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it out. This

5:27

altitude I can run flat out for a half

5:29

mile before my hands start shaking. Hello

5:50

boys and girls, ladies and germs, this is

5:52

Tim Ferris. Welcome to another episode of the

5:54

Tim Ferris show where it is my job

5:56

to sit down with world-class performers from every

5:58

field imaginable to tease out the habits,

6:00

routines, favorite books, and so on that

6:02

you can apply and test in your

6:05

own lives. This episode is

6:07

a two for one, and that's because

6:09

the podcast recently hit its 10th year

6:11

anniversary, which is insane to think about,

6:14

and passed 1 billion downloads. To celebrate,

6:16

I've curated some of the best of

6:18

the best, some of my favorites from

6:20

more than 700 episodes over the last

6:23

decade. I could not be more excited

6:25

to give you these super combo episodes,

6:27

and internally we've been calling these the

6:29

super combo episodes because my goal is

6:32

to encourage you to, yes, enjoy the

6:34

household names, the super famous folks, but

6:36

to also introduce you to lesser known

6:39

people I consider stars. These

6:42

are people who have transformed my life, and

6:44

I feel like they can do the same

6:46

for many of you. Perhaps they got lost

6:48

in a busy news cycle, perhaps you missed

6:50

an episode. Just trust me on

6:52

this one, we went to great pains to

6:54

put these pairings together. And

6:56

for the bios of all guests, you

6:59

can find that and more

7:01

at tim.blog slash combo. And

7:03

now, without further ado, please enjoy

7:06

and thank you for listening. First

7:09

up, Dr. Brené Brown, a

7:11

research professor at the University of

7:13

Houston and author of

7:15

six number one New York Times

7:18

bestsellers, including Atlas of the Heart,

7:21

Dare to Lead, and The

7:23

Gifts of Imperfection. You

7:25

can find Brené at BrenéBrown.com.

7:29

I think you can have

7:32

self-love and self-acceptance and

7:34

want to be better in ways. Here are the

7:36

things I want to unwind. I

7:38

don't think you can truly change

7:41

for the better in a lasting,

7:43

meaningful way, unless it is driven by self-acceptance.

7:45

I agree with that. So I think being

7:47

the shit out of yourself for performance, which

7:49

I work with a lot of sports people

7:52

now, it works. And

7:54

if all you have to do is pay someone for one

7:56

season, or all you do is one game or one whatever,

7:59

you're okay. But last... meaningful change has to

8:01

be driven by self-acceptance. The

8:03

other thing that is just so shocking to

8:05

me about complacency

8:08

and self-acceptance is,

8:11

as I think back, and I would really have to go

8:13

into the data, but just sitting here, I don't

8:16

think I have ever come

8:18

across a single person, not

8:21

a single person that I

8:23

can think of who was

8:25

complacent, driven by self-acceptance. I

8:27

don't know that that is not an

8:30

oxymoron. I gotta tell you that self-aware

8:34

complacency doesn't work

8:36

for me as a construct. Self-aware, no. Or

8:39

self-accepted complacency. I don't

8:41

know that I believe that. Yeah, I'll push a

8:43

little bit. I

8:45

mean, you're going to get by the look on your face. I

8:48

hope you caught that in the camera.

8:50

I think that I'm struggling for the

8:52

right terminology, but I think we all know

8:54

people who are alcoholics,

8:58

have various issues, and they

9:00

are in denial of having

9:02

problems. Yes. Well, let me

9:05

stop you there and say that is

9:07

neither self-awareness nor self-acceptance. Definitely not self-awareness.

9:09

But not self-acceptance either. Well, I would,

9:11

and maybe there's a better word, but

9:13

I would just say that there are

9:16

people who are delusional to the extent

9:18

that they either believe they don't have

9:20

a problem that they have or they

9:22

have a problem and refuse to accept it

9:24

as a problem. We can go a lot of directions

9:26

with this, but I would say that I think we

9:29

can agree there are complacent people. There

9:31

are complacent people. And among those complacent people,

9:33

I think there are those who

9:37

hate themselves. There are those

9:39

who sort of love themselves and are

9:41

narcissistic. And I know a number of these. And

9:45

then there's a lot in between. And I

9:47

think that there are complacent, in

9:50

some respects complacent narcissists who

9:52

almost by definition being a

9:54

narcissist love themselves. So is

9:57

that self-acceptance? Maybe yes, maybe no. I

9:59

would say that... that it is, but

10:01

it's a disabling self-acceptance. Whereas

10:03

to your point about

10:05

lasting behavioral change, I

10:08

think that at least psychologically, if

10:11

you are divorcing parts of yourself,

10:14

if you hate parts of yourself, aspects

10:17

of yourself that have been informed by

10:19

your history, and I'm borrowing this phrase

10:21

from somewhere else, but like what you

10:23

resist persists, and that you are going

10:26

to carry that unproductive, and

10:28

in some ways self-defeating tension

10:31

within you, even if someone

10:34

is forcing you to change your behavior, or

10:36

incentivizing you to change your external behavior. And

10:38

so even if technically you're

10:40

changing a behavior, if you carry

10:43

self-loathing, even partial self-loathing with you,

10:45

hating an aspect of yourself, or

10:47

certain emotion within yourself, I

10:49

view that as a loss. I agree. Yeah,

10:53

so, this is getting out there a bit, but

10:55

this is the type of stuff that, sometimes I

10:57

worry that I've lost my audience. Can

11:00

I make a confession? Yeah. Because

11:02

for a long time, I was thinking about writing a blog

11:04

post about this, but for a very long time, if you

11:07

look at all the books that I've written, it's

11:09

like book on entrepreneurship, book on physical performance,

11:11

book on cognitive performance and learning, the For

11:13

Our Chef, et cetera, et cetera, it's

11:16

mostly developmental. It's about improving

11:18

performance in one or more

11:20

areas. And now

11:22

what I've spent more and more time on, like

11:25

we're spending time on it right now, is the

11:27

inner game. For sure. And

11:29

the importance of developing a

11:31

keen level of self-awareness so

11:34

that you can examine the contents

11:36

of your, this is gonna get super woo

11:39

for a second, or it's gonna set up

11:41

the contents of your consciousness. Wherever you go,

11:43

you're carrying your mind with you, and so

11:45

to develop a familiarity with that, I think

11:47

is the crux skill

11:50

that underlies everything else. And you

11:52

and I both know plenty of

11:54

achievers who are miserable, who

11:57

are for sure high performing, well. known

12:00

people who are utterly miserable. And to

12:02

me, the question of why is

12:04

that? How can that be the case? Is

12:08

the question that I'm extremely interested

12:10

in these days. But I worry

12:13

that having built an audience who

12:16

is largely, not entirely kind of

12:18

go, go, go, rah, rah, rah, win,

12:22

win, win. There's nothing wrong with that. But people

12:24

who are trying to develop skills and then competitive

12:26

advantages and so on, that I

12:28

may lose a large portion of those people in

12:31

shifting into talking about more of these things. We'll

12:33

see where it goes. But that's something that has

12:35

occurred to me. And I think I'm willing to

12:37

make that trade. I think I'm willing to take

12:39

that if that's the cost of doing business. I

12:41

don't know. So a

12:44

couple of things. One, the go,

12:46

go, go audience

12:48

that you've built, this may scare

12:50

them. But I mean, as someone who

12:52

works with elite athletes and professional folks and CEOs and

12:54

those things, what I can tell you is this

12:57

is the hardest challenge you've issued. And

13:00

it's not about the conceptual complexity of

13:02

what we're talking about. It's

13:04

about unlocking performance

13:07

is one thing. Unlocking people,

13:10

way harder, way scarier and

13:12

unlocking ourselves and creating

13:15

self-awareness. To me, you

13:17

would be remiss not to go here. Because

13:20

I don't know. I think something you

13:22

said when you were talking about, we all know a

13:24

lot of narcissists and they love themselves, but that's

13:26

actually not true. Do you

13:28

know that narcissism is the most

13:31

shame-based of all the personality disorders?

13:34

Narcissism is not about self-love at all.

13:36

It's about grandiosity

13:39

driven by high performance and self-hatred. You

13:41

know, I define it as the shame-based

13:44

fear of being ordinary. And

13:46

so you have, to me, you have

13:48

this audience that, and I'm one of them,

13:51

I mean like, and I'm probably an outlier,

13:53

I guess, and it's like me being a

13:55

Rush fan. Of course, there's always outliers. The

13:57

audience is like 40, 50%. female,

14:00

but I appreciate it. Is it? Yeah, it is. It's

14:02

shifted a lot in the last handful of years. Yeah,

14:05

but I think when

14:08

I get invited in by a

14:10

Fortune 50 CEO, and here she says,

14:12

look, we need help, we

14:14

need help with the team, they're not asking

14:16

me to help with time productivity. They're

14:18

not helping me to set up a scrum

14:21

or agile process for software development. They're saying,

14:23

we're at each other's throats, we

14:25

hate each other, it's a shame-based, finger-pointing,

14:28

it's all about self-awareness and changing

14:30

those behaviors. And to me, the

14:33

hard thing about this area

14:35

in your work is

14:38

a lot of what I've learned

14:40

from you that has changed my life has

14:42

been not only effectiveness-based,

14:44

but efficiency-based. And

14:47

so where you can lose people with this conversation

14:49

is this is not an efficient process. Yeah,

14:51

right. Do you know what I mean?

14:53

There's no, I don't think there's a

14:55

four-hour self-awareness. I

14:58

have no plans to write that one. Yeah, but I mean, but

15:00

people would love it if you could, if you

15:02

could unlock that fast. But to me, this

15:05

is the capstone conversation for you. Yeah.

15:08

Do you know what I mean? I do. Because what's

15:10

it all in for? Yeah. You

15:12

know, like, I'm fit,

15:14

I'm winning, I'm

15:17

smart, I'm successful, and

15:20

I'm on my third marriage, and I

15:22

don't speak to any of my children. Yeah, which

15:25

you see a lot, or I mean, I. I

15:27

see all the time. All the time, yeah. Right,

15:29

because I'm gonna tell you, not

15:32

to dismiss the importance of that work, that's

15:35

easier. Yeah, yeah, it is easier.

15:37

It is easier, you know, because the

15:41

thing about these conversations that

15:43

you and I end up having every time we sit down, or this is

15:45

the second time, that both times we've sat down is what

15:48

differentiates us as a social species is

15:51

the need to be

15:53

seen and known and loved, and

15:56

the need to see and know and love

15:58

others. And

16:00

no one rides for free. Like,

16:03

we all come into this adulthood with

16:06

hard stuff. And

16:09

what I would say is true

16:11

about complacency. And

16:15

95% of what I see that

16:18

people call pathology is its armor.

16:21

Yeah. Its behaviors and ways of

16:23

thinking that I've developed to

16:26

protect myself from being hurt. I have

16:28

a question. I'll tell you about that.

16:30

So my question related to armor

16:33

is, I'll get to through a

16:35

segue, which is a quote that I want to

16:37

say Terabrak, the well-known

16:39

meditation teacher, also writer, radical acceptance

16:41

is a fantastic book, shared

16:44

with me, which I'm going to paraphrase. And it's

16:46

along the lines of, you know,

16:48

a great sage once said, there's

16:51

only one real question that matters. And

16:53

that is, what are you unwilling to feel? I've thought about that a lot.

16:56

And not to say I have any

16:58

concise answers to that, but I think it's

17:01

an anecdote really worth meditating on. I've thought

17:03

about it. What do you

17:05

say to the people you meet who

17:07

are on the third marriage, their kids don't talk to

17:09

them, and there are certain

17:12

things that they have convinced

17:14

themselves subconsciously or otherwise,

17:17

maybe through an abusive upbringing or

17:19

trauma, whatever it might be, that

17:21

is unsafe to feel certain things. You

17:24

come in, they've asked for help, but

17:27

they do not

17:29

want to open Pandora's box, right?

17:31

They do not want someone to drag them

17:33

into the deep waters of

17:35

emotions that they've kept under lock and key for so

17:38

long. How do you help someone like that? What do

17:40

you suggest to them? Because it does

17:42

get messy, right? It's going to get messy before it

17:44

gets clean, right? At least in my experience, it's

17:46

like, oh, you're going to do spring cleaning? Guess

17:48

what? You got to take all the things that are

17:50

up on the shelves, all the things in the drawers, all the things

17:52

that are hanging on coat hangers, and you're going

17:54

to put them in the middle of the room. It's

17:56

going to be a mess. It's going to be a fucking mess. Yeah, you're

17:59

going to be pissed. that

18:01

group. But you can't really get

18:04

past go without that type of step. So for

18:06

someone who's listening to this and says, you know

18:08

what, I buy it, like I get it. And

18:11

yet, what do I do? Because I've

18:13

had on this armor for so long. So I

18:15

would say a couple of things. And the first thing

18:17

I always feel like is really important to say is

18:19

that I'm a researcher and so I'm not a therapist.

18:21

That would be differentiate me with Esther. Like,

18:23

I don't see clients if I go in and I'm

18:26

working with CEOs and this question comes up all the

18:28

time. What I would

18:30

say to people is Pandora's box is

18:32

closed right now. But are

18:35

you under the impression that you're living outside of the

18:37

box or in the box? Like,

18:39

yeah, I like that. You don't want to open

18:41

Pandora's box. That's strange to me because you're living

18:43

inside Pandora's box. And what I feel like you've asked

18:45

me to come here to open it up.

18:48

We're not going to do this process without walking through some

18:50

deep shit where there's going to be deep swift water. And

18:53

if the water is super deep and swift, you need

18:55

to go through that with a therapist and get

18:57

that settled before we work in the organizational way. But

19:00

what I would say to people that I always

19:02

say is the same for me and I'm

19:05

sure the same for you that we all

19:07

grew up and experienced varying

19:10

degrees, trauma, disappointment, hard stuff.

19:15

We armored up and at some point that

19:18

armor no longer serves us. And

19:20

so what I think I would say to that

19:22

person is how is not talking about this

19:24

serving you? Like

19:27

I've been sober for 23 years. So

19:29

someone in AA would be like, how's that shit

19:31

working for you? I

19:33

probably would put a softer spin on it than that over

19:36

black coffee in a cigarette. But

19:38

I would say that it's not

19:41

serving anymore. And

19:43

now the weight of the armor is too heavy and

19:46

it's not protecting you. It's keeping you from

19:48

being seen and known by others. And

19:51

so this is, I mean, just how you

19:54

point essentially, this is the developmental

19:56

milestone of midlife from

19:58

late... 30s

20:00

to through probably your

20:03

60s. This is the question. Yeah,

20:06

this is when the universe comes down and

20:08

puts your hands on your shoulders and

20:10

pulls you close and whispers in your ear, I'm

20:13

not fucking around. You're halfway to dead. The

20:16

armor is keeping you from growing into the

20:18

gifts I've given you. That is not without

20:20

penalty. Time is up. So

20:22

this is what you see happen to people in midlife.

20:25

And it's not a crisis. It's a

20:27

slow, brutal unraveling.

20:30

And this is where everything that

20:32

we thought protecting us keeps

20:34

us from being the partners, the

20:37

parents, the professionals, the people

20:39

that we want to be. And

20:41

I've only seen this is a fork

20:44

in the road. I've only seen two responses

20:46

to this visit from the universe. There was

20:48

my response, which I was like, screw you,

20:50

bring it. Do you think you can

20:53

best me? And then it was just one

20:55

nightmare situation after another until you're not going

20:57

to win that fight. I

20:59

think if you say, you know what, I'm not

21:01

going to do it, then you've got to double

21:04

down. These are the people that

21:06

walk through the world, double down on

21:08

their own shit in denial, you know,

21:11

cheek squeezed as they walk and

21:14

cause so much pain

21:16

in the world to themselves as well.

21:18

I mean, yes, because it is so

21:20

much easier to offload pain than

21:23

to feel pain. Yeah. And

21:25

so you really have a

21:27

choice in midlife. The first step of

21:29

it, the whole process is what armor,

21:31

I'm not saying just pull

21:34

off all the armor and streak through

21:36

Austin, because I think you can't

21:38

replace the armor with something. I

21:40

think it's curiosity is what

21:42

you replace. You just become very curious about

21:45

yourself, about the world. Why did

21:47

I react that way? When Tim asked me that

21:49

question, I wanted to like hit him over the

21:51

head with a topo cheek bottle. You know what

21:53

was going on there? Do you know what I

21:56

mean? Like, what is my obsession about this? You

21:58

just become very curious is curiosity. Is

22:01

really the superpower for

22:03

the second half of our lives because it

22:05

keeps us learning it keeps us asking questions and

22:07

increases our self awareness. But

22:10

when you see and i think it's

22:12

really hard because you know i walk

22:14

into situation and they'll be the person who invited

22:16

me usually the CEO. And

22:19

then you'll have like the cross armed

22:21

pissed off clench sheet like f

22:24

you look in person operations

22:26

or technology you know and then

22:28

they're like what's the business case for you being here.

22:31

Yeah like this here's our stock

22:33

price here's what's going on here's evaluation like

22:35

what do you need and then you know

22:37

the CEO usually say i can hate each other.

22:40

And this can only last for so long you

22:42

know it's the end of every great band right

22:45

like this is gonna come to an end and

22:47

it's gonna be terrible. And

22:49

so i don't know i

22:51

think you can't pull it all off at

22:53

once for all of this is trauma. Yeah people

22:55

are like no there's not trauma for all of this is

22:57

trauma for you know people who

22:59

have been abused. Physically sexually

23:02

emotionally there's trauma for people of color and people

23:04

who have been on the margins the trauma

23:06

for all of this is just different levels

23:08

of trauma yeah you know i mean. Escape

23:12

childhood with nothing is. I

23:15

haven't met that person yeah no i have any right

23:18

so the trauma staff literally

23:20

the trauma message in our body

23:22

is you take this armor off

23:24

we die so you protect us at all costs

23:26

and leave the phone a lot of that work

23:29

has to be done with the therapist. The

23:33

other two hacks that i think have saved

23:36

our marriage the size just showing up and

23:38

kind of using some of these things like

23:40

what's working what was hard. Is

23:43

the 8020 so

23:45

everyone says marriage should be 5050 it's the biggest

23:47

rock a bull should i've ever heard it's never

23:49

5050. Yeah and

23:52

so what we do is we quantify where we

23:54

are so if Steve comes home and he'll be like

23:57

i got 20. Just in

23:59

terms of energy. energy, investment,

24:03

kindness, patience, out of 20.

24:05

And I'll be like, I'll cover you. I got your brother.

24:07

I'll pull the 80. Sometimes

24:10

we come home, which we have done a lot. My mom

24:12

has been sick. And I'll

24:15

say I've got 10. And she like two days

24:17

ago said, I'm riding a solid

24:19

25. So we know that we

24:21

have to sit down at the table anytime we

24:23

have less than 100 combined and figure

24:26

out a plan of kindness toward each other. Oh, I love

24:28

that. Yeah, because the thing is,

24:30

marriage is not something that's 50 50.

24:32

A partnership works when you can carry their

24:35

20 or they can carry your 20. And

24:38

that when you both just have 20, you

24:40

have a plan, we don't hurt each other.

24:42

Yeah, your threadbare. Yeah. And

24:44

so, so what we'll say is I'm like,

24:46

I've got 10. And he'll be like, I got maybe 25.

24:49

We're like, put all the groceries that are supposed

24:51

to be great and healthy in the freezer for

24:53

ordering out, get the housekeeper

24:55

here an extra day. And we're

24:57

canceling anything with people that we really actually don't like.

25:00

So how can we create some buffer? No, we do

25:02

that. So like, and then you know, then we'll like

25:04

a day or two later, I'm like, he'll be like,

25:06

I'm riding a 60. I'm like, Oh my god, work

25:08

is kicking my ass. I'm still at 20. He's like,

25:11

I got you, but we're spare 20. So you know, Liz

25:13

asked Charlie if he wants to skip water polo practice today.

25:15

And let's all turn in at eight o'clock. Huge.

25:17

The other thing I would say to that now I'm

25:19

thinking about that is we made a determination very

25:21

early. There's kid focused families,

25:23

parent focused families, and family

25:25

focused families. We're a

25:27

family focused family. So that

25:30

means that if

25:33

you want to do water

25:35

polo, Eagle Scouts, tennis, and

25:37

skeet shooting, the net

25:39

comes to the family. And the family

25:41

agrees what will keep the family healthy. Like

25:43

I've got a book launch. I've got this. She's

25:45

got patients. He's taking on others. You know, he's

25:47

a pediatrician. He's doing this. So what works for

25:49

our family right now is you

25:52

can do two extracurriculars and

25:54

I'm going to have a two week tour, not a

25:56

four week tour, but we put the family as

25:58

the system that we serve. It's not

26:01

the kids that the parents cost or the parents that

26:03

the kids cost. It's the family and it is

26:05

remarkable. How do you

26:07

weigh, if you

26:09

do it all, the voting system so to speak?

26:12

Rance, have you all come to the table? Does

26:14

everyone have equal vote

26:17

in the decision making process?

26:19

No. No. No,

26:22

that's a dictatorship. Yeah. We don't

26:24

even bullshit around that. It's like when my kids like, if

26:26

I say like, oh shit, my kids are like, oh, you

26:28

can't say that. I'm sitting on

26:30

one. You can't say that. And when you're old enough, you

26:32

can do whatever you want. You get your

26:34

cursing license. Yeah. Yeah. But

26:37

right now I can totally do that. Watch me.

26:39

So we have very, we talk to our kids

26:41

about everything. We're super open. Steve and

26:44

I both have veto power and we

26:46

rarely use it. I bet I pulled out my veto card

26:48

once in the last five years. Veto

26:50

meaning kids says, I want to do X and you say

26:53

can't do it. Or Steve. Or Steve.

26:55

Yeah. I'm like, I have to veto that.

26:57

I cannot do that. And then we really respect the veto

26:59

because we don't overuse it. So our

27:02

thing with our kids, this

27:04

is my theory on parenting. My

27:06

theory on parenting is the

27:09

best we can do is a

27:11

loving course from compliance to

27:13

commitment that

27:15

your kids need to do what you're asking them to do

27:17

out of compliance. So don't run into the street. Don't

27:20

do this. You're not allowed to watch that kind of TV. You're

27:23

not allowed to play that kind of video game. You need

27:25

to comply. Otherwise there's some natural consequences.

27:28

At some point, I've got a 14 year old now. He's

27:30

at other people's house doing video. And

27:33

so if all I teach him is compliance and don't

27:35

give him the why about why you can't do

27:38

that. If I don't say

27:40

yes every time I can and explain the no's,

27:43

then when he's there and I can tell you that like we

27:45

got a call from a parent maybe a month

27:47

ago and said the boys were having a sleepover.

27:50

They wanted to watch. I know some R rated violent

27:52

thing and Charlie said, can we watch something else? My

27:54

parents are not cool with this. He didn't have to do

27:56

that. And he's moved to a commitment

27:59

to our family values. Because we say

28:01

yes every time we can. We

28:03

don't do any of that stuff that my parents did because

28:05

I said no. Just

28:11

a quick thanks to one of our sponsors and we'll be right back

28:13

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credit. That is linkedin.com/TFS as

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in Tim Ferriss show. One

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more time linkedin.com/TFS terms

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and conditions apply. And

29:32

now Edward O. Thorpe, legendary

29:35

blackjack player, hedge fund manager,

29:37

and mathematics professor and

29:40

author of Beat the Dealer and

29:42

A Man for All Markets from

29:45

Las Vegas to Wall Street, How I

29:47

Beat the Dealer and the Market. Find

29:50

him on Twitter at Edward O. Thorpe.

29:54

Ed, it is so nice to see you and thank you for making the

29:56

time. Pleasure to be here, Tim. I've

29:59

enjoyed many of your videos. It's

30:01

lovely to finally connect and perhaps we'll get

30:03

to the small world that connected us at

30:06

some point, but I thought we could begin

30:08

with a little bit of background for people

30:10

who may not have the entire

30:12

context and then we can fill in the

30:15

gaps. So perhaps you could speak to a

30:17

little bit of your growing up

30:20

and your formal education, if

30:22

you wouldn't mind. I was born in

30:24

Chicago during the

30:26

reign of Herbert Hoover, President number

30:28

31. So I've

30:30

seen 16 presidents. I

30:33

moved out to California with my parents during

30:35

World War II and basically

30:38

grew up in California, went through

30:40

junior high school and high school, now I see her,

30:42

and then went to UC Berkeley

30:45

and UCLA and I got a

30:48

bachelor's degree and a master's

30:50

degree in physics and then in

30:52

the middle of my PhD for

30:55

physics, I realized I needed

30:57

more math so I started taking it and

30:59

then I saw I could graduate more rapidly

31:01

in mathematics so I got my PhD in

31:03

math instead and then I went

31:06

on to teach at UCLA, MIT, New

31:09

Mexico State University and finally

31:11

University of California, Irvine. Now

31:13

how did gambling or

31:15

interest in those types of

31:17

applications of physics or mathematics

31:19

enter the picture for you?

31:23

Well I'm a curious person and you could

31:25

say that it happened purely by chance. When

31:29

I was teaching at UCLA, I

31:31

got interested in beating blackjack.

31:33

Somebody told me about

31:35

an article that would let

31:37

me play almost even. So

31:40

one Christmas vacation, my wife and I

31:42

went out actually Christmas vacation of 1958

31:44

just after I got my

31:46

PhD. We went out to Las

31:49

Vegas and I never gambled because I

31:51

knew it was a loser for most

31:53

people and the odds were

31:55

against you but I got $10 and I

31:58

played for about 40 minutes. and I had

32:00

an interesting experience. The first 20 minutes I

32:02

had a little card telling me what to

32:04

do, and people thought I was a fool

32:07

who knew nothing about the game, and they were

32:09

right that I knew nothing about the game. But

32:11

the card made me much smarter than the other

32:13

players. I made some remarkable

32:16

plays that attracted their attention, and

32:18

then they all hovered around. They wanted to see

32:20

how I was making these plays. In one of

32:23

them I got a seven card 21, which is

32:25

very rare, and

32:28

in most places paid a bonus. They didn't

32:30

pay bonus in this particular place, but they

32:33

thought I was trying for that, and I

32:35

somehow managed to produce it. So I realized

32:37

they didn't know much about the game, really.

32:40

And I went back and read carefully

32:42

the statistics article, and realized that

32:44

I could see from my

32:46

math background how to actually devise

32:49

the system to beat the game. Then I set about

32:51

to do it. And about

32:53

that time I moved from UCLA

32:56

to MIT, and I had access to

32:58

the big computers at MIT. This was

33:00

back in 1959. They

33:03

had an IBM 704, which

33:05

was a refrigerator-sized machine that served

33:07

30 New England universities. So

33:10

I taught myself how to program, and

33:12

as I worked my way through with my

33:14

ideas, I saw that I had a winning

33:16

system, and it was just a matter of finishing

33:18

all the calculations. So I went ahead and did that. I

33:21

wanted to get this system published, because

33:23

I thought that from my

33:25

experience in mathematics and what I've seen happen

33:28

elsewhere, other people would claim they did it

33:30

and grab the credit. That annoyed me,

33:32

because it already happened to be in mathematics a couple

33:34

of times. So I went

33:36

shopping for somebody who could get me

33:39

quick publication, and it

33:41

turned out that on the MIT campus, there

33:44

was a man who I knew nothing about named

33:46

Claude Shannon, who was an Institute

33:48

professor, and he was a

33:51

member of the National Academy of Sciences. So

33:53

he could get me, if he

33:55

approved before I wrote, a quick publication, and

33:57

the proceedings of the National Academy would only

33:59

take... a couple of months to get

34:01

it out. So I had

34:36

submitted an abstract to the American Mathematical

34:38

Society meeting in Washington,

35:01

DC, where I was going to present. By

35:04

the way, they initially rejected the abstract

35:06

saying that this is just another fool

35:08

with a system that doesn't work because

35:10

we know you can't beat Gamboi game.

35:13

But on the abstract committee was a person

35:16

I knew well from UCLA, a number

35:18

theorist named John Selfridge, became quite well

35:20

known in number theory. And he said,

35:22

well, if Thorpe says it's true, it

35:24

probably is. So you should accept this

35:26

abstract. So I went

35:28

there and I presented and I thought

35:31

there'd be about 50 mathematicians in

35:33

the audience, but instead there were

35:35

300 people. It was jammed. And

35:38

a lot of people were very

35:40

odd looking. They had pinky rings

35:42

on and sunglasses and tropical shirts

35:44

in the middle of winter. So

35:48

after I finished, they lunged for my

35:50

little handout. I brought 50 handouts saying

35:52

that's all I need there. And I

35:54

basically tossed the handouts out and laughed

35:56

as quickly as I could. up

36:00

by a fellow named Tom

36:02

Wolf who became a famous American

36:04

novelist. He was a young

36:07

reporter then. He wrote a piece for AP

36:09

which went across the country and so it

36:11

got massive press. That led

36:13

to me writing a book and telling

36:15

everybody how to do it after a couple of years.

36:18

Between the time I wrote the book though and

36:20

when I told people how to

36:23

do it by publishing, I

36:25

went out and played Blackjack myself and

36:28

proved the system worked. I

36:30

figured that there's no point in writing a book unless I

36:32

knew it really worked. I knew it worked in theory but

36:35

what if you actually tried to do it? A

36:37

lot of things, they seem to work in theory

36:39

but when you get down and actually put something

36:41

to the test, you find out there are all

36:43

kinds of things you didn't think of. It turned

36:45

out in this case, it worked very well. We made in

36:47

one weekend with a test $11,000 which is about that with

36:49

a zero on the end of

36:55

today's money. This is in

36:57

about 20 hours of serious play.

36:59

I had a lunch money at MIT for

37:01

a very long time thereafter. Ed,

37:04

let me just jump in for a moment. A

37:06

couple of questions. I could have a thousand

37:08

follow-up questions but I'll just limit it to

37:10

a handful. The first was for that $11,000

37:13

which would be

37:16

say $110,000 in today's dollars, 20

37:19

hours of serious play. Do you recall

37:21

roughly what the bankroll

37:23

was? Yeah, it was $10,000. Oh,

37:27

that was the starting. Okay, got it. We

37:29

started and we added $11,000. I

37:32

see. I see. Got it. On top of that. My

37:34

prediction before we went was that that's what would happen.

37:38

It panned out. Two other questions rewinding a bit

37:40

to your earlier story. When you were first sitting

37:42

at that blackjack table, if I heard you correctly,

37:44

you said you had a little card. If I

37:46

heard you correctly, could you describe what was on

37:48

the card? It was a

37:51

set of rules for hitting and

37:53

standing, doubling down, and fair splitting.

37:55

It was the

37:58

best way to play with a high score.

38:00

degree of approximation it was the best because

38:20

the cards that are used up are not a

38:23

representative sample of the cards in the deck.

38:25

They can vary quite radically. For example, you

38:27

might use all the aces early and that

38:29

would be bad for the player or

38:32

you might use none of them up until late in

38:34

the game and that would be quite good for the player. And

38:37

with Claude Shannon, the

38:39

person who doesn't meet anyone, you said you

38:41

were able to get five minutes at lunch.

38:44

Why were you able to get time with

38:46

Claude or why do you think he was

38:48

willing to spend time with you? It turns out that he

38:51

was willing to spend five minutes I think probably

38:53

just to get rid of me but after we

38:55

talked he kept asking me

38:57

questions and it became 15 minutes and

39:00

then he approved the paper that I wanted to

39:02

submit and then he said what else are you

39:05

working on? So I

39:07

said well there's another project which

39:09

actually I started before Blackjack and

39:12

which got me interested in gambling and

39:15

that's a way of beating roulette and

39:18

Claude Shannon turns out was probably

39:20

the king of gadgeteers.

39:22

He built many ingenious machines

39:25

over the course of his life. He

39:27

built robots that would run mazes, machines

39:30

that would play chess. He

39:32

just loved all that sort of thing and

39:35

he had a house full of gadgets and

39:37

equipment, hundreds of thousands of dollars worth and

39:40

valued money back in

39:42

1958-59. So when he

39:44

heard about roulette and I explained to him what

39:46

my ideas were there he got very excited. So

39:49

we continued to talk and this

39:51

five-minute meeting became half

39:54

an hour and then an hour and then we adjourned

39:56

to the cafeteria at MIT

39:58

to grab a bite. We

40:00

went on for another couple of hours and

40:03

we decided that we would join

40:06

together and make an all out

40:08

effort to build a machine that

40:10

would allow us to project the outcome of our

40:13

roulette game. And the

40:15

house and casinos

40:17

have had to, I was going to

40:20

say adapt, but really counteract your

40:23

strategies and tools by changing the

40:25

rules. So could you say more

40:27

about what you then devised in

40:30

the case of roulette? What we did was

40:32

we built a small computer

40:34

that had about 11 transistors

40:37

in it, 11 or I

40:40

don't remember which because we had two versions and

40:42

I forget whether we ended up with the 11

40:44

or 12 transistor version. The

40:46

computer is now at the MIT

40:49

Museum in Cambridge. It's been on exhibit

40:51

in various parts of the world at

40:53

one time or another. In

40:55

any case, over about a 9

40:57

or 10 month period, we worked in

41:00

Shannon's basement almost full time and

41:02

we built this wearable computer. It turned out to

41:04

be the first wearable computer

41:06

according to the MIT Media Lab.

41:10

And one person would wear

41:12

the computer and enter push button

41:14

information about the position and velocity

41:16

of the ball and

41:18

the rotating wheel in the center. And

41:21

then the computer would instantly, there's

41:23

a trick there. I do mean instantly, it would instantly

41:26

tell you where to bet. And

41:28

so the other person would sit at the roulette

41:31

table apparently connected with the observer

41:33

who was busy putting in the

41:36

roulette information. And

41:38

that person would hear a series of musical tones.

41:41

And when the musical tone stopped, the

41:43

last tone in the octave would

41:45

tell them what section the wheel to bet on.

41:48

We divided the wheel into eight sections with a little

41:50

bit of overlap. And so the

41:53

person who bet, which happened to be me, was

41:56

able to quickly put down money on

41:58

five needles. neighboring numbers on the

42:00

wheel. And it had a

42:02

massive edge of 44%. So the piles of dimes we

42:07

started out with our experiment, dime chips

42:09

became huge piles of dimes very quickly.

42:12

So the computer

42:14

worked wonderfully well. Yeah, I

42:16

want to take a step back just for people

42:18

who are listening and say that there

42:21

are many reasons that I wanted to have

42:23

this conversation with you. And it is

42:26

not specifically related to gambling in

42:28

the sense that what most there

42:30

are many things that interest me

42:32

about your life and your thinking.

42:35

And my hope is that

42:37

for people listening, they get a window

42:39

into at least two things. One would

42:41

be your methods

42:43

of thinking, framework works for thinking,

42:45

how you think about thinking. And

42:48

then also your personal

42:50

approach to health and

42:54

fitness. Because as people may

42:56

have picked up with some of the references,

42:58

could you tell everyone listening what your age is

43:00

as we speak today? I'm

43:03

89. And for

43:05

those people who can't see video, you look like

43:07

you're in your 60s. And I am just

43:10

beyond excited to hop

43:13

right into that. So we're going to jump around

43:15

quite a bit. We want to do this exactly

43:17

chronologically. But could you perhaps

43:21

describe your

43:23

approach to health and

43:25

fitness? And you could tackle that starting wherever

43:27

you like. Is it just that you were

43:30

given the right parents and out of the

43:32

box have tremendous genetics? Is there more to

43:34

it? How would you begin to unpack this?

43:37

I kind of wandered into health and

43:39

fitness by accident initially, just like I

43:42

wandered into blackjack and roulette.

43:44

I'm curious and always looking for things to

43:46

understand. I like the idea of self improvement

43:49

too. So I was walking behind the student

43:51

co-op one night when I was about 20

43:54

and heard a bunch of clanking. I looked

43:56

down in the basement and there were

43:58

some fairly burly guys down there. there

44:00

pumping iron and I walked in I

44:02

said you know this is this is a waste of time this

44:05

is ridiculous so one of them said to me I'll

44:07

bet you a milkshake that if you work out with

44:09

us for a year just one

44:12

hour an evening three

44:14

evenings a week you'll double your

44:16

strengths in a

44:18

set of exercises that they described

44:22

so I said I don't believe it let's try it I

44:25

went down and the four exercises were the

44:28

squat with a barbell

44:30

on a rack the

44:32

military overhead press the

44:35

bench press and

44:37

deadlift wasn't deadlift it

44:39

was something else I forget the fourth

44:41

one it's the moment I'll think of it yeah

44:44

clean and jerk maybe who knows our bet

44:46

row it was something along those

44:48

lines but a compound exercise like

44:50

like the others yeah so there

44:52

was a fourth exercise so anyhow what happened

44:55

was I was a

44:57

I wouldn't say 98 pound weekly but

44:59

maybe 150 pound weekly and at the end

45:04

of the year I could military press 185 which was at

45:06

least double what I started

45:10

with I could bench press 375

45:13

I could do 15 at 325 and I could

45:15

yeah I could

45:22

squat with 375 I could

45:25

do souths because the

45:27

other one was wish I could

45:29

remember it in any case I was astounded that

45:31

all this came to pass so

45:34

maybe pay attention to strength

45:36

at least and some time

45:39

went by and I little

45:41

swimming because I got interested in scuba

45:43

diving and then one

45:46

day in my 30s I was

45:48

jogging along the beach with my brother-in-law

45:52

and he said let's go for a little jog

45:54

I went about a quarter mile and I was gasping I was

45:56

35 then I remember I said this

45:59

is awful I'm a shape. I have to

46:01

do something about this. So

46:06

they had a book on aerobics by somebody named Ken Cooper who has a lab

46:08

down in Texas and started in large part

46:10

the aerobics revolution that swept the country.

46:13

So I started keeping track of his points.

46:16

He gave you points for various degrees

46:18

of aerobic effort. I think

46:20

if you did a mile in between

46:22

12 and 15 minutes, you got one point and

46:24

you did between like 10 and

46:27

a half and 12, you got two points and so

46:29

forth. So I started trying to run

46:31

a mile a day and I did that. Well,

46:33

I ran a mile every Saturday to start with. And

46:36

then one

46:38

Saturday I just had to try a little further. So I

46:40

ran two and then

46:42

three and then I said

46:44

I'll try a 10 mile race. I

46:47

got under a 10 mile race which was kind of foolish

46:49

but I finished and I did

46:51

reasonably well. So then I said I'll try a

46:54

marathon. So then I got into marathon running and

46:57

I really liked that. I did that for

46:59

about 20 years until I hurt my back

47:01

weightlifting. All my

47:03

bad events have been from pushing

47:05

myself athletically. So hurting

47:07

my back is probably the worst thing.

47:09

I hurt needed a disc so I

47:12

had to stop heavy pounding, heavy running.

47:14

But 20 years of road running, well

47:17

more than that, maybe 25 years and

47:19

a marathon gave me I

47:21

think a very good base for going

47:23

forward. And so now I do

47:26

things like a walk about three

47:28

miles, three or four times a

47:30

week and I spend about two days in the gym

47:33

doing stretching and strength

47:36

exercising, core strengthening and so on.

47:39

A lot of emphasis on core because of my

47:41

back which is just fine now. I

47:43

was just going to ask how your

47:45

approach seems like it has evolved and

47:47

changed over time. Say after 50 years

47:49

of age or in the last say

47:52

40 years or so, are there any particular

47:54

changes that you made in addition to

47:56

the core strengthening to

47:58

support the back? you think have contributed

48:02

to your longevity? I've

48:04

evolved. I try to listen to my body, so

48:07

I do what I enjoy and

48:09

the rule I started to follow was some is better

48:12

than none and more up to

48:14

a point is better than less. So

48:16

there's no excuse. I mean if

48:18

you tell yourself, gee, I'm not going to do this because

48:20

I can't do the whole program, that's a

48:22

big mistake. Just start doing it. And

48:25

I find that if you start doing it and you

48:27

get used to it, you find more and more things

48:29

that you kind of like that you could build on

48:31

and then you just keep getting better at it. I

48:35

was probably in my best shape at around 55 to

48:37

65 because of all this. That

48:40

is inspiring. I am just about

48:42

to turn 45 and even

48:45

amongst my, just to say,

48:47

age cohort, it's very

48:50

common for me to see people

48:52

giving up even in their 40s

48:54

and blaming it on age. But

48:56

with you sitting in front of

48:59

me describing your trajectory and sort

49:01

of adaptive habits, I

49:03

feel like those excuses don't

49:05

hold a whole lot of weight. One

49:08

thing that's pretty neat is race

49:10

walking. I did that for a while

49:12

and that's something that is lower impact

49:14

than running, but you can get

49:17

the same kind of aerobic workout. So

49:19

that's something I direct people towards.

49:22

What does your strength training look like

49:25

now or over the last few decades?

49:29

Well, as I get older,

49:31

it declines. I get weaker and it gets

49:33

a little harder to do things. And

49:36

I feel a little tired or I can't do as many reps

49:39

or sets of things. So

49:41

I have a mix of

49:43

things that I do now. I will do

49:45

squats, usually now just

49:48

body weight. And I

49:50

try to, I'll do dumbbell squats

49:53

or lunges with a lot of

49:55

emphasis on one leg and then

49:57

shift and do a lot of weight on the other. the

50:00

leg, do pull-ups. I

50:02

think the best part is

50:04

that I do a lot of back exercises regularly on

50:07

the mat. That's very helpful for

50:18

keeping my back in shape and keeping my core in

50:20

pretty good condition. We

50:22

may come back to this, but let's segue

50:25

and go back in time

50:27

yet again and look at investing.

50:30

How did finance or investing enter

50:34

the scene for you? Well,

50:37

the way I got into finance and investing was

50:39

that I made money at Blackjack and

50:42

from book royalties. This first

50:44

time in my life, I had any spare money. Before

50:46

that, as an academic, my wife

50:48

and I were living from month to

50:50

month with no surplus. Then

50:53

kids were coming and that

50:55

made it even tougher. Once

50:58

I had some money from both gambling

51:00

and book royalties, I

51:02

wanted to figure out what to do with it. Investing

51:05

made good sense to me. I

51:07

would put some capital aside and let it grow. I started

51:11

out by making a lot of

51:13

foolish beginner mistakes, which cost me. Then

51:16

I decided to sit down and re-figure

51:18

this thing out. I began to study

51:21

investing in my spare

51:23

time. I spent the summer of

51:25

1964, which was I

51:28

guess the third year I was at

51:30

New Mexico State. Just reading all summer

51:32

in a big bookstore in Beverly

51:35

Hills, Martindale's, reading all the investment

51:37

books and newspapers they had. Then

51:39

I started again in the summer of 65 reading

51:42

whatever I could find. I happened to get a

51:44

little book on warrants, common

51:47

stock purchase warrants, which were

51:50

the forerunner to what people

51:52

call call options now. When

51:55

I saw that, a light came on and I

51:57

realized that I could mathematically this and I could

51:59

figure out how to value these

52:01

things. And if I

52:03

did that, I'd probably be head of the crowd

52:05

who didn't know how to do these things. And

52:08

so I'd probably have an edge. By

52:10

chance I came to UC Irvine when it opened in the

52:12

fall of 1965. And I was telling

52:15

one of the deans there about

52:17

this idea that I had and that I was working

52:19

on. He said, oh we have someone else who does

52:21

that. And it turned out to be Shane

52:24

Kasuf. And so the two

52:26

of us hooked up and Shane Kasuf

52:28

had actually been doing it in practice.

52:30

And he'd already made an elementary model

52:33

for trying to judge warrants. So

52:35

we decided to write a book together and

52:37

work out more of the

52:39

details and theory. And so that

52:41

became the book Beat the Market. And

52:44

that launched both of us into

52:46

separate businesses. And so I

52:48

began to do what I

52:50

call warrant hedges. And

52:53

basically you buy a cheap warrant and you

52:55

short comment stock against it. That's one way.

52:57

Or you buy an overpriced warrant and

53:01

you short it. I said buy. You

53:03

short an overpriced warrant and you

53:05

buy the common stock against it to

53:07

hedge the risk because they tend to

53:09

move together. In the case that the

53:11

overpriced warrant as it collapses towards a

53:13

zero or toward its conversion value, you

53:16

capture an excess return. And what I

53:18

found was that you could make a

53:20

steady 25% a year with practically no

53:23

risk doing this. So

53:25

I was doing it myself and

53:27

then work spread around UCI campus

53:30

and people wanted to sign up. So

53:32

I signed up the Dean of the Graduate Division

53:35

and I also signed up the secretary

53:37

to the chancellor and

53:40

some people in the math department and so

53:42

forth. I was managing a whole collection of

53:45

little accounts for people

53:47

and they were making 25% a year and they

53:49

kept telling everybody about it. The

53:52

Dean of the Graduate Division happened to be an

53:54

investor also with a fellow

53:56

named Warren Buffett. And

53:58

Warren Buffett was effective. point

54:00

shutting down his partnership the

54:19

Dean gave me his money to invest and

54:21

so I got to know Warren Buffett and I was

54:23

sorry to see that he was going out of business

54:25

because I thought as I told my wife

54:27

then this is going to be the richest man in the

54:29

world. We'll come back to that a little later. I think

54:32

you'll find a follow-up to that quite

54:34

interesting. So I got the

54:37

idea of forming a hedge fund from

54:39

Warren Buffett who was just closing down

54:41

his hedge fund. So I went into

54:43

business managing accounts

54:45

and then merged the accounts into the

54:47

hedge fund and started this

54:50

hedge fund for private limited partnership. That

54:53

ran for about 20 years and used

54:56

ideas that I kept generating,

54:58

mathematical finance ideas to keep

55:01

staying ahead of other investors and making

55:03

excess returns. In 20 years we

55:07

only had three down months out of all

55:09

those months and those down months

55:11

were less than 1%. So

55:13

basically just printed money every month and

55:16

it made just under 20% annualized

55:18

during that time. I'm

55:20

very risk averse as you'll find this we

55:22

continue to talk and so this

55:24

thing ran with extremely low risk but yet

55:26

had very high return. So

55:28

that was my entree into investing. One

55:32

hell of an entree. 20

55:35

to 25% annually. Let's

55:37

touch on a few points here. So there

55:40

were two other people who

55:43

I believe read Beat the Market or

55:45

were influenced by it, Fisher Black and

55:48

Myron Scholes. Could

55:50

you just perhaps fill in the

55:52

dots with that because Nassim Taleb

55:54

refers to the Black Scholes model

55:57

with a different name. Could you perhaps just fill

55:59

in the gaps? there for people who are

56:01

listening? I was

56:36

the only one who had this model. So when the

56:38

Chicago Board Options Exchange opened

57:05

in 1973, I thought I'd have the

57:07

feel to myself. But unfortunately,

57:10

Fisher Black and Myron Scholes published

57:12

the idea and they

57:14

did a better job of the model than

57:16

I did because they had very tight mathematics

57:19

behind their derivation. I had to

57:21

make a couple of assumptions to get to

57:23

the same point, but they were

57:25

reasonable assumptions. It turned out to stand up in

57:27

practice and in theory later on. So in any

57:30

case, they published the model and I thought, oh,

57:32

I have this hedge fund I've been running for

57:34

a few years, it's been doing well, we're going

57:36

to make a lot of money in options, but

57:39

now Black and Scholes have told everybody what the

57:41

secret is. But people

57:43

didn't catch on right away. So when

57:45

the Chicago Board Options Exchange opened for

57:48

business in April 1973, the

57:50

only people on the floor were my traders. It

57:55

was like having machine guns against bows

57:57

and arrows. For people who don't know,

58:00

Scholes went on to win the Nobel Prize for Economics

58:02

in 1997. Yes.

58:04

And Black would have been there too if he

58:06

hadn't died of cancer before that. Robert

58:08

Merton was at MIT where they've been

58:11

doing a lot of good theoretical work on

58:14

the development of warrants and

58:16

options. And so he wrote

58:18

some beautiful papers about this theory about the

58:21

same time that Black and Scholes were doing

58:23

their work. So the

58:25

prize was awarded jointly to Merton

58:28

and Scholes. And I will

58:30

say this about the prize. The

58:32

people who publish are the ones who get the

58:34

prizes. The people who don't publish,

58:36

it doesn't matter what they figured out or when

58:38

they figured it out, they don't get the prizes

58:41

since they don't deserve to because if you don't

58:43

publish, you haven't really proven to the

58:45

world that you really did this on the one hand

58:47

and you haven't really changed the world in the same

58:49

way that people who publish do. So

58:52

I think the people who don't publish

58:54

don't have claims to these prizes. Having

58:57

the tool in place turned out to

58:59

be revolutionary for my life because I was

59:01

able to use this tool and I had

59:03

some shortcuts in using it that other people

59:06

didn't have for a very long time because

59:08

I developed it myself beforehand and

59:10

they didn't get around to seeing it the way

59:12

I thought. These shortcuts were very useful. We

59:14

stayed ahead of the marching

59:17

legions of PhDs who came later. We

59:19

stayed ahead of them all the way

59:21

through into atomic-losing partnership in 1988. Let

59:25

me hop in for a moment here to ask

59:28

a few questions about your meeting

59:31

or at least one with Warren Buffett.

59:33

Why in that meeting did you come away

59:35

saying you thought he would end up being

59:38

the richest man in the world? What did you see

59:41

or hear or observe in that meeting that led you

59:43

to that? I saw

59:45

that he was compounding at

59:47

a high rate of return, that

59:50

he'd been doing it for a long time. He

59:52

was very, very smart and

59:54

that he really knew a tremendous amount

59:56

about companies. So he was

59:59

a good evaluator. company.

1:00:02

And he demonstrated a very large partnership

1:00:05

from 1956 to 1968 and had about a 30%

1:00:07

before fee annualized return

1:00:13

rate. And

1:00:15

I was sorry that he was going out of business and

1:00:18

that things look so bleak from

1:00:20

the standpoint of sacrificing to

1:00:22

him at that time. Interesting

1:00:25

follow-up to that story. What Warren

1:00:27

Buffett did at that point was he decided

1:00:30

to make a poor

1:00:32

tax towel company in I

1:00:34

forget where it was, somewhere in New England

1:00:36

called Berkshire Hathaway. He decided to make that

1:00:39

his own little private mutual fund. And he

1:00:41

bought up as many shares as he could.

1:00:43

And he didn't particularly

1:00:46

encourage his exiting partners to take shares

1:00:48

in that company because he wanted them

1:00:50

himself. They did have a choice. They

1:00:52

could take cash or they could take

1:00:54

shares in Berkshire and not

1:00:57

knowing what to do. Many of

1:00:59

them just took cash and exited. Some

1:01:01

of them took Berkshire though. Berkshire I think

1:01:03

was they would have gotten something like $12 a share in 1964.

1:01:05

Now it's a little under

1:01:10

$500,000 a

1:01:12

share. The

1:01:15

Berkshire's fair is kind of interesting. I

1:01:17

knew how smart he was and I said the way he's

1:01:19

compounding he's going to be my opinion

1:01:21

the richest man in the world in

1:01:23

a while. It'll just take time. I

1:01:26

lost track of him. I figured he was

1:01:29

just working for his own account and there

1:01:31

was no opportunity for an investor. That was

1:01:33

largely the case. But then up

1:01:35

in 1982 I happened to

1:01:37

see an article about Berkshire Hathaway and I saw that

1:01:39

he was running it. And then I just started to

1:01:41

take a look and I said oh it's

1:01:43

gone from 12

1:01:46

to 982. So is the

1:01:48

opportunity gone? Many people who owned it had

1:01:50

sold on the way up taking their enormous

1:01:52

profit of a multiple of 5 or 10

1:01:54

or 15. And I said I know

1:01:59

what he's doing. I know this man, I know what he's

1:02:01

going to do. I'm buying a 982, even

1:02:05

though I missed out the move from 12 to 982. And

1:02:08

of course, buying a 982 turned out to be a good

1:02:10

move. Yeah, I would say so. Just

1:02:16

a quick thanks to one of our sponsors and we'll be right back

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a wealthfront.com/Tim. teaching

1:04:00

a, let's just

1:04:03

say, what could be undergraduate

1:04:05

or graduate seminar in investing

1:04:07

now? So you were teaching

1:04:09

a class of neophytes

1:04:13

how to invest, and some are

1:04:15

say mathematically inclined and some

1:04:17

are not. It's a very mixed group. What

1:04:20

types of tools or thinking

1:04:22

frameworks, heuristics, mental

1:04:24

models, anything would

1:04:27

you focus on in

1:04:29

the first handful of lectures? Well,

1:04:33

the first thing I would tell them is

1:04:36

the answer is really easy for

1:04:38

almost everybody, but you're not

1:04:40

going to believe me until you work

1:04:42

through yourself and understand it. And

1:04:44

I'll tell you the answer to start with, and

1:04:47

then I'll try to convince you that it's the right

1:04:49

answer. So I'll just tell you the answer to start

1:04:51

with. The answer is if

1:04:53

you're a long-term investor, you should just

1:04:55

buy and hold equities. And

1:04:58

the best place to have bought and hold

1:05:00

equities has been the US for the

1:05:02

last couple of hundred years. Overall, equities

1:05:05

here have compounded at about

1:05:08

10% or 10.5% for 200 years. The

1:05:13

data for the first 100 years is not as good as

1:05:15

the data for the last 100, but the data

1:05:18

for the last 100 is quite good and

1:05:20

very well-documented. How

1:05:22

does that do against everybody else? Well,

1:05:25

you can prove by

1:05:27

logical and mathematical arguments, and

1:05:30

I won't go into all the details here. Some

1:05:32

of it's in my book. It's also in other places. You

1:05:35

can prove that if

1:05:37

a person simply buys the index

1:05:39

and holds it, he will

1:05:41

outperform most

1:05:43

all the other players. The

1:05:45

people who buy and hold the index will beat the

1:05:48

whole collection of people who don't do that. They

1:05:50

do way better on average. The ones who

1:05:52

don't do that pay trading costs. They

1:05:55

have more volatility from

1:05:58

diversification generally. lack

1:06:00

of diversification and they

1:06:03

often they

1:06:06

also pay taxes when they trade. So that's

1:06:11

the simple answer for people who don't know

1:06:13

anything about investing. Now you might say, well

1:06:28

yeah but I'm pretty smart, I hear all

1:06:30

these stories, I listen to Kramer on TV,

1:06:32

jumps around, makes a lot of noise and

1:06:34

sounds good. So why can't I do better?

1:06:38

Well the academics have something called the efficient

1:06:40

market theory in which they claim that you

1:06:42

can't do better. Now I've

1:06:45

already explained that that's wrong. You

1:06:47

can find instances where you can do

1:06:49

better. Warren Buffet did much better. I

1:06:52

found with my hedge fund I could do much

1:06:54

better but the kind of work you

1:06:57

have to put in to do much better is

1:06:59

substantial. It doesn't seem like it at

1:07:01

first but when you get into

1:07:03

it there are all kinds of details and

1:07:05

follow-ups and things to be checked out and

1:07:07

you end up spending a substantial amount of

1:07:09

time and energy figuring out

1:07:11

how to do it better. And

1:07:13

for everybody who finds out how to

1:07:16

do it better, the rest

1:07:18

of the crowd who isn't buying the

1:07:20

index is doing a little bit worse

1:07:23

because you can show that

1:07:25

the whole collection of people who

1:07:27

don't buy the index are

1:07:30

themselves as a group like the

1:07:32

index. Because everybody

1:07:34

is a group is like the index,

1:07:36

you subtract the index part out and

1:07:38

the rest is like the index too. So

1:07:41

the people who aren't buying the index

1:07:43

but are like the index as a group are

1:07:46

busy paying all these costs, taxes,

1:07:49

investment advisors, and so forth. So on

1:07:51

the average that whole group does

1:07:53

worse. You're paying basically a

1:07:55

casino of ignorance or whatever if you're not

1:07:57

indexing and you've got a beat. that in

1:08:00

order to do better than the and

1:08:19

so forth. So that's what I would tell yourself

1:08:26

and trying to do it because you are

1:08:30

not investing, you might actually find a way

1:08:32

to win and you'll learn

1:08:34

about how the world works and a lot

1:08:36

about life too. The things

1:08:38

you learn from what seems

1:08:40

like a narrow specialized field generalize

1:08:42

very widely to all kinds of

1:08:45

things if you're the kind of person who can

1:08:47

take a lesson in one part of life and

1:08:50

transport it to another part of life. What

1:08:52

are some of those transferable lessons in

1:08:56

your mind? Let's

1:08:58

take a risk as a

1:09:00

good example. You learn about investment risk and

1:09:03

how you want to

1:09:05

avoid very great risks or

1:09:08

minimize them. Great investment risks can

1:09:10

take you out of the game altogether. So

1:09:12

you might have a thing where you multiply

1:09:14

money by 10 times but you

1:09:17

might also lose it all. Some

1:09:19

things that are highly volatile like buying

1:09:21

cryptocurrency are in this category

1:09:24

where you may have the chance of a very

1:09:26

large gain but also the chance of a very

1:09:28

large loss and if you lose most of your

1:09:30

capital it's very hard to climb back out. For

1:09:32

instance, if you lose 90%

1:09:34

of your capital you've

1:09:37

got to multiply what's left by 10 in

1:09:39

order to get back to even which

1:09:41

means you've got to make 900% to offset that 90% loss. That's

1:09:43

not going to be easy

1:09:48

to do. It takes a long time. So

1:09:51

you want to avoid really bad

1:09:53

outcomes. So I

1:09:56

applied that for example to COVID.

1:09:59

I thought about what to do and how

1:10:01

to deal with it. And I said, you

1:10:03

know, at my age, the

1:10:06

stats from China, which came over early 2020, showed

1:10:09

that people 85 and up were

1:10:12

dying at the rate of, if

1:10:14

they were male, 18% of

1:10:17

those who got it. And even

1:10:19

now, the death rate is very high for those

1:10:21

who get it if they're unvaccinated. It's probably pretty

1:10:23

close to that. And if they're vaccinated,

1:10:25

it's maybe a temp stat. So

1:10:29

I consider that a risk that can take

1:10:31

me out of the game with a fairly

1:10:33

high probability. So I'm going to avoid getting

1:10:35

COVID if I possibly can. I'm

1:10:38

going to mask up. I'm going to

1:10:40

avoid crowds. I'm going to think about what

1:10:42

the risks of various activities are that I

1:10:44

do and decide whether it's worth it. So

1:10:47

I did my own

1:10:49

analysis of COVID and its risks

1:10:52

and tried to be very careful

1:10:54

from then on. I think it's paid

1:10:56

off for my family

1:10:58

too. I've passed this information on to people

1:11:00

around me. Do you have

1:11:02

any recommendations for, and

1:11:04

this might sound a little meta, but how

1:11:06

people should think about long-term

1:11:09

thinking or the long-term?

1:11:11

Because the recommendation for,

1:11:15

say, an equity index or

1:11:18

index ETFs was

1:11:21

predicated on investing and

1:11:23

holding for a long period of time. What

1:11:26

would you consider the minimal, viable, long period

1:11:28

of time if you have an answer to

1:11:30

that? And how can people become more aware

1:11:32

of their own weaknesses

1:11:34

related to short-termism or short-term

1:11:36

thinking and switch to more

1:11:39

long-term? I

1:11:41

tend to be a long-term thinker. You might say, well,

1:11:43

if you're 89, I'm going to

1:11:45

be a long-term thinker. Well,

1:11:47

I have children and grandchildren.

1:11:51

I also feeling pretty good and staying in

1:11:53

good shape. So 89 may not be

1:11:55

all that old at this point. In

1:11:57

any case, I would say that if... You're

1:12:00

looking at 15 or 20

1:12:02

years or more. Maybe

1:12:05

you have a dynasty trust or something like that,

1:12:07

or you have descendants, and you

1:12:10

yourself expect to live 15 or

1:12:12

20 years or more. The

1:12:14

best investment, I think, is

1:12:16

to buy almost entirely equities

1:12:18

and hold it. You might want to have a

1:12:20

little cash around. I think Buffett recommends 90% index

1:12:22

and 10% bonds, or

1:12:25

short-term intermediate-term bonds for cash. That

1:12:28

does just about as well as 100% equities. I

1:12:31

just put it all in equities because I have enough so

1:12:33

I don't have to worry about fluctuations up and down. If

1:12:36

you have a shorter time horizon, you may

1:12:38

want to do things differently. And

1:12:41

it depends on how much you're going to need

1:12:43

and how much you have. I have

1:12:45

a set of rules that are a little bit helpful here.

1:12:49

I'll start with what I call the 4% rule. Suppose

1:12:52

that you're going to retire and

1:12:54

you want enough to

1:12:57

last you from your capital

1:12:59

throughout the rest of your life. I would

1:13:01

say a pretty good working rule, but

1:13:03

mostly in equities, and spend

1:13:06

4% of your capital each year, or

1:13:08

less if you can. And that ought to

1:13:11

last you from, say, the 60s

1:13:13

till the end of your life. It's

1:13:16

that guaranteed, but a pretty good chance

1:13:18

it will. Then I have the 2% rule,

1:13:20

which I found by studies,

1:13:23

both mathematical and by simulation

1:13:25

of stock returns. If

1:13:28

you only drain 2% out per year,

1:13:32

then that money will probably

1:13:34

grow in perpetuity. There's a small chance

1:13:36

it'll be extinguished by really bad downturns,

1:13:38

but it's very small. There

1:13:40

is an organization that freezes people,

1:13:42

and they asked me for advice

1:13:45

about how to invest their endowment

1:13:47

fund. Freezing me, meeting

1:13:49

cryogenically free. And

1:13:52

so I said, for the endowment fund,

1:13:55

which is going to get people out of

1:13:58

being frozen sometime in the far future. future of $1,500,

1:14:00

$200, $200 out. For that

1:14:02

fund, you're going to want

1:14:04

to invest long term and let it run because

1:14:06

that's gonna get you the most money down the

1:14:08

road. And if

1:14:10

you're going to attempt to reanimate

1:14:12

somebody, there is no specific

1:14:16

timetable. If you don't have enough money to reanimate

1:14:18

them at a certain time, you can wait a

1:14:20

few years and let the money grow a little

1:14:22

more. So you want money

1:14:24

to grow to as big an amount as

1:14:26

possible in the far future. And

1:14:29

so the 2% rule for

1:14:31

the endowment fund, I think, was a

1:14:33

pretty good rule for spending

1:14:36

because all the simulations showed that it would

1:14:39

grow to a very large amount over

1:14:41

a period of time. So that's long term

1:14:44

thinking. The intermediate term, I think of that

1:14:46

as maybe five to

1:14:48

15 or 20 years. And

1:14:52

there, something like the 4% rule that I described

1:14:54

might be good. And for short

1:14:56

term, it's just a matter of what your needs

1:14:59

are and what you're going to have to come

1:15:01

up with. And people are in

1:15:03

various ranges of wealth. There's what you

1:15:06

might call poor where you don't have

1:15:08

very much to save or put aside

1:15:10

and it can be hard to retire

1:15:12

and hard to make it. Then

1:15:14

there may be middle class people who can

1:15:16

put a moderate amount away. I know somebody,

1:15:19

for example, she has saved about a million

1:15:21

and a half and she is in

1:15:23

her mid 50s. I

1:15:25

think she'll be fine. I've explained to

1:15:27

her, pile it all in equities and let it rip.

1:15:30

She gets scared every so often when there's a downturn.

1:15:32

She calls me and I tell her, hold

1:15:34

fast. And then it goes back up. She says,

1:15:37

I'm really glad I held fast. A

1:15:40

lot of people are what I call scared rabbits. And

1:15:44

when the market goes up, they get

1:15:46

confident and they start buying. And then it drops and they

1:15:48

get really scared at the bottom and they sell out. And

1:15:51

then it goes back up and they buy again. Then

1:15:53

it drops and they get really scared at the bottom and

1:15:55

they go back out again. So they seem to have the

1:15:57

worst of it all the time. Yeah,

1:16:00

it doesn't feel good to go

1:16:02

through life as a scared rabbit and certainly

1:16:05

it certainly hurts your financial standing. That's

1:16:07

where thinking for yourself comes in. You

1:16:10

won't hold fast to something unless you understand it

1:16:12

yourself. There's an old saying, give a person a

1:16:14

fish and they eat for a day. Teach a

1:16:16

person to fish and they eat for a lifetime.

1:16:19

And it's a simple thing for thinking.

1:16:21

If you give somebody advice about a

1:16:23

problem, they might solve that one problem.

1:16:26

If you teach them how to think about problems, they

1:16:29

can solve problems for the rest of their life. And

1:16:31

so that's the way to go. And also if you

1:16:33

give them advice and they don't know understand what the

1:16:35

advice is or how to think about it, there's

1:16:38

a good chance they won't take their advice. I'll

1:16:40

give you an example. Back in

1:16:42

1991, I was invited to

1:16:44

review the portfolio of

1:16:46

McKinsey and Company back in New

1:16:50

York. And so they

1:16:52

had a profit sharing and a pension plan.

1:16:54

And I came and I looked

1:16:57

at all the things they had and things they had

1:16:59

worked really quite good. But there

1:17:01

was one very strange investment

1:17:03

they had. It printed out one or two

1:17:06

percent a month every month. They've been doing

1:17:08

it for years. They had

1:17:10

a record going back into the late

1:17:12

60s supposedly. And

1:17:14

I said, how do they do this? And

1:17:18

they said, well, we don't know

1:17:20

exactly. They tell us that they won't explain what

1:17:22

their message is. But we can show you our

1:17:24

accounts. So I looked at their accounts and

1:17:28

I saw that this account

1:17:30

bought stock and

1:17:32

it put option positions on call

1:17:34

callers. They had to put option a little

1:17:36

below stock price and they bought a call

1:17:38

option a little bit above. And

1:17:40

the two things pay

1:17:43

for themselves. It was self-financing. So they didn't

1:17:45

have apparently a whole lot of risk. But

1:17:48

I could show that in a down market they

1:17:50

would lose in a down month. And in a

1:17:52

month they would win. But they won every month.

1:17:55

And the reason they won every month was

1:17:58

because a mysterious trade was put

1:18:00

on involving S&P

1:18:02

index options. And it was always

1:18:04

in the right direction. So if they were going

1:18:06

to lose, it would be a winner. And if they

1:18:09

were going to win, it would be a loser. So

1:18:12

I said, this is not possible. I said,

1:18:14

I want to go over and look at this place. So

1:18:17

they called the person in charge, who happened to

1:18:19

be at that time Peter Madoff, the

1:18:21

brother of Bernie Madoff. Bernie was off in Europe

1:18:23

raising money. This is 1991, mind you. So

1:18:26

when Peter Madoff heard I was coming, he said, no,

1:18:28

I won't let him in the front door. So

1:18:32

I held my nose, and I said, I want to take a better look at

1:18:34

all this. So I looked at all their

1:18:36

trades, and I saw that half the

1:18:38

trades never happened when I researched them. That

1:18:41

is, there was no trades

1:18:43

occurred on any exchange at the prices they

1:18:45

were making them at for these options. Another

1:18:49

quarter of the trades had so much

1:18:52

volume that the

1:18:54

volume couldn't have happened because there wasn't that much

1:18:56

volume on the exchanges that they traded. The

1:18:59

last quarter of the trades, which

1:19:01

consists of 40, there were 160 to

1:19:04

start with, the last quarter of the trades didn't

1:19:06

happen anywhere. There was no

1:19:09

explanation. So I said, OK, let's

1:19:11

look at some of the trades that actually could

1:19:14

have happened. So I

1:19:16

went to a vice president of Bear

1:19:18

Stearns, rest in peace, and

1:19:21

said, you know, we do

1:19:23

a lot of business together. I'd like to

1:19:26

ask you a special favor, which you might or might not be

1:19:28

able to grant. I'm going to give you

1:19:30

10 options trades. I'd like to

1:19:32

know who was on the other side of

1:19:34

these trades, in

1:19:36

particular, was made

1:19:39

off in company on the other side of any of them.

1:19:42

So they researched the trades, and they came back and said,

1:19:44

no, can't find any trace of any made off in company.

1:19:47

So I said to McKinsey, this is

1:19:49

the fraud. And they said, but we're making 20% a year.

1:19:53

I said, well, you're making 16% a year currently in

1:19:55

your other investments. And if I'm right, this

1:19:58

20% is not real. going to

1:20:00

fall in someday and you

1:20:02

might lose your jobs. On

1:20:05

the other hand, if I

1:20:07

am right and you move,

1:20:11

you have saved this problem. If

1:20:13

I'm wrong and you move, you're only going from 20% to 16%. So

1:20:17

you know it makes a lot of sense to just

1:20:20

exit. So they

1:20:22

exited in two months and

1:20:24

we inquired of

1:20:27

everybody we knew, I through my network,

1:20:29

they through their network to find out

1:20:32

who had investments we've made off and how

1:20:34

much they had. Now we

1:20:36

could only cover a small part of the territory

1:20:38

because our network was not comprehensive and

1:20:41

it turned out that about

1:20:43

half a billion we were able

1:20:45

to identify. Now that

1:20:48

meant that there was a lot more than half a

1:20:50

billion out there, how much more we couldn't say. But

1:20:54

things were looking very bad. On the

1:20:56

other hand, how could you challenge Madoff? He was a

1:20:58

pillar of the National

1:21:00

Association of Securities. I think

1:21:03

he'd been a past president, he'd been

1:21:05

on committees there. He was the biggest

1:21:08

third market that has not the exchange maker

1:21:10

in the country. So a

1:21:12

respected person and

1:21:15

well-known to everybody. He had thousands of

1:21:17

investors as it turned out and because

1:21:19

he had so many investors, everybody

1:21:21

knew it had to be right because surely those people

1:21:23

have checked it all out. Now the

1:21:27

finale of the story is that when

1:21:30

I was doing this, the person who

1:21:33

invited me, who was a hedge fund

1:21:35

manager himself, who

1:21:37

invited me to do this for McKinsey,

1:21:39

he had been an advisor to them. This

1:21:42

person believed in Madoff

1:21:44

and continued to go out and raise

1:21:46

money for him. And in

1:21:49

2008 when the news came

1:21:51

out that Madoff was a fraud, my

1:21:54

son called me up and said, you know, Dad, the

1:21:56

stuff you've been telling him to be about for 17

1:21:58

years has finally happened. It blew up.

1:22:02

So anyhow, this fellow who had been

1:22:04

running a fund of funds and

1:22:07

included Madoff in that fund of funds, it's

1:22:09

a special type of hedge fund that invests in other

1:22:12

hedge funds. He had been doing this and had a

1:22:14

very big fund of funds. He

1:22:16

was raising money for Madoff the same

1:22:18

week that the bad news came out

1:22:21

and he had his own personal

1:22:23

money and his family's money

1:22:25

and trust fund money with

1:22:28

Madoff. But I had explained

1:22:30

everything to him and great detail. I knew him quite

1:22:32

well. At the time back in 1991 that

1:22:35

McKinsey and Company had this

1:22:37

analysis explained to them and decided to pull out.

1:22:40

So the whole point of this is

1:22:42

here's a person who had all the

1:22:44

information, it was explained very

1:22:46

clearly, and he just didn't

1:22:49

believe it. And

1:22:51

he himself was an investment business and

1:22:53

was very successful. But he

1:22:56

was a reporter in times past and

1:22:58

his family made a lot of money in

1:23:01

the 30s. He came from

1:23:03

a rich family in Chicago and

1:23:05

the way he figured things out was he

1:23:08

would pull people and he

1:23:10

would ask people what they thought

1:23:12

about something. It would be like I asked

1:23:14

you what's the best diet pill

1:23:16

I can take. You'd probably say there aren't any good

1:23:18

ones and I could probably agree with you. He'd

1:23:21

ask 100 people and then they

1:23:24

would in fact be a poll and

1:23:26

he'd go by the poll. So just

1:23:29

imagine that you asked 10,000 people

1:23:32

whether they thought you

1:23:37

could travel faster than light. And

1:23:40

all but one said, yep, you

1:23:42

can do it. I saw it

1:23:45

on TV and only one guy said, no,

1:23:47

you can't do it, Albert Einstein. So

1:23:50

a guy like him would overwhelmingly reject

1:23:52

Einstein and believe the 10,000 average people

1:23:55

who just said, yeah, you could do

1:23:57

it because the poll was

1:23:59

no. 9,99 to 1 on

1:24:03

one side. So he

1:24:05

doesn't think for himself. He lets the crowd think

1:24:08

for him. And that, I

1:24:10

think, is a fundamental mistake that many

1:24:12

people make. They let the crowd do

1:24:14

their thinking. They don't figure it out for

1:24:16

themselves. Let's talk about

1:24:18

toolkits and bring

1:24:20

in – we don't have to focus

1:24:22

on him necessarily, but since

1:24:25

Warren Buffett came up earlier, you

1:24:27

have then his partner Charlie Munger, who is

1:24:31

well known for mental models.

1:24:33

And I think Buffett describes him as

1:24:35

having the best 60-second mind he's

1:24:38

ever met, something like that. What mental

1:24:42

models do

1:24:44

you find helpful or would

1:24:47

you teach in that class that

1:24:49

I mentioned earlier? And you can really approach it

1:24:51

in any way that you think is sensible.

1:24:54

But how should people think

1:24:57

about mental shortcuts or mental models? And

1:24:59

are there any that come to mind

1:25:01

that you think are particularly valuable? I'll

1:25:03

tell you about a few, and then I'll

1:25:05

tell you where to get more. Perfect.

1:25:08

Let's take a notion

1:25:11

that economists call by their

1:25:13

priestly name, externalities.

1:25:15

Have you heard of that term? I

1:25:18

have. I have heard the term. Okay. Good.

1:25:20

Most people have not, as it turns out. So

1:25:23

you're way ahead already. Well,

1:25:25

externalities – So, let's see where we go. And

1:25:29

externalities, simplistically, is

1:25:32

a consequence of

1:25:35

somebody's action that's generally

1:25:37

not intended and

1:25:40

it's usually bad, but it's sometimes

1:25:42

good. I'll give you examples

1:25:44

of each of varying sizes. Here's

1:25:46

a bad one that happened to me actually

1:25:49

last week. I go out to

1:25:51

get my car and I find out that the

1:25:53

tires slapped. I look and

1:25:55

I see a sheet metal screw in

1:25:57

the sidewall, which means the

1:26:00

that this tire is going to have to

1:26:02

be replaced. So I ended

1:26:04

up taking care of the problem. Where did the problem

1:26:06

come from? Most

1:26:08

likely, I think. Down

1:26:11

the road from me, there's been a lot of construction

1:26:13

going on. I've noticed

1:26:15

as I go for walks that

1:26:18

pieces of metal are

1:26:20

often lying in the road, sheet metal

1:26:22

screws, nails, other things

1:26:25

that aren't good for tires. I

1:26:27

think I'm up when I happen to walk by, but

1:26:30

I don't get them all. And the

1:26:32

workers are carelessly deposited

1:26:35

anymore. Not very many, but it

1:26:37

only takes one to give me a flat. So

1:26:41

this is an unintended

1:26:44

bad consequence of the work going on

1:26:46

there. Who benefits?

1:26:49

Well, the homeowner does because he doesn't have to

1:26:51

police his guys to clean up carefully and sweep

1:26:54

the streets afterwards. He doesn't have to spend another

1:26:56

$5 a day on

1:26:59

sweeping labor to make sure that none of

1:27:01

these things are there. But it

1:27:03

cost me $500 for new tires. Unfortunately,

1:27:06

it's a Tesla Plaid with

1:27:08

a 10 1 by 2 inch wide Michelin tire. So

1:27:10

the tires are not cheap. So

1:27:14

this is an unintended bad consequence

1:27:16

for me that saves a

1:27:18

very small amount for the guy who's

1:27:20

doing the construction, few doors down. Let's

1:27:23

take a little bigger one. When

1:27:26

I was a chemistry student

1:27:29

back at age 14 in 1946, teaching

1:27:34

myself, I mean, there wasn't

1:27:37

a decent chemistry class around. I

1:27:39

came across a fellow named Svante

1:27:41

Arrhenius, a great Swedish

1:27:43

physical chemist from the latter part

1:27:45

of the 19th century. He,

1:27:48

at that time, and I

1:27:50

learned it then, did a study of

1:27:54

how gases in

1:27:56

the atmosphere trap heat. And

1:27:58

he explained how much the heat trap heat. trapping power

1:28:00

was of various gases including carbon

1:28:02

dioxide. He explained very

1:28:05

clearly how much carbon dioxide would

1:28:07

contribute to global warming as it

1:28:09

increased. So this was known way back

1:28:11

then. When I knew it was a 14-year-old and

1:28:14

the mechanism is obvious, you can

1:28:16

sit behind a plate glass window

1:28:18

when the sun is shining and

1:28:20

feel everything heat up around

1:28:22

you, the greenhouse effect. So

1:28:25

it's simple, it's obvious, it's got plenty of

1:28:27

science behind it. What do people do

1:28:29

now? Well, they

1:28:32

create a negative externality by

1:28:34

polluting. People drive around

1:28:36

in cars and dump CO2 into the atmosphere

1:28:39

and each individual is convinced

1:28:41

by being able to drive around in his car.

1:28:44

But he contributes to a

1:28:46

global problem, a problem that won't

1:28:48

come back perhaps to haunt him if

1:28:51

he doesn't live long enough or maybe

1:28:54

so gradually he doesn't notice it. But

1:28:57

everybody together is busy

1:28:59

contributing this major externality

1:29:02

to the world which

1:29:04

leads to a second little mental model.

1:29:07

It's called the tragedy of the commons. It's

1:29:09

a pretty famous thing by a guy named Garrett Hardin.

1:29:13

The simple example is you've got a village with

1:29:15

a little green in the middle and

1:29:17

it's got a lot of grass growing and only a

1:29:19

few people live in the village. So

1:29:22

one guy has sheep and he lets his sheep graze

1:29:24

on the green and there's plenty of grass so it's not a problem.

1:29:27

A few more people move in, they get some sheep,

1:29:29

they turn them loose on the green. Pretty

1:29:31

soon there are too many sheep for

1:29:34

the green and it's all eaten up. So

1:29:37

each person acts in his own self-interest

1:29:39

but collectively what

1:29:42

they do is against the common good. So

1:29:45

that's another little mental model or

1:29:47

idea. So the whole collection of

1:29:49

these things that are out there

1:29:51

that are very valuable for thinking

1:29:53

purposes. One collection is, there's

1:29:56

a 50 item collection that came out

1:29:58

under I-N. He period

1:30:01

on the internet. Apart from You Unmasked,

1:30:03

that's quite good. As also

1:30:05

Charlie Mongers book for Charlie's Almanac

1:30:07

yeah which has a lot of

1:30:09

the things embedded in it. One

1:30:11

my favorites is the has a

1:30:13

strange name. Of

1:30:16

our fundamental attribution error.

1:30:20

And. I didn't like me. I

1:30:22

said charlie, why you com the fundamental attribution error.

1:30:25

Well charlie. Actually just picked

1:30:27

it up from. Sociology.

1:30:30

And psychology. That's what they call it. And.

1:30:34

I thought that's a terrible name you should call

1:30:36

something else but as I thought about the more

1:30:38

to satisfaction of a bad dame after all. Roughly

1:30:40

speaking, what it does. Is.

1:30:44

Is. A human tendency to.

1:30:47

Make. Assumptions. That. Are Not.

1:30:49

Fully. Just fall by the evidence. For instance,

1:30:51

you go to lunch. And

1:30:53

the person you're by doesn't show up. So

1:30:57

you begin to. Speculate well,

1:31:00

Maybe. He just forgot his of for death,

1:31:02

forgot. Or. Up maybe. Since.

1:31:05

We have a look for oil two weeks ago.

1:31:07

Maybe that was it? Maybe just maybe he's gonna

1:31:09

show me or something else or to start making

1:31:11

of stuff to try to explain it. But.

1:31:14

You don't have the oven for it. It turns

1:31:16

out that the of time zone away with

1:31:18

busy dealing with all the far from a

1:31:20

car accident and two hours later use final

1:31:23

what I should happen and. It's

1:31:25

too bad V apologized profusely. But.

1:31:28

You didn't have any idea what actually happened is

1:31:30

submit the stuff up. That is something that we

1:31:32

humans do over and over and we're wired for.

1:31:34

It's evolutionary. The ties into a

1:31:37

famous book. Thinking fast and slow.

1:31:39

Daniel Kahneman? Yes, exactly. And.

1:31:42

So he has example their up here

1:31:44

in the forest. And.

1:31:47

You hear a roar. You

1:31:49

don't stop to find out where there was coming from

1:31:51

the run up the nearest tree because of my The

1:31:53

Alliance. In fact I'm I just something entirely different. But.

1:31:56

You don't take any chances, you you react. and

1:31:59

if is not alive You've made fundamental attribution

1:32:01

error. You attribute it to being lying when

1:32:03

it wasn't. But it saved your life,

1:32:06

often when it wasn't an attribution error.

1:32:09

That ties in with something else, which is learning how

1:32:11

to think. If you think fast,

1:32:14

kind of emotionally from the gut, responding

1:32:16

without really reflecting, you will make a

1:32:18

lot of mistakes. Sometimes

1:32:21

though, it's a way of saving your

1:32:23

life. For example, somebody else fires. You're

1:32:26

at the door of the theater. You run out the door

1:32:28

immediately before you find

1:32:30

out whether there is a fire. There

1:32:33

might or might not have been. But

1:32:36

running out the door before the sound of the

1:32:38

reflect, in which case it might be too light, is a good thing

1:32:40

to do. I hold it all up for

1:32:42

everybody else too as I run out. I

1:32:46

just want to mention a few things.

1:32:48

On the externalities piece, in thinking about

1:32:50

the, say, unintended secondary or

1:32:52

tertiary effects on the collective,

1:32:54

there can also be positive

1:32:57

externalities or externally benefit.

1:33:00

Like if you were to buy fire insurance

1:33:02

for your house, your neighbor might be a

1:33:04

little bit safer. So it can

1:33:06

go both ways. That's a good example. And

1:33:08

it's one that actually was a

1:33:10

real life experience for me right here. We

1:33:13

had a fire a year, a wildfire a couple of

1:33:15

months ago. We all had to evacuate. And

1:33:20

I have a chub, and they have wildfire

1:33:23

insurance. And so

1:33:25

I have that. And so a chub actually had a

1:33:27

water truck out here, which protected not only me, but

1:33:29

lots of other people in the neighborhood. So

1:33:32

is the next step after identifying these

1:33:35

externalities, for instance, in the case of

1:33:37

the construction site, thinking

1:33:39

about how to somehow

1:33:43

create and enforce incentives

1:33:47

such that someone is

1:33:50

acting to the benefit of the

1:33:52

collective, for instance, the construction site, where someone's

1:33:54

not spending $5, but it

1:33:56

costs individuals who are effective $500

1:33:59

to replace. a given tire. I'm

1:34:01

sure there are a million different examples of

1:34:03

this. Does that then lead to a study

1:34:05

of incentives? Yes, that's a

1:34:08

good point, that if somebody

1:34:10

creates an extra analogy that's

1:34:13

negative, a good thing to do is

1:34:16

to tax it. What we've learned is if you tax

1:34:18

something, you get less of it. So

1:34:22

let's say carbon, for example. If you

1:34:25

tax carbon, you get less of it in

1:34:27

the air. So

1:34:29

a carbon tax is the rational,

1:34:31

logical solution to the whole pollution

1:34:33

problem. All you have to

1:34:35

do is make the tax big enough and people

1:34:37

find other ways to do things than pollute with

1:34:39

carbon. However,

1:34:41

that leads to another

1:34:44

thought principle, which is

1:34:46

the difference between rational

1:34:48

solutions to social problems.

1:34:51

A rational solution is one that is

1:34:53

generally good for almost everybody as

1:34:56

opposed to a select few. You

1:34:59

can have rational solutions to social problems, but

1:35:02

you often can't get them implemented.

1:35:04

So you also have

1:35:06

to think about what can you actually

1:35:08

accomplish politically. And there's a great book

1:35:10

about that. There's a professor

1:35:12

at Yale, the Sterling Professor of

1:35:15

Political Science, Ian Shapiro. I

1:35:17

listened to podcasts, yours

1:35:20

included, when I go for my walks. And

1:35:23

his course was one of the ones I

1:35:25

listened to. It's absolutely great. It talks about

1:35:28

how to actually get something

1:35:30

done politically. And

1:35:33

we've seen, for example, the

1:35:35

Biden administration has had great difficulty getting very

1:35:37

much of what it wants to do past.

1:35:40

And they could learn a lot from this professor who has

1:35:42

a lot of good things to tell them. He has

1:35:45

a book called The Wolf at the

1:35:47

Door, which is

1:35:49

fairly recent, which basically

1:35:51

explains the things that I learned in his

1:35:53

political science course a few months

1:35:56

ago. And it tells you

1:35:58

how to form coalitions that can win. and

1:36:01

how to pass things that will stay in

1:36:03

place. For example, Social Security stayed in place

1:36:06

because it had a strong constituency

1:36:08

that it created right away and

1:36:10

that constituency was going to defend

1:36:13

it forever after. Politically,

1:36:16

even though some politicians and

1:36:19

occasional political parties have tried to destroy

1:36:21

it, they have not been

1:36:23

successful because the consistency is so embedded and

1:36:25

so strong now. So, anyhow, he

1:36:28

has a clear description of

1:36:30

how you can actually get things done and

1:36:33

he believes, I think, that you

1:36:35

can make incremental progress discouraging as

1:36:37

though it seems these days by

1:36:40

doing the right way of

1:36:42

putting coalitions together and

1:36:44

defending against blocking coalitions.

1:36:47

So, it's a very insightful course. Anybody

1:36:49

who wants to get something done evolutionarily,

1:36:51

I would recommend reading his book. And

1:36:54

I might say, we're in a crisis

1:36:56

of democracy now, in my opinion,

1:36:59

and simplistically, we have three

1:37:01

paths. There's devolution, which I think,

1:37:04

oh, we're undergoing now. There's

1:37:06

evolution, which I hope is

1:37:09

the way things work out in which we

1:37:11

fix things and things get better, and there's

1:37:13

revolution, which is extremely ugly and

1:37:15

unpleasant. And one

1:37:18

of your previous interviewees, Ray

1:37:20

Dalio, has a book that

1:37:22

I think is very well

1:37:24

worth reading, even though it's a tough slog,

1:37:26

and maybe I changed the

1:37:29

writing a bit, but it's

1:37:31

a real contribution to thinking about the

1:37:33

crisis that we're going through now, and

1:37:36

it talks about the changing world order,

1:37:38

I think that's the name of the book, and

1:37:40

the rise of China

1:37:43

as an empire and the decline of the United

1:37:45

States as an empire. And I think that we

1:37:48

have some serious thinking to do. We can't just

1:37:50

sit back on our laurels and say, we've been

1:37:52

so great, we've been the world superpower, and

1:37:55

hope that it's going to last. We have

1:37:57

to do things differently. I'd recommend that.

1:38:00

I also would second that recommendation.

1:38:02

Francis Fukuyama has also some fantastic

1:38:04

writing that is worth exploring and

1:38:06

I have that Daliyo book within

1:38:08

15 feet of me here where

1:38:11

I sit right now. And

1:38:14

speaking as someone who studied

1:38:16

also in China

1:38:18

myself at a pretty fascinating

1:38:21

time to be there. I was around

1:38:23

in Beijing at two universities

1:38:26

in 1996 and have tracked

1:38:28

things pretty closely since that

1:38:30

it's definitely worthwhile to read

1:38:32

up also on the history

1:38:35

of China because that is going

1:38:37

to and is coming to bear

1:38:39

as we speak on the entire

1:38:43

three-dimensional chess of geopolitics

1:38:45

which is fascinating

1:38:48

and also at times terrifying certainly.

1:38:51

Let me ask you if I may what

1:38:54

other investors aside from Warren

1:38:56

Buffett impress you and

1:38:58

they could be people who are

1:39:00

no longer actively investing, they could

1:39:02

be current, but are there any other investors

1:39:04

who come to mind who have particularly impressed

1:39:07

you outside of Buffett? And the reason I

1:39:09

ask for people who are wondering is

1:39:12

related to what you said earlier that

1:39:14

by studying investing, by participating in investing,

1:39:17

you get to stress test and

1:39:19

look at how other people stress test thinking

1:39:22

and cognitive biases and so on. Is there any

1:39:24

anyone who comes to mind for you outside of

1:39:26

Buffett? There are people in

1:39:28

the hedge fund world who have done remarkable

1:39:30

jobs at various times but

1:39:32

they're not accessible to

1:39:35

most people. For example, let's take Jim

1:39:38

Simon of Renaissance. Renaissance

1:39:40

Partners is basically a

1:39:42

private operation at this point but

1:39:45

it's been extraordinarily successful uses

1:39:47

PhDs and computers and

1:39:49

math and code breaking and so forth

1:39:51

and it has from

1:39:53

around 1989 or 1990

1:39:57

on been spectacular in its performance.

1:40:00

probably the best risk adjusted record

1:40:02

in the world from that time forward. And

1:40:05

for people who want to read more about Jim Simons, there's

1:40:07

a book called The Man Who Solved to the Market, which

1:40:09

is a good read. Although you're

1:40:13

probably not going to be able to,

1:40:15

as you mentioned, emulate the sort of

1:40:17

quant approach that he is taking for

1:40:20

a million and one reasons, but absolutely

1:40:23

fascinating story. Any other names

1:40:25

who come to mind? I'm

1:40:27

trying to think of who I would give money to

1:40:29

to invest. I don't have anybody

1:40:31

now that I'd give money to to invest. There

1:40:34

are a few good hedge funds around, but

1:40:37

they take too much for

1:40:39

the general partner and leave too little for the

1:40:41

limited partner. And they also

1:40:44

generate income that is

1:40:46

highly taxed if you're a taxable

1:40:48

investor. So they're

1:40:50

only good for nonprofits at this point.

1:40:57

What about past investors, say

1:40:59

in decades past, who you would have given

1:41:02

money to willingly? Does anyone come to mind?

1:41:04

Well, I did give money to Ken Griffin's

1:41:07

Citadel from the time it

1:41:09

started. I think I was

1:41:11

investor number one after Frank

1:41:14

Meyer, who was the other general partner

1:41:16

with Ken Griffin. Frank Meyer

1:41:18

was a longtime friend of mine from the past. So

1:41:20

that's how I learned about it. I actually had Ken

1:41:22

Griffin out of the house when he

1:41:24

was about 18 or 19. And just starting up

1:41:27

with Frank and talking about how my

1:41:30

hedge fund, Princeton Newport, worked. And we

1:41:32

discussed at some length the

1:41:34

idea of profit centers and subsidiary

1:41:36

businesses. And I handed them

1:41:38

boxes of prospectuses that were hard to get

1:41:40

on all kinds of convertible securities. These things

1:41:43

would come out when the securities were issued

1:41:45

and then they would no longer be findable

1:41:47

anywhere. They were just like rare books. So

1:41:50

I handed them my whole collection of cards of these things.

1:41:52

So I had a very good ride with them and I

1:41:55

finally exited recently

1:41:57

because the taxes

1:42:00

take two big a bite out of the

1:42:22

introduction but what was it at

1:42:25

the time that

1:42:30

made it past muster for you?

1:43:00

And there are a million others that

1:43:02

I would love to talk about but

1:43:04

could you please speak to having enough?

1:43:08

You've spoken about or at least written about how your

1:43:10

hedge fund could have taken over your life and

1:43:13

you could have just ended up as

1:43:15

a capital accumulator, as your full-time job

1:43:19

plus. How did

1:43:21

you make the decision to wind it

1:43:24

down and how do you

1:43:26

think about having enough? It doesn't strike

1:43:28

me as something I come

1:43:30

across often with people who are

1:43:32

really good at investing. The

1:43:35

way I got into the investment world, I was

1:43:37

an academic and I was curious and I found

1:43:39

things interesting. I wasn't really in there to get

1:43:42

rich. I was in there to deal with

1:43:44

interesting math problems that kept coming up. Blackjack,

1:43:47

that was a math slash physics problem. Investing

1:43:50

was for me lots and lots

1:43:52

of math. So I enjoyed

1:43:55

that. I just do things I like

1:43:57

and I don't worry about money. As

1:44:00

my former sister-in-law once said, do what you

1:44:02

love and the money will follow. She wrote

1:44:04

a book that title and

1:44:08

I said, you know, that's right. Do

1:44:11

what you love and the money may follow and if it

1:44:13

does, that's fine. If it doesn't, you're still doing what you

1:44:15

love. What's

1:44:17

important in life, I think, is

1:44:20

the journey and

1:44:22

the people you

1:44:24

know and you spend your time with and

1:44:27

how you spend your time otherwise also. That's

1:44:30

how I looked at things and I started

1:44:32

out as a child with the Great Depression

1:44:34

so I knew what it was like to have basically

1:44:36

no money. I used to

1:44:39

sleep four or five hours a night in

1:44:41

high school and get up at two or

1:44:43

three in the morning and deliver newspapers and

1:44:45

I made $25 a month which seemed

1:44:47

like really big money and I saved

1:44:50

part of that for college and invested

1:44:53

part of it in science equipment, chemistry,

1:44:56

telescopes, electronics and so forth just

1:44:58

because I like playing

1:45:00

with those things and learning about them. My

1:45:02

goal wasn't to make money, it was to have

1:45:04

a good life and enjoy myself and have fun

1:45:07

and it just so happened that it turned out a lot

1:45:09

of money too. What I found though in

1:45:12

the investment world is lots of people go in it

1:45:14

for the money and when they do, they

1:45:17

keep going and going and going and

1:45:19

it's a validation of them. They

1:45:21

can't stop. They

1:45:24

end up with oh

1:45:27

five or ten villas, a

1:45:30

yacht, a jet and

1:45:33

unless I'm asking you have five houses

1:45:35

just to take an example, how much of your

1:45:37

time you spend in each house? It can't be

1:45:39

on average more than a fifth bitch of my

1:45:41

mouth. And you're not going to

1:45:43

be in your house all the time anyhow, you're

1:45:45

going to be vacationing, traveling, meeting and so on.

1:45:47

So maybe it's a sixth or seventh of

1:45:50

the time on average. Now some houses

1:45:52

are going to spend more time than some less. You may

1:45:54

spend a tenth or fifteenth of your time or none of

1:45:56

your time almost in one of those houses. So you end

1:45:58

up with a whole lot of stuff. to

1:46:00

manage and take care of and you

1:46:03

end up hiring people to do that. So

1:46:05

you don't have to do it and then you have to manage

1:46:07

those people and then you have to

1:46:10

hire people to manage the people who manage the people

1:46:12

and so on. It's like one of your business. It's

1:46:14

terrible. You

1:46:17

don't get to enjoy the important part of your life which

1:46:19