Founders - #93 Ed Thorp (A Man for All Markets)

Starting point is 00:00:00 Ed Thorpe's memoir reads like a thriller, mixing wearable computers that would have made James Bond proud, shady characters, great scientists, and poisoning attempts. The book reveals a thorough, rigorous, methodical person in search of life, knowledge, financial security, and not least of all, fun. Thorpe is a generous man, eager to share his discoveries with random strangers. Something you'd hope to find in scientists, but usually don't. Yet he is humble. He might qualify as the only humble trader on planet Earth.

Starting point is 00:00:36 So unless the reader can reinterpret what's between the lines, he or she won't notice that Thorpe's contributions are vastly more momentous than he reveals. Why? Because of their simplicity, their sheer simplicity. For it is the straightforward character of his contributions and insights that made them both invisible in academia and useful for practitioners. My purpose here is not to explain or summarize the book. Thorpe, not surprisingly, writes in a direct, clear, and engaging way. I am here as a trader and a practitioner of mathematical finance to show its importance and put it in context for my community of real-world scientist traders and risk-takers in general.

Starting point is 00:01:21 That context is as follows. Ed Thorpe is the first modern mathematician who successfully used quantitative methods for risk taking, and most certainly the first mathematician who met financial success doing it. Thorpe's method is as follows. He cuts to the chase in identifying a clear edge, that is something that in the long run puts the odds in his favor. The edge has to be obvious and uncomplicated. For instance, calculating the momentum of a roulette wheel, which he did with the first wearable computer and with no less a co-conspirator than the great Claude Shannon, father of information theory. He estimated a typical edge of roughly 40% per bet. The computer turned a 5.3% disadvantage into a 40% edge. But that part is easy, very easy.

Starting point is 00:02:15 It is capturing the edge, converting it into dollars in the bank, restaurant meals, interesting cruises, and Christmas gifts to friends and family. That's the hard part. It is the dosage of your betting, not too little, not too much, that matters in the end. A bit more about simplicity before we discuss dosing. For an academic judged by his colleagues, rather than the bank manager of his local branch or his tax accountant, a mountain giving birth to a mouse after huge labor is not a very good thing. They prefer the mouse to give birth to a mountain. It is the perception of sophistication that matters to them. The more complicated, the better. The simple doesn't get you citations

Starting point is 00:03:03 or some other metric du jour that brings the respect of the university administrators, as they can understand that stuff, but not the substance of real work. The only academics who escape the burden of complication for complication's sake are the great mathematicians and physicists. Ed was initially an academic, but he favored learning by doing with his skin in the game. When you reincarnate as a practitioner, you want the mountain to give birth to the simplest possible strategy and the one that has the smallest number of side effects, the minimum possible hidden complications. Ed's genius is demonstrated in the way he came up with very simple rules in blackjack. Instead of engaging in complicated and challenging card counting, something that requires one

Starting point is 00:03:51 to be a savant, he crystallizes all of his sophisticated research into simple rules. Go to a blackjack table. Keep a tally. Start with zero. Add one for some strong cards, minus one for weak cards, and nothing for others. It is mentally easy to just bet incrementally up and down, bet larger when the number is high and smaller when it is low, and such a strategy is immediately applicable by anyone with the ability to tie his shoes and find a casino on a map. Now money management, something central for those who

Starting point is 00:04:25 learn from being exposed to their own profits and losses. Having an edge and surviving are two different things. The first requires the second. As Warren Buffett said, in order to succeed, you must first survive. You need to avoid ruin, at all costs. Academic finance did not get the point that avoiding ruin, as a general principle, makes your gambling and investment strategy extremely different from one that is proposed by the academic literature. Thorpe and Kelly's ideas were rejected by economists, in spite of their practical appeal. The famous patriarch of modern economics, Paul Samuelson, was supposedly on a vendetta against Thorpe.

Starting point is 00:05:11 Not a single one of the works of these economists will ultimately survive. Strategies that allow you to survive are not the same thing as the ability to impress colleagues. So the world today is divided into two groups using two distinct methods. The first method is that of the economists, who tend to blow up routinely or get rich collecting fees for managing money, not from direct speculation. Consider that long-term capital management, which had the creme de la creme of financial economists, blew up spectacularly in 1998, losing a multiple of what they thought the worst case scenario was. The second method, that of the information theorist that's pioneered by Ed,

Starting point is 00:05:54 is practiced by traders and entrepreneurs and scientists. Every surviving speculator uses explicitly or implicitly this second method. I said every because those who don't will eventually go bust. Some additional wisdom I personally learned from Thorpe. Many successful speculators, after their first big break in life, get involved in large-scale structures with multiple offices, morning meetings, coffee, corporate intrigues, building more wealth while losing control of their lives. Not Ed. After the separation from his partners and the closing of his firm, for reasons that had nothing to do with him, he did not start a new mega fund. He limited his involvement in managing other people's money. But such restraint requires some intuition, some self-knowledge.

Starting point is 00:06:49 It is vastly less stressful to be independent, and one is never independent when involved in a large structure with powerful clients. It is hard enough to deal with the intricacies of probabilities. You need to avoid the vagaries of exposure to human moods. True success is exiting some rat race to modulate one's activities for peace of mind. Thorpe certainly learned this lesson. The most stressful job he ever had was running the math department at the University of California, California Irvine. You can detect that the man is in control of his life. This explains why he looked younger the second time I saw him in 2016

Starting point is 00:07:31 than he did the first time I saw him in 2005. Okay, so that was an excerpt. It was written by Nassim Taleb from the book that I read this week, which is the autobiography of Ed Thorpe. The book is called A Man for All Markets, From Las Vegas to Wall Street, How I Beat the Dealer and the Market. You can actually read the entire forward that Taleb wrote for the book for free. He posted it on his Medium page, and I will link to it in the show notes. Now, this is the sixth part of a series that I'm doing that started back on Founders number 88, which is a podcast I did when I read every single shareholder letter Warren Buffett has ever written. And in the past few weeks, I've read books about people Warren Buffett mentioned and admired. And I do this to try to deepen my understanding of how Buffett thinks and the kind of ideas and people that he favors. And Ed Thorpe is one of those people. Okay, so I want to go right into Ed's early life.

Starting point is 00:08:32 And he quickly starts out with what I call Thorpe's four rules. And so first, let's talk a little bit about when he was born and how that may have influenced like the ideas and the way he ran his business in his life later. So he says, I began life in the great depressions of the 1930s. Along with millions of others, my family was struggling to get by from one day to the next. Though we didn't have helpful connections and I went to public schools, I found a resource that made all the difference. I learned how to think. Because of circumstances, I was largely self-taught and that led me to think differently. So he jumps into his four rules for learning. First, rather than subscribing to widely accepted

Starting point is 00:09:19 views, such as you can't beat the casinos, I checked for myself. So it's important to note, he uses this trait over and over again in life. Example, when everybody knew that you can't beat the casinos, I checked for myself. So it's important to note, he uses this trait over and over again in life. Example, when everybody knew that you couldn't beat any of the games in Las Vegas, not only roulette, they told him you couldn't, and then blackjack. And then also everybody knew, in news and quotes, that the market was efficient and it's impossible for you to find any kind of edge, so why would you bother trying? Ed didn't believe either of those, and he wound up finding a lot of opportunities

Starting point is 00:09:47 because he didn't accept conventional wisdom. Rule number two. Since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought, such as a formula for valuing warrants, and using it profitably. So he'll talk about warrants a few times. It's one of his most,

Starting point is 00:10:03 his actually first very successful idea in finance. using it profitably. Rule number three, when I set a worthwhile goal for myself, I made a realistic plan and persisted until I succeeded. Number four, I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I learned the value of withholding judgment until I could make a decision based on evidence. Okay, so he mentioned a little bit about his early life. There's another important part. So not only were they extremely poor, but both of his parents had to work. They weren't making a lot of money. And so he, as a large part, he grew up rather unsupervised. And

Starting point is 00:10:49 so one of the most important things that happened to him at a very young age is he developed a love of reading. And so he talks a little bit about that here. He says, my parents were usually gone or sleeping, seldom seeing us or each other. That left my brother and me to raise ourselves i responded by exploring endless worlds both real and imagined that i found in the books that my father gave me i learned about heroes and villains romance justice and retribution i admired the heroes who through extraordinary abilities and resourcefulness achieved great things and that that sentence right there is a good description of Ed's life. Through extraordinary abilities and resourcefulness,

Starting point is 00:11:30 he achieved great things. I was inspired to mirror this in my future by using my mind to overcome obstacles. Though we were poor, my parents valued books and managed to buy me one occasionally. Now, he talks a lot about how early, and this is universal human trade, like we're formed by, there's things that happen to us early in our lives that stick with us for the rest of our lives. And there's heavy influence on how we

Starting point is 00:11:56 think, how we organize relationships, how we organize our work. And the Great Depression, as we've seen many times on the podcast with other founders, anybody that grew up during the Great Depression, they kept that with them for their whole life. And Ed was no different. And he says, this is the long-term effects of the Great Depression on Ed. As we were barely managing my father's depression-era wages, an academically advanced private school was never an option. The depression permeated every facet of our lives. We lived on my father's $25 a week salary. As such, we never wasted food and we wore our clothes until they fell apart. For the rest of my life, I would meet depression era survivors who retained a compulsive,

Starting point is 00:12:39 often irrational frugality, and an economically efficient tendency to hoard and you'll see kind of an echo of this like conservatism in ed a little later on although he was certainly like would seize opportunities uh when it presented itself and bet heavily but uh he was running a very successful hedge fund and he did so for like 20 something years and i think something like the first 10 or 12 years he refused to quit his day job. So he's doing both. And he was working at the University of California, Irvine. All right.

Starting point is 00:13:12 So going back to his early age, this is some early lessons in entrepreneurship and something he retains with him for the rest of his life. He says, when my father gave me a nickel to shovel the snow from our sidewalk, I hit a bonanza. I offered the same deal to our neighbors, and after an exhausting day of snow removal, I returned home soaked in sweat and bearing the huge sum of a couple of dollars, almost half of what my father was paid per day. Soon, lots of other kids were out following my lead, and the bonanza ended. This was an

Starting point is 00:13:42 early lesson in how competition can drive down profits and why you need to find your edge. So one of the most shocking things I found in the book was he has a large part of his family was in the Philippines and during World War II, they were prisoners of war when the Japanese invaded the Philippines. So his family suffered greatly as a result of this. And this is some lessons and some motivation they took away from this. He says, after the war, meanwhile, American troops had liberated the survivors of my mother's family from a Japanese prison camp in the Philippines. Multiple families came over from the Philippines to live with us.

Starting point is 00:14:21 So at the time, even though they didn't have a lot of money and a lot of space, they wind up, there's 10 plus people, multiple families living with them at this point. They told us stories such as my aunt and her husband who had been beheaded in front of their children by the Japanese. And then my grandfather had died painfully of prostate cancer in the camp

Starting point is 00:14:40 just a week before liberation. Seeing what World War II had done to my relatives and how World War I plus the Great Depression had limited my father's future, So I'm going to skip forward in the timeline. I'm going to get to when he gets to college. Now, before college, he's like, you know, even at the time, I think he said college was something like $70 a semester at this time. And he still didn't know if he could afford that. And so he had this idea a few years in advance to buy these war bonds. And the maturity, the time they were mature would be just about the time he was going to college. And so he's like, okay, I'm going to use this as basically a college savings account. And so this section I'm going to read to you is how he supported himself in college.

Starting point is 00:15:29 And he didn't come from a well-functioning family. His parents wind up cheating on each other. They get divorced. He then went from living with his dad to seeing his dad like once a week. And then he's betrayed by his mom here. His mom takes – so he says, whether I could support myself at the university was now in doubt. What does that mean? His mother took his bonds, cashed them out, and spent the money. So he says, I survived with scholarships, part-time jobs, and $40 a month for the first year for my father. I got by on less than $100 a month, including everything,

Starting point is 00:16:01 books, tuition, food, shelter, and clothes. On Sundays, when my boarding house did not provide meals, I visited church open houses where I consumed large quantities of free hot chocolate and donuts. When I read that part, that was a very similar, it reminded me of the very similar situation that Steve Jobs was in before he started Apple, where he wasn't eating a lot, and the one good meal they would have is every, I think, Sunday, they would walk over to the, I think it was like Harry Krishna or something like that, to get one good meal.

Starting point is 00:16:28 So Ed's kind of, we're seeing similarities in Ed's early life. So while he's in college, he picks up a habit that he maintains for the rest of his life and that benefits him for the rest of his life, and that's a focus on health and fitness. So the main point I took away from this book and what I learned, really it's a book, it is a book about entrepreneurship and risk-taking and working hard and educating yourself. But really at its core, it's a book about how to live well. And one way Ed did that is he didn't over-optimize just for money. And we've seen that in past podcasts. So there's a lot of autobiographies, you know, the entrepreneur waits close to the end of his life, starts writing his autobiography. And there's a lot of regret.

Starting point is 00:17:10 So the two to come to mind right now are Sam Walton, the founder of Walmart, and Phil Knight, the founder of Nike. Both of their autobiographies, they talk about, you know, spending so much time on their business that if they could do it over again, they would have spent more time with their family. Ed doesn't make that mistake. So he makes a lot of money, but he also spends a lot of time with his family and loved ones. He also takes care of his health. And in addition to reading this book,

Starting point is 00:17:32 I also took notes because I would say, I think there's two or three different talks I found of his. And one of them, I've showed the video to several people. And I was like, tell me how old do you think that guy in the video is? And they hear him talk, they look at him, they're like, I don't know, 60, 65. He's 85 years old in the videos. And today's 87. And he's still fit and healthy. So one of the things that he's going to stumble upon now in college is he starts to develop

Starting point is 00:18:02 simple systems, just like he developed simple systems for everything in his life, to maintain a healthy lifestyle because he understood how that affects every other aspect of your life. So he says, one evening I heard the sound of iron clanking. Curious, I ventured inside and found three muscular residents hoisting barbells. When I suggested that this seemed like a lot of work for who knew how much gain, they bet me a milkshake that if I would work out with them for one hour, three times a week for a year, I would double my strength. I accepted their challenge. When the year ended, I had more than double what I could lift and gladly paid off the bet. This was the beginning of a lifelong interest in fitness and health.

Starting point is 00:18:41 Okay, so now I'm fast forwarding. He's in grad school studying physics and there's like, he's at this gathering and there's a group of physics students that are saying, it says, someone who had been to Las Vegas was explaining that no one could beat the casinos. This was the consensus view of the group. It was also the view of the world in general, backed up by the painful experience of generations of gamblers. So this back to his trait what he recommended earlier we investigate things for ourselves right and so this is also when he starts taking the idea to beat roulette seriously so he says i argued with others at the table that you could beat roulette using what i learned from physics i explained that friction would gradually slow the orbiting ball in the circular track until finally gravity would

Starting point is 00:19:23 be enough to cause it to spiral down and in towards the center. I argued that an equation could forecast the ball's position during this process. Limiting the predictive power of my equations were random irregularities that can't be forecast. This is what mathematicians and physicists call noise. Conventional wisdom said that noise was enough to ruin the prediction i didn't think so and i decided to find out so this is what i was uh what to love was referencing in the the forward of the book where he him and claude shannon actually build a one of the first wearable computers and they take what uh what what winds up being a negative what five percent edge whatever it was

Starting point is 00:20:00 to a to a positive edge of 40%. So he actually winds up being correct. And this is a weird, and I mean that in a positive way because I love weirdos and misfits. I mean, that's what this entire podcast is about, right? You're not going to write a biography on your life if you just towed the line and just accepted conventional wisdom and never deviated from that, right? So he meets Richard Feynman, right? And he's encouraged, he asks, let me just read

Starting point is 00:20:27 this to you. And then I guess, so I don't triple for my own point. So he winds up stumbling at this party, stumbling into this party and Richard Feynman's in the corner playing bongos. And so he walks up to him. He says, if anyone knew whether physical prediction at roulette was possible, it should be Richard Feynman. I asked him, is there any way to beat the game of roulette? When he said there wasn't, this is the weird part, which I admire, I was relieved and encouraged. Okay, this suggested that no one had yet worked out what I believed was possible. With this incentive, I began a series of experiments. So then this next paragraph, before I read, or as I was reading the book book i also read like blog posts and anything i could to try to study to understand ed thorpe a little bit more

Starting point is 00:21:08 and so there's a blog post called a dozen lessons from ed thorpe if you google that you can see it um and there's a quote there he says try to figure out what your skill set is and apply that to markets thorpe likes to stay within his circle of competence this is going to echo warren buffett right this is a hallmark of people who are rational. In that sense, Thorpe reminds me of Warren Buffett. Not only does he remind me of Warren Buffett, but it's exactly what David Olgivie told us a few weeks ago. He's like, listen, I'm an idiot on everything except advertising. On advertising, I got my stuff together. So what David's saying there is like, I know what my circle of competence is. I'm going to stay within the circle of competence based on my research of consumer

Starting point is 00:21:43 behavior and the applications of that research to advertising. And so Thorpe is echoing that later. He says, I also believe then as I do now as more than 50 years as a money manager that the surest way to get rich is to play only those gambling games or make those investments where I have an edge. Now, while he's doing – let me go back to the book. Now, while he's doing this research on roulette, he also comes across, there's some academic papers at this point. Now, keep in mind, Ed Thorpe, he thought he was going to be an academic his whole life. Him and his wife, when they got married, they said,

Starting point is 00:22:17 okay, we're not going to make a lot of money, but we'll be around other smart, interesting people, and we'll just do the best we can. He did not expect to become fabulously wealthy. And while he's doing this, he's reading all these papers on blackjack, and other people are computing. You know, it's been like 150 years at this point of people trying to compute different odds on casino games, games that are common for people to gamble on.

Starting point is 00:22:42 And so that's when he comes, he's like, starts studying blackjack. He said, well, maybe like roulette, I have to build, he wants to have him to build a computer, but he was like, maybe I can come up with a formula or the system where I don't need any hardware. Right. So he's doing this as you think about roulette, but before he starts working with Claude Shannon. And what I took from this is like being driven and curious, it can lead you anywhere.

Starting point is 00:23:02 He does the same thing when studying blackjack that he does when he starts his business he sits in a room and thinks about how to win and then he goes out and tests the the results of that computation so he says it wasn't the money that drew me to blackjack what intrigued me was the possibility that merely by sitting in a room and thinking i could figure out how to win i was also curious to explore the world of gambling about which I knew nothing. That's another thing. I think I cover it later on. He wants to becoming a millionaire, I think at age 43. And he did that direct result from finance. He never even thought about finance till he's 32 years old. So this, this, this trade about being interested in things that he knew nothing about, he didn't think of that as a barrier. He just thought about that as an opportunity.

Starting point is 00:23:46 I think that's good for all of us. So he writes, he has this theory. This is where he's, you might have heard card counting. Ed Dorp is credited with the invention of card counting. He actually wrote a book called Beat the Dealer that winds up selling over a million copies. It was published in 1967 or something like that. This is before the book and before he becomes like infamous for that or famous for that. And he has this theory, but again, he's still an academic. So what happens is he wants to publish his theory on blackjack

Starting point is 00:24:15 because he feels it's a problem of mathematics in a journal. So he can get credit for coming up with that idea because in the past he had previous work stolen by other academics. He'd send a paper off to somebody for review and say, hey, what do you think of this? And then he never heard back from them. A year later, that guy's giving presentations on Thorpe's idea and passing it off as his own. So as a result of wanting to publish this, he's at MIT right now, working at MIT. He meets Claude Shannon. And so he says, to protect myself from this happening with my work on Blackjack, I settled on the National Academy of Sciences. This is where he wants to publish his work on Blackjack. This required a member of the academy to approve and forward my work. So I sought out the only mathematics member of the academy at MIT,

Starting point is 00:24:59 Claude Shannon. Claude was famous for the creation of information theory, which is crucial for modern computing, communications, and much more. Essentially, we wouldn't have the entire technology, like internet economy we have now without Claude Shannon. I'm not going to cover too much of that. I'm going to read his biography. It'll be coming in the next few weeks. But I also talked about the impact of Claude Shannon last week on the Founders episode I did on Fortune's formula.

Starting point is 00:25:24 So if you want to learn more, I don't want to repeat that if I've already covered it in a previous podcast. But I do want to talk a little bit about their work together. And I just find the mind of Ed Dorp and Claude Shannon fascinating. So Claude agrees to meet with him. Claude says, OK, I like your idea. Yes, I'll forward this to the National Academy of Sciences. He also asked him, hey, do you have any other ideas? And that's when he brings up this idea for the roulette computer. Claude Chan is one of his most famous passions was building gadgets. He had this thing in his house called the toy room, which had over $100,000 in 1960s money of gadgets, early predecessors computers, some things that were completely mechanical. He just loved building

Starting point is 00:26:07 weird things. He'd build like a slack line in his house and he'd get on the slack line and juggle. He's just a very interesting person. So as a result of the publication of his work, he then is invited to give a bunch of talks and hundreds of people show up. And normally these talks at the time, there'd be like 50 people, you know, 50 academics, but the great started being covered in the press. And then, you know, you have mobsters, you have all kinds of crazy people that want to find a way to, you know, get rich quick, essentially. And so the press is largely cynical of him. But what I found interesting was these are his thoughts right after he's done talking. So he gave his talk,

Starting point is 00:26:48 he thought about all these bizarre twists in his life that just happened. And he says, during the long ride back, I wondered how my research into the mathematical theory of a game might change my life. In the abstract, life is a mixture of chance and choice. Chance can be thought of as the cards you were dealt

Starting point is 00:27:04 in life. Choice is how chance and choice. Chance can be thought of as the cards you are dealt in life. Choice is how you play them. I chose to investigate blackjack. As a result, chance offered me a new set of unexpected opportunities. And so that's a really important part that the future and the world that we live in is way too complex to predict. All you can do is hope that you're exposing yourself to enough experiences that open up opportunities later in your life. In his case, he still thinks he's an academic. I'm going to study blackjack. Maybe I can figure something out. Maybe I can't. Wines up making money at blackjack. Wines up making money selling a book at blackjack. Then realizes, which I'll cover in a little bit, hey,

Starting point is 00:27:38 I can apply these ideas to the stock market, which just seems like a large mathematical problem, just like a large casino. And then that forever changes the path of his life. So I like that idea about chances, the cards you're dealt and choices, how you play them. Now, this is one of the things I admire most about Ed and what I'm learning from him. And I'll talk more about this in a little bit, but this is really Ed's philosophy on life. And I just want you to remember this part for when I get to the end. Claude, he's working about 20 hours a week in addition to all his other duties with Claude Shannon at Claude Shannon's house. He's building the roulette computer. Claude asked me at dinner if I ever thought anything would ever top this in my life. My thoughts then were much like I had

Starting point is 00:28:20 expected his to have been. That acknowledgement, applause, and honor are welcome and add zest to life, but these are not ends to be pursued. I felt then, as I do now, keep in mind he's around 85 when he's writing these words, I felt then, as I do now, that what matters is what you do and how you do it, the quality of time you spend and the people you share it with. So now he's talking about taking on the casinos and realizing that they think everybody else is a fool, that they have the edge. That's why casinos can build hotels and shows. Where did that money come from?

Starting point is 00:28:55 It came from the people that went in there and gambled away their money. The next paragraph I'm going to read you is he's describing the casino here. But what he's really saying is that he's operating with an edge. And it's also why we're able to start new companies that can, you know, everybody thinks that if the efficient market theory was correct, like then no one would be, there would be no such thing as the reason to start new businesses because the existing businesses would have already seized all the opportunity.

Starting point is 00:29:23 We know that is fundamentally untrue. And so he's talking about a casino here. I want you to think about, okay, one, he's talking about you need an edge. And then second, take that thought that you need an edge and think about that you can apply that edge to an unlimited number of opportunities in business. Because again, I love going back to that. The best basic way to think about for people that haven't started a business yet is like, I don't know what to do.

Starting point is 00:29:46 Just think about what Richard Branson said. A business or a product is just something that makes somebody's life better. If you apply that thought to the world, you'll see that there's unlimited opportunities for that. And so I also want you to think about how he's just describing the Goliath as the existing companies

Starting point is 00:30:04 that may be missing opportunities or may be too arrogant to think about how he's just describing the Goliath as, you know, the existing companies that may be missing opportunities or maybe too arrogant to think that other people can capture opportunities from them. So he says, even though the Goliath I was challenging had always won, I knew something no one else did. That's his edge, right? He, meaning the Goliath, was nearsighted, clumsy, slow, and stupid. And we were going to fight on my terms, not his. So part of the benefit in counting cards is you know when you have the edge to make a larger bet and when the casino has the edge. So as a byproduct of that, you reduce your risk, right, and your bet. Now, this is a lesson he learned from Blackjack that he later applies to his hedge fund. It's literally, when you read the book, you're like, wow, this guy just took the basic idea and applied it to different domains. This is really genius. He says,

Starting point is 00:30:53 this plan of betting only at a level at which I was emotionally comfortable with and not advancing until I was ready enabled me to play my system with a calm and disciplined accuracy. This is the same thing. That could be said by Buffett, by Munger, by any of the people that we've been studying. The lesson from the blackjack tables would prove invaluable throughout my investment lifetime as the stakes grew even larger. Now, there's something really interesting that he discovers as a life lesson, you know, because he was kind of bullied when he was younger and realized, hey, I may think differently. I'm kind of different than other people, than normal people, so to speak. But living in academia, he got exposed to, you know, some kind of pettiness and stuff like that. But what he's going to, he's getting a life lesson

Starting point is 00:31:43 in human nature here. And what he discovers, to, he's getting a life lesson in human nature here. And what he discovers, right? First, he discovers it when he's trying to beat the casinos. And later he applies this to the investment world at large. He actually, interesting enough, part of his, I mean, this guy's had an amazing life. He winds up discovering the Ponzi scheme of Bernie Madoff like 18 or 19 years before Madoff gets caught. But anyways, what he's learning here is that cheating is rampant in gambling, investing, entrepreneurship, anything that business, just anything that has to do with humans being able to gain by cheating, right? And so he says, cheating was so relentless during those days in Las Vegas that I spent as much time learning about the many, many ways it was being done as it did playing.

Starting point is 00:32:27 Everywhere we went, we reached a point where we were cheated, barred from play, or the dealer reshuffled the cards after every hand. So if they're reshuffling the cards, they're taking away his ability to continue counting because the longer he can count, the more precise the odds get. And therefore, his bets are going to be better. So when I was taking notes on one of the talks he gave while promoting this book, he said something that I wrote down and put in my notebook. And it was interesting. And he says that business and investing is very much like making a good Super Bowl team. And I was like, what do you mean by that? So he says, if you want a good Super Bowl team, you need a good offense and a good defense. So your offense is your edge,

Starting point is 00:33:08 right? What does he mean by good defense? A good defense keeps other people from taking your money. So you can apply what he's discovering, that almost every single system is rigged. And therefore, if you're naive to that, you have a bad defense. And therefore, other people are going to take their edge, which going to take your money so you need your edge for your offense but also you need a good defense to protect you from other people's edges and this is a crazy story he's he's doing all this research right he's really not trying to get rich on blackjack still at this point and he figures okay well i'm discovering all different ways that uh that casinos are cheating so of course the nevada gaming control board who

Starting point is 00:33:45 is the regulator of the casinos want to know right so he goes to them with another trusted person uh that has a relationship with them and he says hey my friend ed's finding all these things out we want to tell you so you can you know stop casinos from cheating regular consumers right and he's going to discover that the ne Game and Control Board is not. The regulator has been captured by the casino. Okay? So they suggest to Ed, hey, when you go gamble at these casinos, take one of our agents with you so he can protect you from their cheating.

Starting point is 00:34:19 Right? And this is what happens. What they'll do is if you're winning, they'll bring in a new dealer right in the middle of your win streak. And that person is very skilled at being able to look at the top card, the card they're taking.

Starting point is 00:34:34 And if it's not good, they can immediately with a really fast sleight of hand take the second card, right? So it's a way for them to, it's called second card in the sense that they're getting the second card. They're getting their choose between two cards instead of one. So it's flat out casinos cheating consumers, right?

Starting point is 00:34:50 And this is happening while the agent's right next to him. And he calls him his protector because that's what he's supposed to be. But that's really false. He says, as my protector followed me outside, I said, did you ever see a second card like that before? Because it got wind of getting stuck and it wasn't like a good sleight of hand. It was very, very obvious. And the guy said the guy replies second what second this agent had been sitting three feet from the dealer he saw everything and pretended to see nothing

Starting point is 00:35:15 realizing that he was there to finger me for the casinos i used the restroom to excuse myself and lose him and went to play at another casino. So there's something else he said that was interesting. This reminded me of what he said about Bernie Madoff. Because he was hired by somebody who had an investment. It was a large institutional investment of Madoff's in the early 90s. And so he goes and investigates the trades. What he learns is that Madoff is basically making up the trades because you can go and check the trades.

Starting point is 00:35:48 Well, he said on this day he traded for this amount. Well, that volume is not there. Okay, that trade never happened. And so he winds up dedicating several weeks to this and he comes out. He's like, this guy, he's a fraud. He's not trading what he's telling you. And so he's asked a question in one of these interviews. Like, did you ever think that you should have gone to the authorities with this?

Starting point is 00:36:07 And his response was really interesting it kind of echoes the experience that he had younger realizing the nevada gaming control board was corrupt he says bernie madoff had been the chairman of the nasdaq he was the third biggest market trader in the united states he was on all types of committees he He was the establishment. The SEC checked him and gave him a rubber stamp of authenticity. And that happened year after year after year. And so what does that mean? If you hear him say that, and then you read his description of the Nevada Gaming Control Board in his book, if you read between the lines, Dorp is telling us that most systems are rigged. So this is an example that he's going to talk more about frauds and swindles that history doesn't repeat, human nature does. All right. So he says the fraud,

Starting point is 00:36:49 swindles, and hoaxes, a flood reported almost daily in the financial press, have continued unabated during the more than 50 years of my investment career. But then hoaxes, scams, and large-scale financial irrationalities have been with us from the beginning of the markets in the 17th century. So he's just telling us, listen, yeah, it's happening today, but it happened 300 years ago. And if something's happening today and happened 300 years ago, good chance that that's just going to be around for a long time.

Starting point is 00:37:15 All right. This is a lesson he learned from his time studying blackjack in Las Vegas. From a mathematical idea in my head, I forged a system for beating the game. He winds up being extremely successful then. I talked a little bit about that last week too then i was ridiculed by the casino which said that it sent cabs for fools like me thinking they played fair remember this i was talking about what his the the impression that he thought about the industry before he started interacting with it is vastly different than the one he actually experiences right thinking they played fair and i was taking my secret weapon a brain to a sporting event i found myself barred cheated

Starting point is 00:37:51 betrayed by a representative of the gaming control board and generally person persona non grata at the tables i felt satisfaction and vindication when the great beast panicked. What he's talking about there is when he publishes a book, they start changing the rules in blackjack. And so that's what he means. He's like, oh, okay, so you said you sent cabs, so I'm an idiot, it's impossible. But then I proved that I was correct and then you changed the rules of the game.

Starting point is 00:38:17 It felt good to know that just by sitting in a room and using pure math, I could change the world around me. So you might be asking, like, he's got the system. He can travel all over the world, make money doing this. Why did he stop? He started being drugged by the casinos. They poisoned the drinks they gave him. And then they're leaving the casinos and somebody tampered the brakes on his car and they almost

Starting point is 00:38:37 stopped him, almost caused him to die. So after being drugged and the brakes on his car tampered with, he decides to focus his talents on the stock market. So he says, I invested money from book royalties and gambling winnings in stocks, but I was ignorant of the market as well as unlucky. The results were poor and I wanted to do better. Investments presented a new type of uncertainty, but the theory of probability might help me make good choices.

Starting point is 00:39:03 Things came together when I realized that there was a far greater casino than all of Nevada. Could my methods for beating games of chance give me an edge in the greatest gambling arena on earth, Wall Street? Ever curious, I decided to find out. I began to teach myself about the financial markets and lighting my way with an unusual lamp, the knowledge that I had gained from gambling gains. So this is how he starts studying financial markets. Relishing the intellectual challenge and the fun of exploring the markets, I spent the summer of 1964 educating myself about them.

Starting point is 00:39:39 I read stock market classics like Graham and Dodd's security analysis, Edward and McGee's work on technical analysis, and scores of other books and periodicals ranging from the fundamental to technical, theoretical to practical, and simple to abstruse. I came away with a foundation of knowledge. Once again, just as with casino games, I was surprised and encouraged by how little was known by so many. And just as in blackjack, my first investment was a loss that contributed to my education. So I'm going to get into that here, but I need to tell you what's going on. There's a lot going on at this point. One, he's paying for his education in financial markets. He buys a stock after a positive news

Starting point is 00:40:23 story. It promptly drops by half. That leads him to the lesson that you are unlikely to have an edge from anything you hear in the news. Two, he buys silver using leverage. The price goes up. Everybody else is using leverage too. When the price starts dropping, the investors are forced to sell because their leverage is now too high. Those sales cause this downward cycle that causes the price to drop even more. Three, he suspects the efficient market theory, which is all the rage in academia, which we know because Buffett talked about it a lot in the shareholder letters, is correct and almost gives up. Four, his natural inclination to not accept things at face value

Starting point is 00:41:00 and verify the accuracy for him kicks in. So let me read this paragraph to you. He says, I learned from this that even though I was right in my economic analysis, I hadn't properly evaluated the risk of too much leverage. For a few thousand dollars, I'd learned from this to make proper risk management a major theme of my life for more than 50 years thereafter. That's the Kelly criterion that we keep talking about that we talked about last week. I don't talk about too much in this podcast but it's essential um he says in 2008 almost the entire

Starting point is 00:41:29 world financial establishment didn't understand this lesson and had it over leveraged itself i also learned from losing my silver investment that when the interests of the salesman and promoters differ from that of the client that the client had better look out for himself after these lessons from mr market i was tempted to client that the client had better look out for himself. After these lessons from Mr. Market, I was tempted to believe that the academics were right in claiming that any edge in the market is limited, small, temporary, and quickly captured. Once again, I was invited to accept a consensus opinion at face value. And once again, I decided to see for myself. Okay, so this is his first successful idea in finance. And this is the only one I'm going to talk about. Because I think like they're

Starting point is 00:42:10 all of them are in the book, some of them still could apply today. But I don't think like listening in a podcast is going to make sense. You have to kind of look at it and understand. But I do want you to understand this because it's he starts out just eventually he's going to work out to a very successful hedge fund, which I already told you, right. But right now he's just investing his own money. So to ever have the idea that you should have a hedge fund, you have to have a good idea first. Then the other point I want to make to you is that he didn't jump from, oh, I'm investing for myself to now I'm running a bunch of money for other people. He did it in steps. And part of that steps is going to have him cross paths and have dinner with Warren Buffett. All right. So this is his first successful idea in finance.

Starting point is 00:42:43 I think it's understandable, but it's the least understandable part about this whole podcast. He said, I formed a rough idea of the rules relating to the warrant price to the stock price. Since the prices of two securities, remember the warrant is just like an option issued from the company, right? So what he's doing, why he calls it a hedge, remember the hedge funds, they're, they're really popular now, back in the sixties, they definitely weren't. And they all existed to hedge. Now it's just more of like, Hey, I have a smart guy. I'm going to run some money and I'm going to, uh, you know, call it a hedge fund or whatever. It's a little, it's different. And he talks about that in the book too, but I exclude that from the podcast. Okay. Uh, I formed a rough idea. Uh, I already

Starting point is 00:43:21 read the part since the pieces of two, the price of two securities tended to move together. So what he means is he's buying his first ideas, why don't I buy different securities for the same company? That's how he's going to make his hedge. Since the prices of the two securities tended to move together, the important idea of hedging occurred to me, in which I could use this relationship to exploit any mispricing of the warrant and simultaneously reduce the risk of doing so. So how does he form his hedge? Take two securities whose prices tend to move together, such as a warrant and the common stock that it can be used to purchase. So he'll either buy the stock and short the warrant or he'll buy the warrant and short the stock. It's the same company though, okay? That's where he's getting

Starting point is 00:43:56 his hedge. So he says, take two securities whose prices tend to move together, such as the warrant and the common stock it can be used to purchase, but which are comparatively mispriced, which meaning that's what he's determining his edge, the fact that the market is mispricing this. Buy the relatively underpriced security and sell short the relatively overpriced security. So that's his first insight that, hey, this is weird that you have different securities that are from the same company or about the same company, and yet their pricing doesn't, they're not acting in relation. It doesn't make sense. He calls them mispricings. If the proportions in the position are chosen well, then even though prices fluctuate, the gains and losses on the two sides will approximately offset or hedge each other.

Starting point is 00:44:39 And so that's this basic idea, which he applies to a bunch of different domains, is why he calls, he has a market neutral hedge fund. And he'll compare and contrast that with the ideas of Warren Buffett later. Now, he gets to his hedge fund in steps. First, he invests his own capital. The next step is this. He's doing well. The fact that the available investment opportunities were much larger than I could explore with my modest capital led to the next step.

Starting point is 00:45:09 I began to manage hedged portfolios for friends and acquaintances. At this point, he's at the University of California, Irvine. A lot of other people understand the work he's doing. And so they say, hey, will you do this for me? So he starts these little bunch of separate little partnerships and sometimes like $20,000 of their money, you know, small, but a bunch of them. Now, as a result of this, one of the deans at UC Irvine was in, I think you know this already, but in case you don't, before Buffett started Berkshire, took over Berkshire Hathaway, he had the Buffett Partnership Limited, which is just an investment fund. And he was winding it down at this point. So one of the people at UC Irvine, this guy named Gerard, who plays an important role in Thorpe's life,

Starting point is 00:45:49 winds up, Buffett's liquidating his partnership, right? This is where Thorpe means Buffett. I need to tell you one thing. Warren is 38 years old here at this point in the story, and his investment partnership is worth about $100 million. He's winding that down and giving the proceeds back to investors or they can invest in Berkshire Hathaway. Of that $100 million, about $25 million of that is Warren's. Okay. So this is Thorpe on Buffett. Warren was a, so anyway, I don't know if I actually said that. Gerard wants Warren to vet Thorpe as a potential replacement. So saying, hey, I'm going to take some of the money out of the Buffett partnership and put it with this guy. So they have dinner. So Warren was a high-speed talker with a Nebraska twang and a stream of jokes, antidotes, and clever sayings. He loved to play bridge and had a natural liking for the logical,

Starting point is 00:46:32 the quantitative, and the mathematical. I learned that he focused on finding and buying into undervalued companies. Warren was asked how he found so many millionaires for his partnership. Laughing, he said to me, I told them I grew my own. As Warren and I talked, the similarities and differences in our approaches to investing became clearer to me. He evaluated businesses with the aim of buying shares of them, or even the entire company, so cheaply that he had an ample margin of safety to allow for the unknown and the unanticipated. Same thing that Thorpe does. Same thing that Shannon does. Same thing that Munger, obviously Munger and Buffett work together. You can see that over and over

Starting point is 00:47:10 again. That's what Taleb said at the beginning, that any successful trader entrepreneur has a margin of safety. And how do you know they have a margin of safety? Because they survive. And the people that don't, they will eventually blow up. That's part of the Kelly criterion. His objective was to outperform the market in the long run, and so he judged himself largely on his performance relative to the market. In contrast, I didn't judge the worth of various businesses. Instead, I compared different securities of the same company with the object of finding relative mispricing, that's what I was saying earlier, from which I can construct a hedge position, long to relatively undervalued, short to relatively overvalued, from which I could

Starting point is 00:47:45 extract a positive return despite stock market ups and downs. Warren's goal was to accumulate the most money. I enjoyed using mathematics to solve certain interesting puzzles, which I found first in the world of gambling and then in the world of investing. Making money confirmed my theories by showing that they worked in the real world. Now, as of right now, what are we doing? We're literally learning from the life experiences of Thorpe, which he spends 60 years accumulating and then writing it down so we could benefit. Well, just as we're learning from Thorpe, Thorpe learned from Buffett. So this is a guy named Gerard. Ralph Gerard gave me copies of Buffett's letters to his partners and his partnership document, a simple two-page affair. It was clear from this that the ideal plan would be to pool my investing

Starting point is 00:48:30 for myself and others in a single limited partnership, just as Warren had eventually done. So at the time, he was just doing all these separate agreements. Like, well, this is stupid. Why don't I just put in one like Warren did? Now, this is the part of the unpredictability of life. We don't know how individuals are going to have lasting impact in our life. And just his decision to take this job at UC Irvine winds up leading him to meet Gerard, who in turn leads him to meet Buffett. Ralph Gerard had a profound effect on the outcome of Ed Thorpe's life. So he says, the time I spent with him, meaning Gerard, had two major effects on my life.

Starting point is 00:49:04 It helped move me along to a path to my own hedge fund this is what this is the vehicle that's going to make um thorpe have more money than he can ever spend and it later led me to make a very profitable investment in berkshire hathaway so what does that mean ed starts because he met buffett and knows a buffett uh from gerard he starts buying berkshire hathaway stock at nine hundred dollars today that single share is three hundred thousand dollars per share he's bought him at nine hundred dollars it's bananas all right i'm gonna run rapidly through his timeline here. Ed starts a hedge fund, right? So first, invests his own money. Then he does these partnerships. Then he's like, I think I have

Starting point is 00:49:49 the handle of this. This takes about, remember, he said in the summer of 64 is when he first starts thinking about finance and studying it. In Iran, I think it was 1969 is when he starts his first hedge fund. And he starts a hedge fund. He finds a partner that will do the things he doesn't like to do. I talked a little bit about that last week, so I'm not going to cover it here. But what stuck out to me is that he has very modest goals. Okay, so he says, discussing how much capital we need to start with, we set $5 million as our target. If we made 20% net of expenses and charged 20% of that as a performance-based fee each year,

Starting point is 00:50:22 we'd share 4% of $5 million. That's $200,000. And that was more than I was making as a professor. Okay. So first of all, they can't raise 5 million because it's a bad economic environment. They raised 1.4 million. But this $200,000 number a year he hopes to make, by the time the hedge fund shuts down, it's 16 million a year, not including the compounding of his own personal investments. He's printing money. All right. Going back to something I want to keep reinforcing in your mind is the simulators of his blackjack strategy and his hedge fund strategy. He talks about that explicitly in the book. Betting on a hedge I had researched was like betting on a blackjack hand where I had the advantage. As in blackjack, I could estimate my expected return, estimate my risk, and choose how much of my bankroll to bet.

Starting point is 00:51:09 Instead of a $10,000 bankroll, I now had $1.4 million. And instead of a $500 maximum bet, the Wall Street casino had no limit. Influenced by having been born during the Great Depression and by my early investment experiences, I made reducing risk a central feature of my investing approach. So as he starts to expand his hedge fund and becomes more successful, now he runs into another problem he doesn't know how to deal with. Didn't know anything about gambling games? Studied that. Didn't know anything about investing? Studied that. Now he's got to study management. He's got to manage people.

Starting point is 00:51:39 He's running a business here. He says, I had to learn to choose and manage employees. Figuring this out for myself, I evolved into the style later dubbed management by walking around. Instead of the endless schedule of formal meetings I abhorred in academia, I talked directly to each employee and asked them to do the same with their colleagues. I explained our general plan and direction and indicated what I wanted done by each person, revising roles and tasks based on their feedback. For this to work, I needed people who could follow up without being led by the hand,

Starting point is 00:52:10 as management time was in short supply. Since much of what we were doing was being invented as we went along, and since our investment approach was new, I had to teach a unique set of skills. I chose smart young people just out of university because they were not set in their ways from previous jobs. Better to teach a young athlete who comes fresh to his sport than to

Starting point is 00:52:32 retrain one who has learned bad form. So I already mentioned this one. I mentioned again, he never even thought about finance until he was 32. By 43, he's a millionaire. And this is when a millionaire, and I think that that would be the equivalent of like eight or $10 million in today's money. When we started back in 1969, I forecast how quickly my wealth and Reagan's, that's his partner, would grow. With plausible assumptions about our company's rate of return, the rate of growth of our partnerships, net worth, and taxes, I predicted that by 1975, we would be millionaires. Sure enough, in 1975, we were both indeed millionaires. His hedge funds called Princeton Newport Partners. It goes from 1.4 million to 273 million. PNP rose from 1.4 million partnership to being perhaps the most mathematical, analytical,

Starting point is 00:53:20 and computer-oriented firm on Wall Street street the partnership capital earned an annual rate of return of 22.8 before fees limited partners saw their wealth grow at 18 per year we added extraordinary investment products that could have expanded our capital base to billions but this was destined to come to an end remember in the in the in the prologue of the forward of the book talks about this fund closes, most people just get back into complexity. Thorpe chooses not to, and he still winds up being fabulously wealthy. And so you might be asking, well, you're making almost 23% a year, why are you stopping? His East Coast office, he's based out in California, that's why the Newport in Princeton, Newport, the East Coast is the ones interacting more

Starting point is 00:54:05 closely Wall Street the East Coast offices his hedge fund is rated and this is why this is part of a campaign by Rudolph Giuliani US attorney at the time to prosecute real and alleged Wall Street criminals Giuliani's real objective in attacking individuals in our Princeton office was to get information to further his case against Michael Milliken they were doing business with Michael Milliken or Milken. He's famous for inventing junk bonds. He went to jail. But I think he also holds like, I think he made the most money ever in four years on income taxes. It was like 250 million a year each year for four years, something like that. So anyways, Julian is after this guy, Michael Milken, and this other guy named Robert Freeman

Starting point is 00:54:45 at Goldman Sachs. Now, why is Ed's East Coast office getting raided? Because his partner, Jay Regan, knew them both well and spoke to them often. They worked together. Freeman had been a roommate of Regan's at Dartmouth. Julian had believed that Regan could help bring him down. So he's trying to, again, nonetheless of human nature, he's squeezing him, saying, I'm going to mess up your life until you give me what you want. Reagan refused to cooperate. Well, that's a problem.

Starting point is 00:55:10 Now, something I want you to know is Ed was clean. He knew nothing was going on. Essentially, he said to do with this illegal tax avoidance scheme that the East Coast office was doing. It's called stock parking. Essentially, faking like you're transferring

Starting point is 00:55:24 assets from one firm to another so you can benefit on stocks so um so a few traders in his office are doing that he says neither i nor the 40 or so other partners and employees in newport beach office had any knowledge of the alleged acts in princeton office we were never implicated in any wrongdoing in this or any other matter limited partners were alarmed by the threat that rico he's julianne the RICO Act, which is normally reserved for like mafia and organized crime, could be extended to their partnership assets. And by the doubts, the investigation raised about some of our leadership in the Princeton office. As 1988 drew to a close, I saw no good way forward for PNP. I said I was leaving and limited partners followed and their partnership then wound down.

Starting point is 00:56:03 The U.S. Department of Justice, and this is a few months after this the u.s department of justice took steps to rein in the tactics tactics in the racketeering prosecutions that sparked controversy during the wall street corrupt corruption cases brought brought by rudolf giuliani uh the pmp defendants appealed and they wind up getting convicted but then they uh they get over um it goes overturned on appeal and all the all it says they threw out the convictions for racketeering and tax fraud the prosecutors dropped the remaining charges against four of the five pnp dependents so an unbelievable destruction of wealth and they get one conviction i think it was like i think the guy had to do like three months or something

Starting point is 00:56:39 like that and pay a little and pay a fine um so ed now this is why i'm only telling you the backstory because this what what's so remarkable and what makes ed dorp's life worthy of study is in part is what he chooses to do next um so this is where in the book where ed is reflecting on what his next move should be and And this is the, he had this quote that I cannot stop thinking about when I took notes on it, uh, probably a week or two ago. And he says, he just says this random comment, life is really about spending time well. And so this is where Ed actually lives by this. Um, he, he reflects on what his next move should be. And he decides to focus on time well

Starting point is 00:57:25 spent. Okay, so he says, what could a PNP have been worth 25 years later? How could I possibly have any idea? Amazingly enough, a market neutral head fund operation was built on the Princeton Newport model. This is the Citadel Investment Group. Citadel was started in 1990. I met with Frank and Ken, these are the founders of Citadel, outlining the workings and profit centers of PMP, as well as turning over cartons of documents outlining in detail the terms and conditions of older outstanding warrants and convertible bonds. So he's giving them his blueprint. Citadel grew from a humble start in 1990 when Ed became its first limited partner.

Starting point is 00:58:05 So again, not only did Ed make money for himself, he winds up having a hedge fund of hedge funds and doing these smaller businesses that are not as complicated and much more automated. But he also made a ton of money on Berkshire stock. He winds up being the first LP in Citadel. So what could that possibly mean? Well, Citadel from 1990 grew from a few million dollars and one employee to a collection of businesses managing $20 billion in capital and having more than 1,000 employees 25 years. They experienced an annualized rate of return at 20% per year.

Starting point is 00:58:35 Ken, one of the co-founders, net worth in 2015 was estimated at $5.6 billion. So not saying that that could have happened, that Thorpe was guaranteed the same results, but it could 5.6 billion so not saying that that could have happened that thorpe was guaranteed the same results but he's you know it could have uh at princeton newport partners as princeton newport partners closed i reflected on the proposition that what matters in life is how you spend your time now he's going to pull from history this is i love this guy i absolutely i'm biased if you came here for i can't be i just just, it's impossible. I love this book. I've texted it so many people this week saying you need to buy this book. I've talked about it nonstop. I just, I'm so happy that I randomly discovered through, you know, the work

Starting point is 00:59:15 of other people at Thorpe. Like my life will be different. I really appreciate this guy. So he's going to go through history and talk about like, am I trying to just be the richest person in the cemetery? Like, what am I doing here? Like, I'm trying to live a good life. So it says, when J. Paul Getty was the richest man in the world and manifestly not fulfilled, he had said the happiest time of his life was when he was 16, riding waves off the beach in Malibu.

Starting point is 00:59:41 I read a magazine profile of multi-billionaire Henry T. Nichols III. Here's what the profile said. It's 1.30 a.m. He sits at his desk in a dimly lit office. He hasn't seen his wife and children for several days. Now, this is a quote from Nichols. The last time we talked, Stacy, my wife, told me that she missed the old days when we lived in a condo. She told me she wants to go back to that life, but they can't go back because he can't give up. He can't let up. They wind up later divorcing. And I also looked up this guy. Not only later divorcing, this guy winds up in rehab in 2008. Then he just gets busted in 2018. He's a billionaire, multi-billionaire. So you think, oh, I'm going to get rich and be happy, right? Gets busted in Las Vegas with some stripper who's almost ODing in his room.

Starting point is 01:00:27 They find him with heroin, ecstasy, cocaine, all this other stuff. Let me tell you something, because my cousin died from a heroin overdose when she was 27 years old. If there is no such thing as a happy person, that's on heroin. Think about this. This guy could have three or five or $4 billion and he's doing heroin. Okay. Back to Ed. I initially thought that I might want to continue on my own with a PNP style partnership. But if I did that, then in addition to the fun parts, I would be responsible for things I didn't enjoy. I gradually wound down our PNP office in Newport Beach, finding good jobs in the security industry for some of our key people

Starting point is 01:01:10 at places like the giant hedge fund, D.E. Shaw. D.E. Shaw, interesting enough, was the job, was where Jeff Bezos worked, right? That was his last job he had before starting Amazon. Now he's gonna go back to history to influence his decision. Joseph Heller and Kurt Vonnegut were at a party given by a billionaire. When Vonnegut asked Heller

Starting point is 01:01:31 how it felt to know that their host might have made more money in one day than Heller's book Catch-22 had made since it was written. Heller said he had something the rich man could never have. When a puzzled Vonnegut asked what that could be, Heller answered, the something the rich men could never have. When a puzzled Vonnegut asked what that could be,

Starting point is 01:01:45 Heller answered, the knowledge that I have enough. When Princeton-Newport partners closed, Vivian, that's his wife, and I had enough money for the rest of our lives. Though the ending of PNP was traumatic for us all and the future wealth destroyed was in the billions, it freed us to do more of what we enjoyed most,

Starting point is 01:02:06 spend time with each other and family and the friends we loved, travel and pursue our interests. Taking to heart the lyrics of the song, Enjoy Yourself, It's Later Than You Think, Vivian and I would make the most of the one thing we could never have enough of, time together. Success on Wall Street was getting the most money. Success for us was having the best life.

Starting point is 01:02:33 So from that, he has this idea he wants to tell us about, which is the difference between satisfiers, I think is how you pronounce it, and maximizers. You can obviously, I'm going to read the paragraph to you, and then I'm going to leave it to your, you can figure out which one Ed Thorpe is. There's a distinction between two extremes on a continuum of types, satisfiers and maximizers. When a maximizer goes shopping, he searches for the best possible deal.

Starting point is 01:03:01 Time and effort don't matter much. Missing the very best deal leads to regret and stress. On the other hand, the satisfier, so-called because he is satisfied with the result that is close to the best, factors in the cost of searching and decision-making, as well as the risk of losing a near optimal opportunity and perhaps never finding anything as good again. All right, now this is Ed on learning. So he writes the quote that's rather famous. Those who cannot remember the past are condemned to repeat it. Though the institutions of society have difficulty learning from history,

Starting point is 01:03:37 individuals can do so. Next, I'll share some of what I learned. Education has made all the difference for me. Mathematics taught me to reason logically and to understand numbers, tables, charts, and calculations as second nature. Physics, chemistry, astronomy, and biology revealed the wonders of the world, and it showed me how to build models and theories to describe and to predict. This paid off for me both in gambling and investing. Education builds software for your brain. When you're born, think of yourself as a computer with a basic operating

Starting point is 01:04:12 system and not much else. Learning is like adding programs, big and small, to this computer. From drawing a face, to riding a bicycle, to reading, to mastering calculus. You will use these programs to make your way in the world. Even more valuable, I learned at an early age to teach myself. This paid off later on because there weren't any courses in how to beat blackjack, build a computer for roulette, or launch a market-neutral hedge fund. And now I finally got to what I feel is the main lesson from this book, and the life of Ed Thorpe. Freud once said that once we have the basic necessities of food,

Starting point is 01:04:53 clothing, shelter, and health, then what we seek is wealth, power, honor, and the love of men and women. For financial titans who aggressively continue to seek tens of millions, hundreds of millions, and sometimes billions, you can ask, Is the winner really the one who dies with the most toys? How much is enough? When will you be done?

Starting point is 01:05:15 Often, the answer is never. To preserve the quality of my life and to spend more of it in the company of the people I value and the exploration of ideas I enjoy, I chose not to follow up on a number of business ventures, although I believe that they were nearly certain to become extremely profitable. Once I worked out the major concepts in the subject and proved them in action, I liked new mental challenges, moving on from gambling games to the investment world with warrants, options, convertible bonds, other derivatives, and then statistical arbitrage. Starting as a university professor, I expected to spend my life teaching, doing research,

Starting point is 01:05:57 and talking to smart, like-minded people. But from childhood, I was intrigued by the power of abstract thinking to understand and direct the natural world. When I later saw how physics could predict roulette outcomes through the fog of chance, and mathematics could tip the odds in blackjack, I was drawn into a lifetime of adventure. It was my good fortune to share most of this journey with a remarkable companion, my wife, Vivian. She loved books and was a voracious reader. She passed on her love of books and her extraordinary facility with the English language to our children and grandchildren. She mastered bridge, studied art and art history, learned to prepare quality healthy meals, completed a master's degree in library science,

Starting point is 01:06:46 inspired her family to focus on personal fitness and health, and supported causes and charities. After she died from cancer in 2011, we celebrated her life with a memorial service. When I think of our lives together, I remember what her brother said then. Nobody can take away the dance you have danced. Life is like reading a novel or running a marathon. It is not so much about reaching a goal, but rather about the journey itself and the experiences along the way. As Benjamin Franklin said, time is the stuff life is made made of And how you spend it makes all the difference Best of all is the time I've spent with the people in my life that I care about

Starting point is 01:07:32 My wife, my family, my friends, and my associates Whatever you do Enjoy your life and the people who share it with you And leave something good of yourself for the generations to follow

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Founders - #93 Ed Thorp (A Man for All Markets)

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