in one year but you would make no more than that if SPY rose more than 30 points (above $365).

These are general descriptions that have more nuance than time and space allow. Also, I've left out specific details because these ideas aren't a perfect fit for all the parameters that you have laid out.

EDIT (with apologies for the length)

As requested, here's a deep dive into one of the approaches mentioned above. This one's for you @Fattie.

(4) A way to leverage return without employing risk leverage is to utilize what is called a Repair Strategy, although in this case, you would not be using it as a repair. The idea is that if you are willing to cap your potential profit, you can obtain no cost 2:1 leverage between current price and a predetermined cap.

EXAMPLE

I have modestly rounded today's quotes up/down in order to make the calculations simpler.

Buy 100 shares of SPY at $340

Buy one Apr $340 call for $23

Sell two Apr $365 calls for $11.50

The proceeds received from the two short $365 calls pays for the long $340 call. The option component (a 1x2 ratio) has a zero cost.

100 shares and a short $365 call is a covered call.

The long $340 call and the other short $365 call is a bullish vertical spread.

There are no naked options.

On an expiration basis:

Below $340 the options are worthless and you'll lose $1 for every $1 just as if you only owned the shares. A failed no cost repair has no impact on the overall position.

For every $1 that SPY is above $340, you'll make $2 ($1 from the SPY and $1 from the vertical spread.

The cap is $365 at which point you will have a gain of $25 on the SPY and $25 on the spread for a total gain of $50 (14.7%) on a $25 point up move (7.35%). This is for ~6 months so it annualizes to almost twice that.

Above $365 you make nothing more.

Dividends received are not included in these calculations.

NUANCES

There's no rule that says that the Repair must be done for zero cost. A credit is better but if you want more potential profit, you'd sell a higher strike price, resulting in a debit. Or sell a lower strike for a credit, reducing your upside. Whatever.

To evaluate these, in lieu of software, drop the option chain quotes into a spreadsheet and compare the return of different expirations as well as different strike price combinations. There are many possible Repairs so choose the one whose profit potential makes you the happiest.

Nearer expirations offer higher annual yield than further expirations.

Implied volatility affects a repair’s cost. The lower it is, the more costly the repair. If higher (for example, just before earnings), the credit will be larger, enabling you to either book the credit or use a lower long strike which will offer a higher profit potential.

Dividends inflate put premiums and deflate call premiums. This has a greater effect on options closer to the money, making a Repair less expensive (a credit). This has a greater effect on nearer expiries.

Prior to expiration, the further out the expiration, the more the options retain time premium (low theta decay) which makes subsequent adjustments (locking in gains) more difficult. For that reason, I do not care for LEAP Repairs.

Now let's dive into some position management to project some what ifs. Suppose it's five months from now and the SPY is $365. Rather than spending time doing option pricing model calculations, look at the current option chain and guesstimate future prices (the assumption is that implied volatility remains the same). Look at the 11/06/20 $315 and $340 calls which have one month until expiration. They're worth $25 and $8, respectively. See if you can figure out why these are representative of future Repair value. That means that the vertical spread has achieved $17 of its potential $25 profit.

Choices?

(1) Do nothing and hope SPY remains above $365 in order to nab the remaining $8.

(2) Close the spread and book the $17.

(3) Roll the $340 calls up, locking in some gain but reducing maximum profit.

(4) Roll the spread to 6 months out and up to say a $365/$390 vertical, giving you and additional $17 of profit potential (higher cap).

(5) Close all of the options and open say a $365/$390 Repair. You have $9 in your pocket plus the appreciation on the SPY covered call.

Such option adjustments require a higher level of option position management and would not be relevant to the buy and hold until expiration type.

There are many, many possibilities. This is just an overview for understanding the strategy.

I think that the official name for what I have described might be a covered call spread. Here's an example of where it's a true Repair for a fallen stock.

Mike drop!

What are the options to beat the returns of an index fund, taking more risk?

Method 1: Use the same index fund, but lever up its returns using margin or derivatives. This increases risk by increasing both the upside and the downside. Refer to @BobBaerker's answer or this: How can I lever up my index fund returns?

Method 2: Instead of buying index ETFs, buy other ETFs that may have higher-risk/higher-reward. For example, ETFs that have lower diversification, ETFs that track small-cap stocks, industry sector ETFs, emerging market ETFs, ETFs that focus on particular regions, or ETFs that have higher beta than index ETFs.

You can buy leveraged index funds and ETFs. See, e.g., this list: https://etfdb.com/themes/leveraged-3x-etfs/ Increase the risk, but also increase the reward if the index the ETF is following does well. Note the YTD returns in that link tho for today (5 Oct) so see some, well, risky numbers...

I'm going to be the wet blanket here: You probably can't beat a broad market index fund, reliably, regardless of your risk tolerance. You can take risks that might, but odds are they won't.

The problem is, for the most part, that whatever profit your higher risk investment gets you is probably going to be either:

• Eaten up by transaction costs
• Cancelled by some other risk

Or, just not enough to bother.

Leveraged index funds aren't investments, they're day trader tools; you are supposed to buy and sell them each day. From SPUU's prospectus:

This leveraged ETF seeks a return that is 200% the return of its benchmark index for a single day. The fund should not be expected to provide two times the return of the benchmark’s cumulative return for periods greater than a day.

Investing in specific industry index funds is a slightly less complicated (and slightly less risky) method of investment than buying individual stocks, but it's really not different ultimately. Unless you know something that the rest of the market doesn't, you're not going to really see any better returns on average than a broad market ETF; of course, for some period of time any given index fund will beat the broad market, but picking which one, when, is the challenge. That's not to say it's a terrible idea - I specifically invest a small amount in a healthcare industry ETF, specifically to hedge against my healthcare costs being higher in retirement! But it's not for the purpose of higher returns than my broad market ETF, nor with the expectation of beating it. It's just insurance against massive healthcare costs.

Picking stocks has the same problem: you might do well, or you might do poorly, but even if you spend a lot of time learning how to pick good stocks, odds are you won't beat the index fund - and even if you DO put a lot of work into it, you STILL probably won't beat the broad market index fund over the long haul.

Buy that index fund, keep 100% of your retirement fund in it, and be happy that you don't have to put a lot of work into things. Unless you like putting a lot of work in it, then feel free to put 10 or 20 percent into something more interesting - leave 80 or 90 percent in the ETF, whatever you feel safe with, and play with the 10 or 20 percent. That's your best bet for retirement, high risk tolerance and all.

Any time, effort and focus you spend trying to get a slightly better return will maybe make you some money.

The same time, effort and focus spent developing your career instead will earn you a lot more money than working on your investment return.

If your goal is just "be well off in retirement" then don't even start worrying about picking your investments until you've got 7 figures in an investment account. Just stick it in a boring index fund and focus on improving yourself and earning more money in the first place.

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Worked Example. I'll use the UK seeing as I know it but any country will have the same dynamic:

Let's say you get a great degree and start on a really good salary of £40k a year.

You and your employer pay the statutory minimum pension contributions: (5% paid by you, 3% matched by your employer).

Let's say you're more fiscally responsible than almost everyone else your age and manage to save 10% of your disposable income.

£40k salary

£2k pension contribution from you, extra £1,200 from your employer.

£9,660 income tax and national Insurance contributions.

£27,700 annual disposable income.

You save 10% = £2,770 (Plus Tax Relief = £3,462)

Total pension contributions:

£6,662 per year.

If you manage to get a better investment return, you might make an extra 2% per year (that would be a very impressive result). £130 more per year.

If, instead, you get a £1k raise and save all of it, that's an extra £726 per year you can save. 5 times as much.

Get yourself a 10% (£4k) raise and that'll increase your pension by 20x as much as getting a better investment return.

Of those 2, getting a 10% raise is going to be a lot easier to accomplish, so focus on that instead.

Things you can do is to activelly follow the trends, and get out of the market if you see things turning bad.

ETF will always follow the market, both down and up, but you don't ahve to move with it.

Let's look few years ahead, we are in a period of unprecedented growth in stocks, it's quite probable the correction will come sooner or later. Now is a good moment to get out of stocks, and hold cash or invest in bonds.

But be ready, once correction happens (eg. market drops 10% or more), buy ETFs with about 30% of your free cash. If it dorops another 10% buy with another 20%. 10% more? invest another 30% (remaining 10% use if the bottom drops out ;) )

This is a variation on a technique is called dollar cost averaging and works well and consistently.

Remember to also take your gains, if the stock/index you've picked goes up 50-100%. Convert a portion of it into cash. Use that cash with the above tchnique again.

If you have set amount of amount to invest per year (eg. as a retirement fund). Check the stock/index value, then set a buy order for half of the intended amount 10% bellow current market value, and another half for 20% bellow (for stocks, for ETFs 5% and 10% as they swing much less). Let that buy order sit for the rest of the year. Most of the time it'll get filled eventually.

The capital asset pricing model gives a theoretical answer to this, which is that you should buy all assets (including oil paintings, real estate, and Elvis dolls) in proportion to their market capitalization, and then if you want a higher return and more risk than that, you should leverage.

The CAPM is just a model, and it depends on various assumptions. However, if you can't identify any of its assumptions that you think are seriously wrong, then you don't have any rational reason for not paying attention to it.

One of the things it's telling you is that you should be skeptical about advice to achieve what you want by buying a lot of small-cap stocks and ignoring S&P 500 stocks. The model tells you that this is not optimal.