Yesterday I related the story of Mark Twain’s ill-fated investments. In Twain’s case, the problem was fraud. That, of course, is one way to lose money. But it’s not the only way. Consider the hedge fund Long-Term Capital Management (LTCM).

LTCM was founded in 1994. That first year, the fund returned 21%. In 1995, it delivered 43%. And in 1996, 41%. The next year, two of LTCM’s founders, Robert Merton and Myron Scholes, won the Nobel Prize. It was an astounding run of success.

But then, in 1998, it all unraveled. It turned out there was a flaw in LTCM’s strategy. Making things worse, the fund had taken on so much debt that the Federal Reserve Bank had to coordinate a bailout to avoid LTCM’s collapse from bringing down its Wall Street trading partners.
The lesson: As an investor, you can never be too careful. This may seem like an obvious statement. But this story illustrates why it bears repeating. In addition to fraudsters and incompetents, there is yet another category: those who appear brilliant but who are also incompetent.