Billionaire businessman Warren Buffett used variations of the nearby line in his shareholder letters during the 1990s and 2000s to describe financial risks.

It’s just as relevant today. The recent near-collapse of high-flying hedge fund Situational Awareness offers a vivid reminder — and a chance to better understand the power and danger of leverage.

Former OpenAI researcher and twenty-something Leopold Aschenbrenner reportedly saw his hedge fund, Situational Awareness, collapse from $45 billion to about $10 billion in a very short time.

The strategy relied heavily on semiconductor stocks and extraordinary leverage — reportedly as high as 400%.

This kind of approach can generate eye-popping returns when markets rise, but it can unravel just as quickly when they fall.

And fall they did. When key holdings dropped sharply, lenders issued margin calls, forcing asset sales at depressed prices.

The Situational Awareness hedge fund was launched in 2024 by the then-24-year-old who had graduated as valedictorian from Columbia University at age 19.

He’s a genius to be sure, but I’ve long found that being smart isn’t the same as being wise. There are lots of smart people on Wall Street, but fewer truly wise investors like Buffett.

According to The Wall Street Journal, Aschenbrenner’s hedge fund racked up gains of more than 1,000% over just two years since inception. But when names like SK Hynix and CoreWeave were hard-hit with prices down about one-third, lenders — including Bank of America, J.P. Morgan and Goldman Sachs — called loans that used the stocks as collateral.

Ken Griffin’s hedge fund Citadel jumped in to take advantage of the situation, reaching a quick deal to buy Situational’s public stock at a big discount. Citadel soon saw a nice rebound in its bargain purchases.

So, what does this have to do with you? The story provides a powerful reminder about the risks of leverage when investing.

There are an increasing number of exchange-traded funds (ETFs) that are eerily similar to Situational, with the combined risks of limited diversification and leverage.

Consider ProShares Ultra Semiconductors (USD), which targets the semiconductor space with 200% leverage. USD holds just 36 stocks with the top five representing about 30% of the fund.

Over the past 52 weeks, the fund price has ranged from $39 to $116. As of June 30, the fund had a one-year return of +183%, but the price chart looks like a very bad EKG with huge swings.

In July, the fund lost a third of its value in just a week as shares went from $92 on July 21 to $68 on July 28. Happily, shares went back up to $93 by Aug. 5.

Over the many years I served as an adviser, I didn’t find very many investors who could handle a 30% drop in one week — and you wouldn’t get the upswing if you didn’t fight the urge to sell.

Not to be outdone in risk, some ETFs even hold just one stock and lever up to seek outsized returns.

Direxion Daily NVDA Bull 2x EFT (NVDU) seeks to amplify returns of NVIDIA with 200% leverage.

Over the week ending July 28, the ETF was down 20% while NVIDIA stock was down just 10%.

In fairness, the ETF rebounded the next week by 30% while NVIDIA stock rose 18%. At least the fund materials clearly highlight “a high degree of risk.”

Finally, investors can take margin loans against their own account holdings. The very wealthy often do this to meet cash flow needs while avoiding big taxes on capital gain, and holding the assets until they get a basis step up at death.

Regular folks can also margin accounts to meet temporary cash flow needs, or look to buy more shares of a stock using borrowed money.

But margin loans come with risk. If the account value falls enough, it can trigger margin calls and holdings may have to be liquidated at the worst possible time — just like with Aschenbrenner.

If you decide to use leverage in your investing, go in eyes wide open, understand the math, and know how quickly conditions can change.

Or you might just find yourself “swimming naked” when the tide changes.