In August 1998, Long-Term Capital Management (LTCM), a large hedge fund, collapsed. LTCM had taken on too much risk and eventually went bankrupt. The fall of LTCM led to a financial crisis and the loss of millions of dollars for investors.
Individual investors can also learn from the mistakes of LTCM. Below are five investment decisions that could haunt you for decades if you’re not careful.
1. Over-Concentration in Public Equities
In the 1970s, John Bogle, the founder of Vanguard, popularized the concept of index investing. Analysts argued that it was impossible to beat the market, so a better strategy was simply investing in the entire market.
This investing strategy has become known as “passive investing.” It’s a sensible strategy for many investors because it’s low cost and easy to implement.
That said, private markets have consistently outperformed public markets over the long term. In addition, public markets suffer steeper drawdowns and longer pullbacks during bear markets.
While the last 13 years have seen an unprecedented bull market in public equities, it’s important to remember that markets don’t always go up. Analysts reveal that public markets are in a “super bubble” that could pop anytime.
The Fed’s policy of unlimited quantitative easing has created asset price inflation, but as 40-year-highs in inflation loom, the Fed is now shifting gears and sharply raising rates.
2. “Stock-Picking” Private Firms As An Early Stage Strategy
A rule of thumb states that out of 10 early-stage companies, only one or two will produce substantial returns. Given these odds, it doesn’t make sense to put all your eggs in one basket by investing everything you have in a few companies.
Given the tremendously large dispersion of returns in private markets, owning a large portfolio of positions is critical. A more diversified approach increases the chances that you’ll have those one or two companies that produce returns that justify the risk.
3. Putting Money Into SPVs with No Skin in the Game
SPVs, or special purpose vehicles, became popular after the financial crisis. SPVs are legal entities used to hold assets or debt and isolate risk.
The problem with SPVs is that they’re often used to invest in risky assets, such as junk bonds, without any skin in the game. This can lead to big losses if the underlying asset defaults.
Moreover, SPVs are often opaque and lack transparency. It is difficult to understand the risks involved and make informed investment decisions.
4. A Narrow Focus on Popular Retail Alts
Cryptocurrencies, such as Bitcoin, and collectibles, such as sports cards, have become popular investments in recent years. While these assets offer high returns, they’re also highly volatile and risky.
Investors should be aware that cryptocurrencies are not legal tender, are not backed by the government, and are often unregulated. In addition, there’s no guarantee that you’ll be able to sell your crypto assets for cash.
Collectibles, such as sports cards, are also risky investments. Speculation and emotion rather than fundamentals often drive the collectible market. This makes it difficult to predict when the market will turn.
5. Over-leveraging
Leverage can be a useful tool to magnify returns. However, it can also magnify losses. This is why it’s important to use leverage only after you’ve done your homework and understand the risks involved.
While institutional investors have teams of experts to manage leverage risks, individuals typically don’t. This makes it all the more important to understand the risks before you use leverage.
With Gridline, investors can avoid these common mistakes and access top quartile investments with low capital minimums, fee transparency, and greater liquidity.