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The Tim Ferriss Show
#596: Edward O. Thorp, A Man For All Markets — Beating Blackjack and Roulette, Beating the Stock Market, Spotting Bernie Madoff Early, and Knowing When Enough is Enough
May 25, 2022
01:35:03
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Quick takeaways
- Long-term investing in equities, particularly in the US market, provides higher returns compared to active trading and can be achieved by investing in an equity index fund or ETF.
- Understanding and mitigating risks is crucial in investing and decision-making, and a risk-averse mindset can help protect one's financial standing.
- Different investment strategies should be employed based on the time horizon, with a long-term perspective essential for retirement planning, using methods like the '4% rule' to determine a sustainable withdrawal rate.
Deep dives
Long-Term Investing: Buy and Hold Equities
The key to long-term investing is to buy and hold equities, particularly in the US market which has a historical average annual return of around 10-10.5% for the past couple of centuries. This outperforms most other investment strategies, as the majority of investors who actively trade often incur high trading costs, taxes, and fees, resulting in lower returns compared to the market index. Investing in an equity index fund or ETF is a simple and effective approach to benefitting from long-term compounding growth.
Risk-Avoidance and Rational Decision Making
Understanding risk is crucial in investing and decision-making. A risk-averse approach involves minimizing great risks that can potentially wipe out one's capital. By avoiding highly volatile investments and focusing on preserving capital, one can protect their financial standing. This risk-averse mindset can also be applied to other areas of life, like health decisions, where assessing and minimizing risks can lead to better outcomes.
Taking a Long-Term Perspective for Retirement Planning
Different time horizons call for different investment strategies. If planning for retirement, a long-term perspective is essential. Using the '4% rule,' one can calculate a sustainable withdrawal rate from their retirement savings by withdrawing 4% of the initial portfolio value each year. This system aims to address individual needs and ensures that the portfolio can last throughout retirement.
The Power of Mental Models
Mental models are cognitive tools that can help individuals understand and analyze complex situations more effectively. One useful mental model is considering externalities, which are unintended consequences of an action. Understanding externalities can help individuals make better decisions by foreseeing potential positive or negative outcomes. Mental models are valuable not only in investing but can be applied to other domains, enabling critical thinking and better problem-solving skills.
The Tragedy of the Commons and Externalities
One of the main ideas discussed in this podcast episode is the concept of the tragedy of the commons and externalities. The speaker explains that individuals often act in their own self-interest, but collectively, their actions may negatively impact the common good. This is illustrated through examples such as pollution from car emissions and overgrazing in a village. The podcast emphasizes the importance of recognizing and addressing these externalities to create a better collective outcome. The speaker suggests that one way to tackle negative externalities is through taxation, such as implementing a carbon tax to reduce carbon emissions and pollution.
The Value of Independence and Having 'Enough'
Another key point highlighted in this podcast episode is the value of independence and the concept of having 'enough'. The speaker shares personal insights on their journey as an investor and emphasizes the importance of pursuing interests and passions rather than solely focusing on accumulating wealth. The speaker believes that independence comes from accumulating capital and making choices that prioritize personal fulfillment and enjoyment. They also discuss the decision to wind down their investment business when it became more burdensome and less enjoyable. The podcast encourages listeners to think for themselves and question the information they receive, ultimately aiming to foster individual independence and critical thinking.
Brought to you by Wealthfront automated investing, Athletic Greens all-in-one nutritional supplement, and Eight Sleep’s Pod Pro Cover sleeping solution for dynamic cooling and heating.
Edward O. Thorp is the author of the bestseller Beat the Dealer, which transformed the game of blackjack. His subsequent book, Beat the Market, coauthored with Sheen T. Kassouf, influenced securities markets around the globe. He is also the author of A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market.
Edward was one of the world’s best blackjack players and investors, and his hedge funds were profitable every year for 29 years. He lives in Newport Beach, California.
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This episode is also brought to you by Athletic Greens. I get asked all the time, “If you could use only one supplement, what would it be?” My answer is usually AG1 by Athletic Greens, my all-in-one nutritional insurance. I recommended it in The 4-Hour Body in 2010 and did not get paid to do so. I do my best with nutrient-dense meals, of course, but AG further covers my bases with vitamins, minerals, and whole-food-sourced micronutrients that support gut health and the immune system.
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Edward fills us in on where he grew up, how he was educated, what made the application of mathematics to gambling such a compelling challenge, and why he rushed to publish his successful system after testing it in the real world. [04:51]
What reference material did Edward use in his first trip to the blackjack table in Vegas, and why was Claude Shannon at MIT — a person known to be difficult to reach — willing to spare five minutes to meet with him around this time? [12:01]
What method did Edward and Claude devise to beat roulette with the assistance of what MIT considers to be the first wearable computer? [15:11]
Edward looks great for a man in his 60s — which is especially incredible when you consider he’s 89! Is it just a case of lucky genetics, or does he follow some kind of mortality-cheating health regimen? Has his approach to remaining in shape changed over the years? [17:13]
How did finance and investing enter the picture for Edward? Where did this lead, and who did he meet along the way? [25:19]
What was it about Warren Buffett that made Edward come away from their first meeting convinced he’d someday be the richest man in the world? [34:22]
If Edward were teaching a seminar in investing to a modern student body (some of whom might not possess an aptitude for math), what frameworks would he impart to get them started? [38:55]
What lessons learned from investing are transferable to other areas of life? [43:50]
Even at 89, Edward considers himself a long-term thinker. How might those of us who struggle to think beyond the short-term be more like Edward? [45:59]
How did Edward suss out that something was fishy about the way the Madoff brothers were doing business 17 years before everybody else finally caught on? [50:58]
Exploring the mental models of externalities, the tragedy of the commons, and fundamental attribution errors. [59:15]
What you should be reading and listening to if you want to enact positive change in the world right now — politically or evolutionarily. [1:08:29]
What investors, aside from Warren Buffett, impress Edward — and why? [1:13:48]
How has Edward known where to draw the line between growing a business and withdrawing before it consumed all else in his life? What catalyzed his decision to wind things down? [1:17:48]
What does independence mean to Edward and how did he spend his time after winding down the investment side of things? [1:22:52]
Is there anything Edward’s particularly curious about learning right now? [1:24:27]
Pondering a conversation between Joseph Heller and Kurt Vonnegut and other parting thoughts. [1:26:37]
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For show notes and past guests on The Tim Ferriss Show, please visit tim.blog/podcast.
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Past guests on The Tim Ferriss Show include Jerry Seinfeld, Hugh Jackman, Dr. Jane Goodall, LeBron James, Kevin Hart, Doris Kearns Goodwin, Jamie Foxx, Matthew McConaughey, Esther Perel, Elizabeth Gilbert, Terry Crews, Sia, Yuval Noah Harari, Malcolm Gladwell, Madeleine Albright, Cheryl Strayed, Jim Collins, Mary Karr, Maria Popova, Sam Harris, Michael Phelps, Bob Iger, Edward Norton, Arnold Schwarzenegger, Neil Strauss, Ken Burns, Maria Sharapova, Marc Andreessen, Neil Gaiman, Neil de Grasse Tyson, Jocko Willink, Daniel Ek, Kelly Slater, Dr. Peter Attia, Seth Godin, Howard Marks, Dr. Brené Brown, Eric Schmidt, Michael Lewis, Joe Gebbia, Michael Pollan, Dr. Jordan Peterson, Vince Vaughn, Brian Koppelman, Ramit Sethi, Dax Shepard, Tony Robbins, Jim Dethmer, Dan Harris, Ray Dalio, Naval Ravikant, Vitalik Buterin, Elizabeth Lesser, Amanda Palmer, Katie Haun, Sir Richard Branson, Chuck Palahniuk, Arianna Huffington, Reid Hoffman, Bill Burr, Whitney Cummings, Rick Rubin, Dr. Vivek Murthy, Darren Aronofsky, and many more.
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