How One Investor Came Back After Losing a Fortune

Victor Haghani, currently with Elm Wealth, cofounded Long-Term Capital Management. (Photograph by Natalie Behring)

Victor Haghani shares the investing lessons he learned after the hedge fund he co-founded, Long-Term Capital Management, collapsed.

In 1998, Victor Haghani lost more than 80% of his wealth over a handful of months. He had been a leading figure on Wall Street for more than a decade: first as one of the pioneers of a lucrative bond-arbitrage strategy at Salomon Brothers, then as a co-founder of the legendary hedge fund Long-Term Capital Management. But when LTCM collapsed, Haghani’s fortune went with it.

What followed was nearly a decade of reflection for Haghani. He ultimately re-emerged with a new investment approach, focused on low-cost, rules-based index investing. He founded an independent wealth advising firm, Elm Wealth, in 2011. And he co-wrote a book, The Missing Billionaires: A Guide To Better Financial Decisions, in 2023.

Today, Haghani publishes academic research on financial theory and helps manage more than $2 billion of client assets through Elm. He spoke with Barron’s about the lessons he learned from LTCM, the lack of personal finance education on Wall Street, and the big question that investors consistently overlook.

Barron’s: Your book is called The Missing Billionaires. Who are they?

Victor Haghani: In the year 1900, there were about 4,000 millionaires living in America. If we were to pick just one of those families, say, a family with $5 million, and assume they invested their wealth in the U.S. stock market and spent it at a reasonable rate, that single family would have generated about 16 separate billionaire households today.

And yet, today there are only 700 billionaires in the U.S., and basically none of them derived their wealth from old money. So there are tens of thousands of “missing billionaires.”

I’m not lamenting that fact. But it’s a parable to show how hard it is for even well-resourced investors to make good financial decisions, especially over long periods.

What are the biggest mistakes people make when it comes to losing wealth?

Families don’t take the right amount of risk. They follow poor spending patterns. These problems aren’t apparent in the short term, but over long periods, they are massive issues.

When I look today at wealthy families, they are still largely invested in relatively concentrated, high-fee, relatively tax-inefficient portfolios. They might own a few stocks that made them wealthy, or they’re in alternative investments with high fees. There’s still a huge amount of room for us to improve everybody’s financial decision-making.

What’s one investing lesson you want the public to learn?

Investing consists of two decisions. You have to decide what you want to have in your portfolio. And then you have to decide how much of those things to have.

A huge amount of ink has been spilled on the “what” question: what’s going up, what’s going down, what’s a good stock, what’s not so good. But people really aren’t prepared for the sizing decision. And that’s remarkable, because the sizing decision is really of equal import: You could decide to invest in non-U.S. equities, but if you just put 1% of your wealth into them, that’s a bad sizing decision.

People don’t have a framework for thinking about sizing. There’s so much reliance on conventional asset allocation ideas, like the 60/40 portfolio, that don’t have anything to do with the changing long-term expected return of stocks and bonds. And the sizing question isn’t a competitive game—it’s not like your gain is somebody else’s loss. It’s an easier question! You don’t even need to get sizing exactly right. You just need to get in the ballpark.

What framework should investors use to size investments?

Suppose we’re trying to decide how much of a risky portfolio to own. The more we own of it, the higher our expected return. But the risk is going up, too, and the cost of risk isn’t going up linearly. It’s going up with increasing speed, because we don’t like big risks. So, when finding the optimal size for an investment, we have to weigh both the returns and the risks.

Academics have tried to come up with some rules of thumb for sizing. The easiest is the Merton share, which Bob Merton wrote about in 1969. That says the amount of a risky asset you want in your portfolio is equal to its expected excess return, divided by the square of the standard deviation of returns. And you also have to divide by your personal degree of risk aversion, because each person can tolerate a different amount of risk.

The Merton share is just a heuristic, but the main point is that investors should have a simple, rules-based framework in mind when thinking about sizing. Many don’t.

Why don’t they?

Most individual investors don’t get financial training at all. The vast majority of investors haven’t taken a course in finance. And even if an investor did take a finance course, they learned the basic concepts of modern finance. They learned about the market portfolio and the capital asset pricing model. But those courses don’t say much about sizing.

How did you found Elm Wealth?

In the early 2000s, I was thinking about how to invest my family’s savings. Initially, I was attracted to the Swensen model [an approach involving high allocations to alternative investments]. But over time, I became disillusioned with the fees, the taxes, the complexity, the concentration. Around 2006, I decided I wanted to primarily have my family’s savings invested in low-cost, broad-market, market-cap-weighted index funds.

Once I decided on indexes, the elephant in the room was allocation. How should I decide how many U.S. stocks, non-U.S. stocks, and bonds to own? Sticking with some fixed percentage just felt wrong and suboptimal to me. In 1989, Japanese equities represented 45% of the global stock market. Having been in Japan and lived through the late 1980s, I knew that if I were managing my family’s assets at that moment in time, I wouldn’t have wanted half my equity exposure to be Japanese equities.

I wanted a simple, rules-based investing approach. When the expected excess return is low in a market, I wanted to cut back. When there’s low volatility, I wanted to increase exposure. So, I tried to find the simplest solution to the problem that would be manageable for me to do. We call the approach at Elm “dynamic index investing.”

Tell us more about what’s going on under the hood with dynamic indexing.

We use simple metrics to come up with expected return and risk—the factors that determine sizing. So, we break the market into four buckets: U.S., developed Asia, Europe, and emerging markets.

Within each bucket, we use the earnings yield, which is simply adjusted earnings over price, and subtract the yield on TIPS [Treasury inflation-protected securities]. That gives us expected excess return. And there are many ways to measure risk, so we just chose the simplest, which is using momentum as a proxy. When expected excess returns are high in a region, we allocate more. When the risk is high, we allocate less.

You might say: What about sectors? What about tech, industrials? That’s where we feel like there’s too much granularity. The earnings yield captures a lot of differences between sectors. For example, the earnings yield of tech companies is lower than the earnings yield of utilities, because tech companies are probably going to grow faster than utilities.

What is dynamic investing saying to do now?

Currently, the elevated price-to-earnings ratio for U.S. stocks translates into a long-term expected return just 1.5 percentage points above Treasuries. However, the current low volatility of U.S. equities pulls in the direction of a higher allocation, netting to a modest underweight. Non-U.S. equities offer a more attractive 4.5 percentage-point risk premium, also with low volatility, leading to a significant overweight.

We manage the ELM Market Navigator exchange-traded fund, which publishes its allocations daily; current weights are 30% U.S. stocks, 45% non-U.S. stocks, and 25% U.S. Treasuries, versus baseline targets of 45%, 30%, and 25%, respectively. Market risk can shift rapidly, and a move to high global equity volatility would prompt us to shift allocations sharply from equities to fixed income.

Many advisors say they aim to deliver “alpha,” meaning they can beat the market. That doesn’t sound like your approach.

We aren’t trying to beat the market. We’re trying to give people a comfortable, sensible exposure to global asset prices with as much diversification as possible, with as low a cost and the greatest amount of tax efficiency we can get.

That’s very different from the philosophy at your previous employers, Salomon Brothers and Long-Term Capital Management.

Those are experiences I wouldn’t trade for anything. There was so much excitement and creativity. Now, I learned a lot about finance, but I learned zero about personal finance there. It’s remarkable that you can go to Wall Street and get no guidance in personal investing.

The biggest lesson in personal finance I ever learned was from losing the majority of my savings when LTCM ended. It was 80% of my savings or more. Losing vastly more than half of my wealth was something that required a lot of reflection. So, for the next 10 years, I did a lot of reflecting.

Investors lose money in investment vehicles all the time. But it was interesting that people relatively well trained in finance, somebody like me, could have such a large allocation to something that could go down by so much. It was kind of inexcusable that I did that.

It sounds like you learned your lesson. Have investors?

It isn’t clear. We see really encouraging investment behavior, with this huge growth in index investing, with 401(k)s and tax-deferred retirement accounts, and very low levels of trading.

But we’re also seeing two different phenomena. One is this frenetic, highly speculative activity by retail investors, driven by zero commissions, the growth of social media, and then turbocharged by Covid-19 when everyone suddenly had so much more time.

Then on the institutional side, university endowments have over half of their assets in extremely high-fee, concentrated, illiquid alternative assets. These illiquid assets aren’t reflecting the true volatility of their value over time. So, we have endowments and other institutions that invest in these things and feel that they aren’t really taking that much risk, just because private assets don’t get marked to market every day. There’s a volatility illusion that has made it attractive for investors.

Thank you, Victor.

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