Borrow to the Hilt and Get 90% Richer

Now here's a daring way to get rich: Borrow money and invest it for the long haul. When I first heard of it, it seemed a little crazy to me, but then I saw that it was a strategy suggested by Yale professors Ian Ayres and Barry Nalebuff, so I thought I'd look into it a little.

The authors try to refute the conventional lifecycle allocation wisdom that we should all have some of our nest egg in bonds, increasing the proportion as we get older. If you're 30 and you follow the common rule of making the stock portion of your portfolio equal to 100 or 110 less your age, you'll be 70% or 80% in stocks, only. Why, when stocks outperform bonds so significantly over long periods, should we park so much long-term money in bonds? That could be a retirement killer.

Check out these statistics: According to research from Wharton Business School professor Jeremy Siegel, stocks have outperformed bonds 71% of the time over all five-year periods between 1871 and 2006. Over all 10-year periods in the same span, that figure rises to 82%. Meanwhile, stocks outperform bonds 95% of the time over all 20-year periods, and 100% of the time over all 30-year periods!

The brazen idea
So what, exactly, does the duo suggest?

In their early working years, people should invest on a leveraged basis [as much as 2:1] in a diversified portfolio of stocks. Over time, they should decrease their leverage and ultimately become unleveraged as they come closer to retirement.

And what's the payoff for this? According to the researches, the expected retirement wealth is 90% higher compared to traditional lifecycle allocation. That would allow workers to retire almost six years earlier or extend their standard of living during retirement by an additional 27 years.

There are some important concepts behind this. For example, think about how money grows by compounding. You start with a little -- in your 20s or 30s, if you're lucky -- and you keep adding over time. Your money grows slowly but surely at first. If you have $10,000 and it grows by the stock market's historical long-term average of 10%, you'll have $11,000 by year end.

In later years, perhaps when you're 50, your nest egg would be $300,000. If so, 10% growth would take it to $330,000 in one year, a $30,000 gain vs. the earlier $1,000 one. In addition, you might be saving and investing $3,000 per year in your first years, but maybe $10,000 or even $25,000 per year by your 50's.

Ayres and Nalebuff lament that the investments with the most power behind them -- the ones with the longest time to grow -- are the smallest because we have less money to invest when we're young. So to remedy that, they suggest augmenting those early dollars with borrowed ones.

CAUTION!
Overall, I confess that their suggestion scares me. That's because it doesn't work as well for certain investors and situations:

• When you use leverage, you amplify both gains and losses. Bad timing can really whack you -- if, for example, you started this strategy early in 2008, before the market dropped 40-some percent. Even the last decade would have been a wash, in some regards. You'd have been paying interest while treading water, essentially.
• Borrowing isn't always cheap. Right now interest rates are low, but they aren't always low. The prime rate was recently around 3.25%, down significantly from 5% a year ago. But in much of the 1970s and 1980s, it was well into double-digit territory, hitting a whopping 21% in late 1980. If you borrow money at 15% and your investments grow by a (market-beating!) 12%, on average, you'll end up losing money and shrinking your nest egg. Even borrowing at 6% can end up hurting you, if your investments grow at a slower rate.
• This is a complicated strategy. Many of us with families and jobs don't have the time to closely monitor the amount of leverage we use in our investments. It's a lot to ask. There are other ways to salvage your retirement.

What to do
So what should you do? Well, if you're interested in this system, learn more about it. But think twice, or thrice, before employing it. Besides, odds are, you're already in middle age, where the option might be moot. If so, you might want to consider lifecycle investing.

Retirement guru Robert Brokamp recommends to Rule Your Retirement members allocation strategies tailored to their personal situation. For example, if you're more than 10 years away from retirement, he suggests the following allocation:

As you approach and enter retirement, you'll want to reduce your exposure to historically better performing but volatile classes (stocks) and ratchet up your allocation toward less volatile ones (bonds).

If you're not sure how to begin saving your retirement, our Motley Fool Rule Your Retirement service can help. In the most recent issue, for example, Brokamp discussed ways you can use different asset classes to improve your returns while reducing overall risk.

To learn more about this strategy and countless other retirement tips, consider a free 30-day trial. You can take advantage of our offer by clicking here. There is no obligation to subscribe.

Longtime Fool contributor Selena Maranjian owns shares of PepsiCo. Petrobras and PepsiCo are Income Investor recommendations. America Movil is a Global Gains pick. The Motley Fool is Fools writing for Fools.