Don’t Risk What You Need for What You Want

Long-Term Capital Management (LTCM) was a hedge fund that performed well for a few years in the 90’s but then lost $4.6 billion (90%+) in a matter of months.

The fund was managed by the creators of the Black-Scholes formula for valuing options. Super smart people worth hundreds of millions of dollars.

By over leveraging themselves for more potential gain, they put themselves in a position where it was possible (no matter how unlikely!) to go broke.

Warren Buffett gave a great, quick talk about this you can watch on YouTube (especially the bit starting @ 2:30):

 

“You only have to get rich once”

His point is that once you’re rich, don’t put yourself in a place where it’s even remotely possible to become not rich.

He uses a fantastic metaphor of a gun with a million chambers and a single bullet loaded in one chamber: no matter what someone offers you to put the gun to your head and pull the trigger once, you shouldn’t take the bet. The downside is just too damn high.

That’s the kind of bet the managers of LTCM made.

They risked what they needed for what they wanted, and lost big.