#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 | The Tim Ferriss Show

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Key Takeaways

  • Stay curious—much of Edward Thorps’s passions and careers happened by accident
    • Do what you love and the money will follow. Even if the money doesn’t follow, at least you’re doing what you love!
    • “I was never there to get rich, I was there to solve interesting math problems that kept coming up” – Edward O. Thorp
  • If you’re a long term investor, just buy and hold equities: “The answer is really [this] easy for almost everybody, but you’re not going to believe me until you work through it yourself and understand it” – Edward O. Thorp
    • Efficient market theory: the work you need to put into beating a passively indexed portfolio is rarely worth it
    • “Hold fast”: The market is historically reliable. Don’t be a ‘scared rabbit’ who only buys when times are good and panic sells when times are bad—then you always get the worst of both sides!
    • Enough is enough: once you get enough capital, let the money work for you—don’t spend another minute doing things in life that you don’t want to do
  • The best thing people can do is to learn to think for themselves
    • Many investors got tricked by Bernie Madoff because they blindly followed the trust of the masses

Intro

Key Books Mentioned

Who is Edward O. Thorp?

  • Studied physics and mathematics at UCLA
    • Originally went for physics but realized he could graduate with fewer credits going the mathematics route
  • Realized that with his background in mathematics, he could formulate a system to beat the game of blackjack
    • Taught himself how to program on an IBM 704 at MIT to perfect the system
    • With the help of Claude Shannon, another American mathematician at MIT, they were able to submit the official abstract for “A Favorable Strategy for 21”
  • “There’s no point in writing a book unless I knew it worked,” so Edward tested the blackjack system himself
    • Won about $11,000 in about 20 hours of gameplay. In terms of the 1960s, that’s a great win—it was a success.
  • Claude Shannon took interest in the rest of Edward’s projects, the next being a wearable computer to help beat the roulette table
    • The computer would instantly evaluate the velocity of the ball and roulette wheel to produce a recommendation on what section (broken down into eight) to bet on
    • Worked 44% of the time, which is incredible given the odds in roulette

Edward O. Thorp’s Investment Career

  • Warrant hedges: either you buy a cheap warrant and short common stock against it or buy an overpriced warrant and buy the common stock against it
    • This was Edward’s system for capturing value (roughly 25% per year) while hedging all risk
  • Word got around about the success rate of Edward’s system, so he started managing accounts for people in the MIT graduate department
    • Warren Buffett was closing down one of his hedge funds, leaving the Dean of MIT’s graduate division in need of a place to put his money. Warren Buffett gave the Dean the green light to invest in Edward’s system.
  • Edward started his own hedge fund using mathematical equations to stay ahead of the market and other investors
    • In 20 years they only had three down months, which were less than 1% losses
    • Ran 20% annualized returns while having virtually zero risk
    • “It basically just printed money every month…but I was never there to get rich, I was there to solve interesting math problems that kept coming up” – Edward O. Thorp

Lessons for Investing

  • “The answer is really easy for almost everybody, but you’re not going to believe me until you work through it yourself and understand it” – Edward O. Thorp
  • If you’re a long term investor, just buy and hold equities
    • Efficient market theory: the work you need to put into beating the average passive indexed portfolio is rarely worth it
    • “Hold fast”: The market is historically reliable. Don’t be a ‘scared rabbit’ who only buys when times are good and panic sells when times are bad—then you always get the worst of both sides!
  • The lessons from investing that transfer very well across general life topics:
    • Risk: don’t get taken out of the game
    • Long-term thinking: all things must pass
    • Enough is enough: once you get enough capital, let the money work for you—don’t spend another minute doing things in life that you don’t want to do

Sussing Out Bernie Madoff

  • Edward reviewed the portfolio of McKinsey & Company and noticed an irregularity in one of their investments, which was run by none other than the Madoff brothers
    • Noticed that the trades within the investment were fraudulent
    • Even with this information, people continued to invest in Madoff. Many investors trusted Madoff simply on the grounds that other investors trusted him too. Always remember to think for yourself.

Mental Concepts

  • Externalities: unintended consequences of your actions, for better or worse
  • Tragedy of the Commons: the common good breaks down when each individual acts in their own self-interest
  • Fundamental Attribution Error: the human tendency to make assumptions that are not fully justified by the evidence
  • Check out Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger for similar mental concepts and models

Physical Longevity

  • Edward is 89 years old, but you’d probably think he’s in his 60s if you had to guess
    • Experimented with weightlifting and long-distance running throughout his life—both of which he stumbled into by accident
  • “Some is better than none, and more is better than less, there’s no excuse” – Edward O. Thorp
    • Just start – find something you like to do and continuously try to push the boundaries
    • Was in his best shape around 55 to 65 because he started and never looked back
  • What does Edward’s routine look like today:
    • Walking three miles three to four days a week; recommends race walking as a low impact alternative to running
    • A couple of times a week he does bodyweight squats, lunges, pull-ups, and other back strengthening exercises at the gym

Geopolitical Books Referenced

Closing Thoughts

  • The best thing people can do is to learn to think for themselves
    • Learn to take a step back and analyze information before accepting it as truth
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Notes By Drew Waterstreet

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