A Tale as Old As time: Getting Rich vs. Staying Rich

**Morgan Housel** (0:06)
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Investing involves risks, including possible loss of principal. If you study enough financial history, you know that in every market cycle, in every era, in every country, whenever there is a booming economy, booming market, there is somebody or some thing, some organization that is kind of christened and anointed the next seer, who can see the future and understands what's going to happen next. And it is so common, it is one of the most common stories in the history of finance, that that person, that organization is one of the first to blow it during that cycle. I've always been really fascinated in the difference between getting rich and staying rich, two extremely different skills, that again, when you look at the course of history, a lot of the people who are very good at getting rich do not have a lot of ability to stay rich. They are the people who are taking outsize risk, that work in one segment, in one era, for one period of time, and revert to the mean with as much spectacular blow up fashion as they did on the way up. This happened last week. And before I get into the details of what happened, and they are very interesting details, I think. I think there's a lot of lessons to it. One thing I want to mention is that I think there is too much Schadenfreude in finance when these things happen. Of course, Schadenfreude is the German word for taking pleasure in other people's downfall, other people's pain. And that always happens when you have a situation like this. When a high flying, very smart fun goes down in spectacular fashion, it's very easy and very common for ordinary people to point and laugh and say, look at that idiot, how could they be so dumb? I don't want to do that here because, for one, if there is any group in the market who should be taking big, outsized risks that they can hopefully manage, it's somebody like a hedge fund. And a lot of hedge funds and private funds that are marketed to rich people do the opposite. They're just taking very boring average risks and charging enormous fees for it. So I don't want to have any Schadenfreude here, but here's what happened last week. A couple of years ago, an extremely smart, highly educated 22-year-old named Leopold Aschenbrenner published a series of essays about the future of AI, and they are fantastic. They are fantastic. They're well written.
A lot of the predictions came true, and they just give a lot of context into what AI is doing, now and in the future. Now, he used that fame that he got from those essays to start a hedge fund called situational awareness.
And situational awareness may have been one of the fastest growing hedge funds, investing funds, in history. So much so that earlier this year, which was two years after he started this fund, and at 24 years old, Leo Aschenbrenner and situational awareness were managing $45 billion, and it was one of the largest hedge funds, and the returns were absolutely off the charts until last week, when it all came kind of crashing down in spectacular fashion. And situational awareness lost about 67% of its value in one month, and its assets that it manages fell from $45 billion to about $10 billion. And the reason that this all happened was because of leverage. The hedge fund, as many funds do, was borrowing billions and billions of dollars to amplify its bets, to buy more of the stocks that it was betting on, going into debt, going into margin to buy this. Now, that story is as old as time.
The idea of a very smart person who claims to see where the world is going and goes into a ton of debt and then that debt backfires on them spectacularly, that has been going on forever and I think will happen forever. And if you're listening to this thinking, Morgan, I'm not a hedge fund manager. Why do I care about this? Let me share some stats with you. This chart that I'm showing you, this is margin, this is debt that ordinary individual investors are going into to buy more stocks, leveraging against their portfolio. And you can see, in 2017, it was about 240 billion. Now it's about 600 billion. That's just kind of ordinary people. This chart is hedge funds borrowing against their portfolio, hedge fund margins. And you can see, it's about the same. In 2017, it was about 300 billion. Now it's over 700 billion. You put those together and total margin debt right now that people are borrowing against their portfolios is $1.3 trillion in that neighborhood. It's not a small amount of money, and a lot of individual investors, maybe some people listening to this, are doing it themselves. This kind of debt is often available to ordinary people, where you can borrow money to buy more of the stocks that you already own. Now, some context here, a trillion dollars plus of margin debt sounds like an incredible amount. What's true is that the value, the total value of the US stock market is about $100 trillion. And so in the context of that, what it's being borrowed against, honestly, not that much in the grand scheme of things. So if you're worried about this causing some kind of system wide blow up, I don't think that's at all what we're facing here. But at the individual level, the people who do borrow money in order to invest, there are a couple of things to keep in mind here.