Most of the lessons surround risk version. It is important to remember to be skeptical. It is important to not invest in things you don’t understand. It is important to remember that leverage is not a good thing or a bad thing. It is like they say with gun control. Guns don’t kill people; people using guns kill people. Leverage kills people if used wrongly. Leverage does not improve investments. It only magnifies gains and losses. So when people get silly and think leverage is a good thing and forget to be risk averse, they take on too much leverage. When you take on too much leverage and things go bad, then it can be a disaster.
“what the wise man does in the beginning, the fool does in the end,” and “being too far ahead of your time is indistinguishable from being wrong.” Well, the third important adage is “never forget the man who was six feet tall who drowned crossing the stream that was five feet deep on average.” It is not sufficient in the investment world, or any other world, to survive “on average.” You have to get through the low points and the bad days. What leverage does is that it reduces your ability to survive the bad day. So you have to realize that using leverage is a tradeoff.
It’s interesting if you think about it. As investors, enter into investments that have positive expected returns, right? If something has a positive expected return and you add leverage, then the expected return will be even higher. This is the trap. All of these things are very simple. This is not a complex business. Peoples say , “I expect 15%, and if I double up by borrowing at 5% and investing at 15%, then I’ll get 25%.” But they forget that part of their probability distribution consists of losses, and leverage will more than double the losses. This is why people must remember that maximizing returns and ensuring investment survival are incompatible.
I think another important lesson that has been understood is that the key to investing is not the art called portfolio management. The key is risk management. You can’t just buy some foreign, some large and some small, and some industrial and some financial and then think you’re safe. You can’t be so simplistic. You have to thoroughly understand the risks in the portfolio.
“what the wise man does in the beginning, the fool does in the end,” and “being too far ahead of your time is indistinguishable from being wrong.” Well, the third important adage is “never forget the man who was six feet tall who drowned crossing the stream that was five feet deep on average.” It is not sufficient in the investment world, or any other world, to survive “on average.” You have to get through the low points and the bad days. What leverage does is that it reduces your ability to survive the bad day. So you have to realize that using leverage is a tradeoff.
It’s interesting if you think about it. As investors, enter into investments that have positive expected returns, right? If something has a positive expected return and you add leverage, then the expected return will be even higher. This is the trap. All of these things are very simple. This is not a complex business. Peoples say , “I expect 15%, and if I double up by borrowing at 5% and investing at 15%, then I’ll get 25%.” But they forget that part of their probability distribution consists of losses, and leverage will more than double the losses. This is why people must remember that maximizing returns and ensuring investment survival are incompatible.
I think another important lesson that has been understood is that the key to investing is not the art called portfolio management. The key is risk management. You can’t just buy some foreign, some large and some small, and some industrial and some financial and then think you’re safe. You can’t be so simplistic. You have to thoroughly understand the risks in the portfolio.
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