I came across this article titled “One of World’s Greatest Hidden Fortunes is Wiped out in Days” last week. Here are some direct quotes from the article.

“Archegos Capital Management, is at the center of one of the biggest margin calls of all time — a multibillion-dollar fiasco involving secretive market bets that were dangerously leveraged and unwound in a blink.”

“One part of Hwang’s portfolio, which has been traded in blocks since Friday by Goldman Sachs Group Inc., Morgan Stanley and Wells Fargo & Co., was worth almost $40 billion last week. It evaporated in mere days.”

“I’ve never seen anything like this — how quiet it was, how concentrated, and how fast it disappeared,” said Mike Novogratz partner at Goldman Sachs who’s been trading since 1994. “This has to be one of the single greatest losses of personal wealth in history.”

You could draw parallels between this story and the fiasco of Long-Term Capital Management in 1998. I am sure you will see a lot more of this story in the coming weeks. Once you start reading these articles, you might come across with some complex terms but remember that at its core, the lessons are pretty simple. So, I wanted to reinforce four investing lessons for investors that are directly applicable to these stories.

  1. Stay Away from Margin and Never Borrow to Invest: One of the most important takeaways for investors is to not use margin to invest. When you open a brokerage account for investing, one of the questions asked in the application process is if you want to open a margin account. A margin account will allow you to borrow money from your broker to invest in the stock market. Investments in the stock market are subject to fluctuations and when you invest with your savings, you can only lose what you have already invested. For example, if you invested $100, all you can lose is $100. Nothing more. In a rising market, it can be very tempting to use margin when you see every stock going up parabolically. You want to buy all the high-flying stocks but you don’t have enough money. So you want to borrow that money from your broker, and buy those stocks. But you have to remember that when the market starts falling and you are using margin, you can lose more money than you started with. So, if you started with $100, you can lose more than $100. This basic principle is the same if you are investing with a few hundred dollars or a few billion dollars as happened in these two cases. In the Archegos case linked above, they were using a 1:7 margin at the peak. That means for every $1 that they invested, they had borrowed $7. That is a recipe for disaster.  So, repeat with me: Don’t borrow money to invest and say no to margin!
  2. The Importance of Having a Cash Cushion: In this article, I talked about my investing process where I highlighted the importance of having an emergency fund before you start investing. Now, in a market situation such as we are in now, an emergency fund will earn basically nothing. For example, a “high-yield” savings account is paying about a 0.5% interest rate right now. That is why I put quotes on high-yield. But I am okay with that return because the purpose of this emergency fund is not to earn returns. The purpose of this emergency fund is to ease my mind in a situation like we are in now when the market is correcting or in a bear market. You should not be forced to sell in a situation like this. In fact, this is the time to take advantage of this opportunity and grab some positions when they are trading at a price that is 20-30% off their high prices.  
  3. K.I.S.S. Principle: When you read the above two articles about Archegos and Long-Term Capital Management, you will come across some complex terms such as derivatives, swaps, leverage, margin calls, hedging. Don’t let those terms confuse you. Remember, that investing at its core is supposed to be simple. Investing is not supposed to be complicated. Investing is not supposed to be entertaining. If you follow some basic rules, investing is supposed to be very boring. Some people compare investing to “watching the paint dry”. You just need to buy good companies and then sit and watch the results of those companies for years and add to your winning positions over time and let those companies compound your money over time.
  4. Investing Psychology: I have always maintained that you do not need an expensive education to become an investor. Look at the people behind these fiascos and you will see a Nobel-Prize winning economist, a MBA from Carnegie-Mello, people who have been trained to be investors and went to prestigious institutions. At the end of the day, investing psychology and your emotions will determine if you are a successful investor or not. Don’t let greed determine your decisions and don’t try to take short cuts. Don’t engage in short-term day trading. Follow a set process for your investing decisions, keep a journal where you write down the reasons why you are buying and selling a company. Keep your emotions in check and don’t be scared by the volatility and do not sell in a bear market. Investing is the only field that I can think of where a novice investor can do better than experts. Can you think of any other field where this is true?

I hope these lessons are useful to you in your investing process. Is there a lesson from these fiascos that comes to your mind that I did not share in this article? Feel free to share that below.