My Most Recent Thoughts
This past year in books was a good one. The number of books was fewer than I had planned but the quality was great. I spent a lot of time on history, which will continue into 2020, but more on that later. Here is the list of the best 5 books I read in 2019.
The Vikings by Robert Ferguson
The list of popular books on Nordic history have a pretty narrow scope – dominated by the Viking age. This period of history runs from roughly 800 A.D. to 1100 A.D.. What I found fascinating, that I did not know, is that the arc of Viking history is mainly a story of religion. It started with the raiding and plundering of Christian monasteries and ended with the large-scale conversion of the Nordic people to Christianity.
The author is a little dry, and despite not being a history professor, it does come across a little like a text book. I found it somewhat amusing because the violence is shocking, even though you know the reputation. The author reports all this brutality in a very matter-of-fact fashion. Take the following excerpt as case-in-point:
“During the attack on the church at Trevet 260 people who sought refuge in the oratory were burnt alive. Cinaed was finally captured and executed by drowning, 'in a dirty stream' according to a source, though the quality of the water can scarcely have mattered to him.”
I'm sure there are more exciting books about the Viking age out there, (and I will get to them at some point) but I loved this book’s factual, event and trend reporting approach. If you are interested in the Vikings, their evolution as a people, and their significance in the history of the greater region, this is a great book.
Snow Crash by Neal Stephenson
I honestly had no idea what to expect from this book when I first picked it up. I just knew that a lot of tech people I follow on Twitter have recommended it as a classic work of science fiction. My feelings about the book evolved as I read it. I started with eager curiosity, moved to straight confusion, but by the end of the book I was immersed into the story.
I could not help but think about all the more modern works that obviously get some inspiration from this book. It was a fun and trippy ride and anyone who likes science fiction and hasn’t gotten to this book yet, should get there quick. I will definitely read more Stephenson in the future.
Lessons of History by Will and Ariel Durant
This book should be mandatory reading for people in the later parts of college. For those that are unfamiliar, Will and Ariel Durant wrote an encyclopedic series of world history that I plan to start collecting as I find them in used book stores and estate sales.
This book is a reflection of the major themes and lessons learned from all those works. It is short, to the point, and reads easily. Even though it was short, it took me a while to get through because, page for page, this was the most note taking I’ve done on a book. It starts with Chapter 1: Hesitations “Most history is guessing, and the rest is prejudice”. It moves quickly into a stream of profound, quotable insights, like this from Chapter 3: Biology and History “The first biological lesson of history is that life is competition.”
I’m glad that I got to this book when I did. The extent of historical reading I have done to this point has made this book even more enlightening as I am familiar with far more of the examples than I would be if I read this book years earlier.
If I were making an All-Decade list of books, which I might at some point if the mood strikes, this book will certainly be on it.
Guns, Germs, and Steel by Jared Diamond
This is yet another history book on the list. This one examines the question - what made some societies thrive and others die off? The short answer is in the title, but there is so much more to learn here. For instance, I was fascinated to find out all the health, cultural, and geopolitical consequences of the innovation of farming. This observation about children is a great case in point “In practice, nomadic hunter-gatherers space their children about 4 years apart by means of lactational amenorrhea, sexual abstinence, infanticide, and abortion. By contrast, sedentary people, unconstrained by the problems of carrying young children on treks, can bear and raise as many children as they can feed.”
Algorithms to Live By by Brian Christian and Tom Griffiths
The most famous example of this book is how to answer the question - how many potential marriage suspects should I date before selecting a spouse? The answer, according to these authors, is 37% of all the possible prospects. This is based on a computer science theory called optimal stopping theory. In order to find the best possible spouse (apartment, employee, etc…) you need to establish some sort of baseline as to the quality of the pool, but at some point you need to pull the trigger and make a decision. In the look vs. leap dilemma, it turns out that 37% is mathematical percentage to minimize regrets of both ‘the one that got away’ and ‘the stone unturned’.
The book is full of interesting insights like this. It also made me feel a lot better about the piles of work on my desk. I have always thought of my work space as my form of organized chaos, while my coworkers would simply call it messy. The authors, on the other hand, use a term used for computer memory systems and call it caching. So now my desk is not messy, it just contains a lot of caches.
The Hero with a Thousand Faces by Joseph Campbell
I had high expectations for this book given a lot of people that I admire have mentioned that this was a life-altering read for them. It is about the 'hero’s journey', and explains many of the common tropes in mythology and story-telling from the reluctant hero, refusing the call to action but eventually acquiescing, to the atonement with the Father (Star Wars, anyone?) and eventually the transformed hero’s triumphant return.
I am a firm believer that when you read a book can be very important in terms of how it impacts you. If I were at a different place in life it could have had a different impression. It was interesting, and the philosophy behind it made sense, but it was a bit too 'meta' for me.
“…for the hero as the incarnation of God is himself the navel of the world, the umbilical point through which the energies of eternity break into time.” What?
Overall, I would recommend it for people to give it a try and make their own conclusions. Perhaps it will prove a fount of inspiration, or maybe you will read and think it sounds too much like mystical mumbo-jumbo. It was an interesting book and worth the read.
The Year 2020
This year I have started a journey into the topic of strategy. I started Robert Greene’s 33 Strategies of War and have the Art of Strategy by Dixit and Nalebuff on deck. The biography of fighter pilot and quite possibly the greatest modern military strategist, Boyd by Robert Coram is also in the queue.
Finally, I am looking forward to shifting my historical focus over to the most famous (infamous?) family of Renaissance Italy with The Medici by Paul Strathern and the biography of Lorenzo d’Medici - Magnifico by Miles Unger. Should be an enlightening year.
Let me know what great books you've read and what you have lined up.
Until next time...
“The more that you read, the more things you will know. The more that you learn, the more places you’ll go.” – Dr. SeussContinue Reading
The Market is revered. I’m talking about The Market, with a capital T and capital M. It can’t be beaten so don’t try. It can’t be forecasted or predicted. It cannot be tamed.
Am I talking about The Market for stocks? The Market for bonds? For houses, tulips, interest rates?
Yes. All of the above.
The worshippers of The Market believe it is an intelligent construct - a global neural net of all the smartest people in the world. Its power expands beyond the sum of the parts to efficiently allocate resources toward their optimal use.
While The Market is the most powerful force for human progress in the history of the world, what is most overlooked is that it is a force without a soul. There is no altruistic prime directive which drives it. It has no agenda and it doesn’t care about you or your bank account.
The market isn’t smart. It’s f’in stupid. That’s why smart people look foolish trying to game it.
Take the over-quoted line from Lord Alfred Maynard Keynes.
“The market can remain irrational longer than you can be solvent.”
Or my own spin, with apologies to Mark Twain
“Don’t try to outsmart the market because it will drag you down to its own level and beat you with experience”
So that brings me to a topic of popular derision. Central Banking in the United States. The Fed is the most common scapegoat for people who lose at investing...
“If only the Fed wasn’t artificially propping up the Stock Market...”
... or keeping the economy from achieving utopian levels.
Furthermore, the common refrain amongst the Libertarian crowd, (those that worship most passionately at the altar of The Market), suggest the Fed is sacrilegious for setting a short-term interest rate.
“The Fed has no business setting the price of money! They don’t know more than the market!”
(I should really put that bold and in all caps)
But guess what. At least The Fed is on your side. The Market for money (interest rates) is one of the most powerful forces in the economy. While The Market for stocks mostly impacts the top 1%, The Market for money impacts everyone – both for the good and the bad.
We saw in 2008 what happens to people when The Market for money breaks down. The economy ground to a halt. Money wasn’t moving anywhere. Andrew Ross Sorkin in his epic book Too Big to Fail brings up the example of GE having trouble finding short-term money for payroll. That is insane.
More important was what we didn’t see in 2008. We didn’t see the complete destruction of our financial system. We didn’t see unemployment go up to 25% like we had in the 1930’s. We saw dozens of bank failures – we didn’t see thousands. The fact is that this is due in large part to a central bank that acted in its role of ‘lender of last resort’. The Market was ready to raze the whole complex and start over. That’s what markets do. They grow, they stagnate, they break. The Market does not come with a warranty or a guarantee of immortality.
The Fed is not a perfect body, but it has something The Market lacks. It has a soul. And it’s guiding principle is to make sure that a soulless market for money doesn’t crush main street into oblivion. The Fed’s mandates of stable prices and full employment run counter to nature of a market which, if left unattended would go about its boom and bust cycle regardless of the body count left in its wake.
So to the people who say “There is no way a group of nine economists should be trying to manage the market for money!” I reply, “Thank goodness they are. Who knows where our country would be if it were left to the vicissitudes of a market prone to raging temper tantrums.”
Let’s go back and check the stats. The list of economic depressions in the United States is as follows:
Panic of 1797 – Land bust following speculative boom
Depression of 1807
Depression of 1815-1821
Panic of 1837 – Banking collapse following speculative boom
Panic of 1857 – Same
Panic of 1873 – Same
Panic of 1893 – Railroad collapse following speculative boom
Panic of 1907 – Stock market crash following speculative boom
Depression of 1920
The Great Depression 1929 - 1939
And that’s the list.
So why did we average one economic depression every 15 years until 1939, and have not seen a single one since?
Well if you have been paying attention you could probably guess where I am going with this. After the panic in 1907, in which J. Pierpont Morgan single handedly saved the US economy from total collapse, law makers thought it might make sense to finally establish a central banking system to act as lender of last resort. After all, you couldn’t always rely on the largess of a financial Titan like Pierpont.
So while the Federal Reserve Act of 1913 established the structure of the Fed, it took until the Banking Act of 1935, in the midst of the Great Depression, for the Federal Reserve and the interest rate setting Federal Open Market Committee (FOMC) to take its final shape. Curious that we have not seen a depression since.
To reiterate: One depression every 15 years before the Fed. ZERO in the 85 years after.
Read about the Great Depression. Take 5 minutes to read the Wikipedia article. Better yet, read up on any of the other depressions that laid waste to our ancestors in the 1800’s. Yes, the march of progress for that century was incredible, but the pain and suffering endured to get there was equally staggering.
I have not fully understood the pillorying of the Fed until recently. I was listening to the Michael Lewis podcast, Against the Rules. If you haven’t listened to it, I strongly recommend you do. It is a series that examines the growing animosity between Americans and the people who are tasked with enforcing the rules. It starts with looking at why everyone hates sports referees. And, while the refs are getting better, athletes, fans, and coaches seem to clash with them more.
The Fed, acting as a governor on The Market, in addition to its role as regulator, fills a similar role. Despite a staggering record of success and a recent example of back-stopping the worst economic crisis since the Great Depression, people still need to have a bad guy to blame.
Lost money in the market? It’s the Fed’s fault! They are manipulating The Market!
“Get off your knees ref! You’re Blowing the Game!”
What does this mean practically speaking? What is the advice?
Stop worshipping at the altar of The Market. Recognize that The Market owes you no debt of fairness and offers no promise of success – long-term or otherwise. Markets tend towards progress but the natural path requires volatility. Boom and Bust. Rinse and Repeat.
We still have the boom and bust nature of markets with us, but at least in the last 85 years we have substituted the word depression for the word recession. Our lows have not been nearly as destructive to the overall economy. That’s because we have a Federal Reserve system which is designed to act as a break-water to hold the most destructive waves at bay.
Is it possible that in their attempt to hold the sea at bay, the Fed is unknowingly allowing an even greater force to form? One that will overwhelm any chance of backstopping the economy? Sure it is. But that doesn’t mean you should just let nature destroy at will. Your alternative is to move off the grid, away from danger. Maybe that is the Libertarian utopia… millions of independent souls living on self-sustaining plots and prospering off of a giant barter system (built on blockchain!). For most of humanity that outcome isn’t exactly ideal.
So by all means, continue to harness the power of The Market. The Market for stocks is an incredible wealth creator, as long as you take heed in what game you are playing. I wrote in How to Win at Investing that your success shouldn’t be based on outsmarting or ‘beating’ The Market, but rather using it to accomplish your goals. Harness its power of progress and ride the waves higher. Just remember that the best results the world has seen come from powerful markets that are governed by strong rules and regulations. Rules and regulations lower the probability of your portfolio blowing up – or the economy blowing up.
The Fed is on your side and trying to protect you. The Market has no such loyalties.
Until Next Time…
A man said to the universe:
“Sir, I exist!”
“However,” replied the universe,
“The fact has not created in me
A sense of obligation.”
― Stephen Crane, War Is Kind and Other Poems
The most interesting thing I saw SuperBowl weekend had nothing to do with football. It was something I saw while my son was playing Fortnite with two of his friends. Saturday afternoon the game hosted a live, in-game virtual concert by famous DJ Marshmello. According to at least one report, there were over 10 million players in the game at the time. That does not include the millions more who were watching online.
The Marshmello concert was the coolest thing I have seen in a video game by far. My son and his friends were absolutely geeking out as their characters used ‘emotes’ that were earned or purchased in the game, to dance along to the music. They were each sitting in their own homes, on their own devices, and yet were able to experience this live event together. While this is not the first ever virtual concert or live in-game event in a video game, it has definitely taken the concept to the next level.
What is Fortnite?
For those of you who don’t know, Fortnite is a battle-royale style shooter game. It started in 2017 and has grown to a freakish level of over 200 million users. For context, Netflix has 148 million subscribers. It is the most popular video game in history and it isn’t close.
The popularity of the game comes from a combination of easy game play and the ability to play together with people across many different game consoles. My son plays on my MacBook, while his friends play on X-box or Nintendo Switch. It is a shooter game but it doesn’t have blood and you don’t “kill” opponents, they get “eliminated” and sent back to the lobby. It has enough cartoony humor, and fun dance moves (according to my wife), to make it palatable for most parents.
What made the virtual concert on Saturday afternoon so fascinating for me, was that this was the first time I really understood what some other commentators have already been saying. Fortnite is not just a game that kids play – it’s a place they go to hang out.
This article from Quartz compares the game to a skate park. Kids get home from school, log-on and hang out with their friends in a virtual world. The actual game aspect serves as the backdrop.
And, if Fortnite is a skatepark, then the gamer known as Ninja is their Tony Hawk. Professional gamers making money on platforms like Twitch (owned by Amazon) and YouTube (owned by Google) has been a growing trend for years now, but Ninja (primarily playing Fortnite) has taken it to another level. If you haven’t heard of the gamer with brightly colored hair, you can read about him here.
Oh yeah, he also made a cameo appearance in the SuperBowl NFL greats commercial. Here is one of the teasers…
So happy to share with you guys one of the many amazing things we'v e been working on and why I've been traveling so much. Catch me in the #NFL100 #SBLIII
commercial right before halftime. pic.twitter.com/FEAQSdsYMP
— Ninja (@Ninja) January 31, 2019
So why do I care? Pokémon Go experienced a ton of growth and was supposed to have ushered in some new age of ‘augmented reality’ (AR) gaming. I don’t see anyone playing that anymore. What makes this different than any other passing fad?
Fortnite is not a unique concept, but rather it’s an evolution of many emerging trends. The “Free-to-play” model with in-game purchases, the battle-royale style of game play have all been done in the past and will continue to get done. Games are now utilizing the same playbook that social networks did a decade ago - grow the user base as fast as possible and then monetize it. It’s all about engagement.
Just like Apple did not invent the smart phone, it just made one that capitalized on growing trends and became more popular than the others. Whether it was Apple, Nokia, or Blackberry that won the contest, it was clear that smart phones were the wave of the future.
Virtual hang-outs and live video game events are today’s future. Whether it’s Fortnite or the brand new Apex Legends (which hashit 25 million players in its first week), or even some platform which allows players and their avatars to travel between multiple games, that’s not the point. The potential has been seen, and money and attention will continue to flow into this space.
Gaming and esports are big business and only getting bigger. Gamers streaming their matches on sites like Twitch are attracting huge audiences. For instance, Ninja streamed a Fortnite match playing with Drake, Travis Scott, and JuJu Smith-Schuster, andattracted over 600,000 concurrent viewers. The video has been seen millions of times since. Gaming has its own tribes, its own superstars, its own elder statesmen, and now it’s even getting its own college teams.
Advertisers are taking serious notice.
Sponsorship deals, esport tournaments, and ad-pop ups on popular streams are all normal right now, but what happens when Pepsi starts sponsoring the next in-game concert, or Apple pays to have virtual posters of Beats headphones put up in the Retail Row section of the Fortnite Map? Will kids be able to buy ‘skins’ of their favorite movie characters for the next big blockbuster. Disney already agreed to let Fortnite use Thanos from their Marvel Universe as a special character in the game for a short time (Disney is a minority investor in Epic Games). The possibilities around this are endless.
Even Reed Hastings, CEO of Netflix, recognized that the competition for attention is heating up and videogames are gaining ground. In his 2018 letter to shareholdershe wrote, “We compete with (and lose to) Fortnite more than HBO”. That should tell you enough.
Gaming is evolving from something kids (and adults… I’ve gotten sucked into playing Fortnite) do, to a place they hang out. That dynamic has changed the business aspect of the industry. Events like the Marshmello concert are only going to become more impressive and more mainstream. The future is “live experiences” and these video games are figuring out how to make them on a scale that has never been seen before.
Will Fortnite become like the Oasis from Ready Player One? It’s already getting there. Whatever the case, this trend is something you should be paying attention to. We aren’t far off from political candidates getting campaign followers by streaming Fortnite battles on Twitch. It's a brave new world.
Fortnite has shown us what the future looks like. It’s time we start paying attention.
Until Next Time....
“For a bunch of hairless apes, we've actually managed to invent some pretty incredible things.” - Ernest Cline, Ready Player One
The 5 Best Books I Read in 2018
While I did not read quite as many books as I would have liked last year, (I never do), I did read some great ones. I started the year continuing a divergence into gilded age and 20's American history. From there, I moved into brain science with some financial crisis, personal finance, and non-fiction mixed in. I try to read several books on a topic that I'm interested in in order to get some varied perspectives.
I heard somewhere that if you read 5 books on a single topic you will know more about it than 95% of the population. I have no idea if that's anywhere close to the case, but it makes for a good aiming point for me. Sometimes I mix it up a little. And, if I pick up an interest mid-stream I have been better about leaning into those instead of fighting them. I can be much more productive when I go with the flow.
Here are the 5 best books I read in 2018.
What I loved about Robber Barons is that it was written in 1934, the depths of the Great Depression, and in some cases just a generation removed from these subjects. It went beyond the most famous profiles of Vanderbilt, Rockefeller, Carnegie, and Morgan with studies of other fascinating players like Jay Gould, Jim Fisk, Jim Hill, Ed Harriman, and Henry Frick. Each of these characters had their own peculiar stories but all had some hand in shaping the course of the US capitalist system.
This book is fantastic for people who are already familiar with this time period and some of these actors. The stories in this book are not necessarily the same that are popular today, and the focus on some of the other players will offer a broader picture of the era. That being said, if you are new to these subjects and this time period, you would do well starting on more contemporary work.
Favorite quote: As the rail lines of Henry Villiard started failing, "His securities continued to sink. As his grip weakened his former associates stabbed at him from behind with the stiletto, according to the traditional ethics of their trade in Wall Street."
This book is a classic of Wall Street history. It opens with the bombing of the JP Morgan offices on Wall Street and ends with the incarceration of Stock Market hero. The stories in here are amazing to read, as this time period was so volatile. It goes from the highest highs of the roaring 20's to the lowest depths of the Great Depression, with all kinds of good and bad actors playing their roles. You do not need to have much background in order to enjoy the story. The author does a good job of putting all these characters in a place where you can follow along.
Favorite Quote: "But it was not only money power that Morgan & Co. exercised over Wall Street in the 1920's. In addition it was the style setter, the court of last appeal, and to a certain extent, the conscious of the place."
All the Devils are Here: The Hidden History of the Financial Crisis by Bethany McLean and Joe Nocera
If you want to get to the core of the financial crisis, there are three real must reads. Too Big to Fail by Andrew Ross Sorkin, The Big Short by Michael Lewis, and All the Devils are Here by Bethany McLean and Joe Nocera. Each book has its focus and this one turns more toward the history of the companies and people who were at the center of the crisis. It looks back to see how each of the players got to the role they eventually played. Anyone who thinks they have a grasp of the financial crisis but hasn't yet read this book is missing key parts.
Favorite quote: "That was precisely the problem. The issue wasn't actual cash losses. It was uncertainty. No one knew where the subprime problem would pop up next, no one could figure out what any of this stuff was worth, and no one believed that anyone who was supposed to know something actually did."
Oh and I was thrilled to get a chance to meet Bethany and she was gracious enough to sign my book. Needless to say, it is now a prized highlight of the collection.
This book took me a very long time to read, but was so worth the time. First of all, it is a bit of a monster weighing in at around 700 pages. Next, I took so many notes. Reading this felt like taking a graduate level class on neural biology. Every time I picked this book up I felt like I was getting smarter, and I ended up filling half of my notebook up with notes. I was writing something down from every other page. It is so full of useful lessons on how your brain works and it is organized in a cool reverse chronological order. I starts from a behavior that happens. It then jumps back one to two seconds to the functions that prep the initiation and working back in time minutes, hours, days, months, decades, generations... to how your brain works to get to that behavior. Anyone interested in human behavior (which should be everyone) should read this book.
Favorite Quote: "Repeat the mantra: don't ask what a gene does; ask what it does in a particular context."
(I love that line because it speaks to the error people make when asking nature or nurture. Is it your biological make-up or your environment? Like everything in life, it is your biology within a specific environment... in other words, it's always both.)
This book was a regular recommendation of the fintwit community (for the uninitiated that just means people on Twitter who talk about finance) so got on the radar pretty quick. It is so easy to read full of smart lessons for everyone from professional investors to the novice just trying to get a better understanding of their personal finances. The geometry angle provides a great structure to hang all of this information on, allowing you to better understand and retain it. If you want to be smarter about money and life in general, this is the book you should pick up.
Best Quote: "...if there were a reliable relationship between greater risk and bigger reward, then technically you wouldn't be taking more risk."
Also I love Chapter 5 - Yes, Not Really, It Depends. The title to the chapter is the answer to the question "can money buy happiness?"
And if you just want a quick "what should I learn about investing as a beginner?" Pick this book up at Barnes and Noble and read Chapter 7 while you drink a latte at the café.
Finally, follow the author on Twitter @Brianportnoy. He is a super smart, and super nice guy. You will learn a lot from his book and you can learn even more by reading his content on Twitter.
Niall Ferguson is a prolific writer and financial historian. If you haven't read his book The Ascent of Money, then your education on finance is woefully short. Go see the PBS documentary if you don't have the book and your short on time (link here). The Square and Tower is similar but instead of profiling the rise of money through history it documents the relationship (and conflict) between network power (the town square) and hierarchal power (the lord's tower). If you want to understand power structure and understand it in historical context this book is the place you should start.
Favorite Quote: "Indeed our species should really be known as Homo Dictyous ('network man') because - to quote the sociologists Nicholas Christakis and James Fowler - 'our brains seem to have been built for social networks.'"
The first book I am reading in 2019, Social by Matthew Lieberman, backs up this idea of 'network man' with a quote that says "Having a poor social network is literally as bad for your health as smoking 2 packs of cigarettes a day." !! With the need to connect so deep and innate within us you can see how the holders of the keys to the network can amass such large amounts of power.
For the rest of 2019 I think I am going to finally get to revisiting the classics of economic study. Books like Wealth of Nations by Adam Smith, General Theory of Employment, Interest, and Money by John Maynard Keynes, Road to Serfdom by Frederich Hayek, and then maybe Human Action by Ludwig Von Mises (to see if I can better understand all my Austrian school, libertarian friends) and Capitalism and Freedom by Milton Friedman. I'm sure that even though I am highly interested in the topic I will need to take a break so will have to insert a fiction book or two to spice things up. I have Snow Crash by Neal Stephenson on order. I have no idea what it is about by it was recommended by a friend so interested to check it.
On a final note, it has been too long between posts and I have fallen short of some goals in that department. Life has been so great, but also very full. I am in a constant state of prioritizing and time managing and go through periods of time where I don't do as well. Sometimes I just realize the energy and time isn't there and I simply decide to step away for a while. I appreciate everyone who gives me feedback on these posts when they do come back. I can't begin to explain how much it means to hear from people who liked a post or have an opinion on one of the books I read. I treasure that interaction more than I can say. Thank You!
So here's to a healthy and wealthy 2019. Get started with a great book!
Until next time,
"The mind needs books like a sword needs a whetstone" - Tyrion Lannister (Final season opens on my birthday!)
Give the gift of learning ---
Imagine you are sitting at a poker table in a Las Vegas Casino. It is a tournament that you have dreamed of playing in for years, and by some crazy stroke of luck you got in this year. All the great famous poker players from TV are here playing. You realize this is a once in a lifetime opportunity and you are just thrilled to take part.
The first hand gets dealt and you get Ace, Ace. Pocket aces, the best possible starting hand.
The action goes around the table, fold, fold, fold, ….and then, All in. Someone has just pushed all their chips into the pot.
You can’t believe your luck! Some sucker decided to push all-in on the first hand and you are loaded with Aces! The next three players quickly fold, and the action gets to you. You're ready to put all your chips in and call - but then, you hesitate.
You're odds of winning with pocket Aces against one other player is somewhere between 70 and 80% - dominating odds. The right move is to call and its not close.
But, this is the first hand. If you lose here your dream comes to an end. It's a very high probability of winning, but its not a certainty. 80% means you would lose that hand 1 time out of 5. What do you do?
Most people here make the 'right' decision and call; and very likely, they would double their chip stack and be in a better position for the rest of the day. But you are also taking a 20 - 30% chance of being the first one eliminated. Everyone would understand - "I had Aces, I had to call." But just because its excusable does not make it easy to spend the day watching from the sidelines. 'Bad beats' happen all the time - and not just in poker.
A few months ago I posted the following tweet about my investment process.
My investment process usually starts and stops with 2 questions.
What is my probability of being right?
What is the consequence of being wrong?
— Keith Akre (@KeithAkre) May 21, 2018
It got a lot more reaction than I expected, including some great questions so I thought it worthwhile to expand a bit on this premise.
Too often the investment world thinks in black and white. Right and wrong. You either did the work, read the research, crushed the Excel models, and came to the right assessment, or you screwed up. It's what Annie Duke, who recently made the podcast rounds to promote her book Thinking in Bets, calls 'resulting'. 'Resulting' is where the outcome determines whether you made the right move. Did the trade make money? Then you were right and did a good job. If it lost money, you did a lousy job.
What is the probability of being right?
Some investors can move beyond the world of right or wrong. They understand that a lot can happen and you cannot know anything for certain. This is why my favorite definition of risk is the one quoted by Howard Marks in his great book The Most Important Thing.
"Risk means more things can happen than will happen." - Elroy Dimson
Single minded people believe that things are bound to happen - that you could figure it out if you were just smart enough or had enough information. Investors thinking probabilistically understand that nothing is certain. There are only degrees of likelihood.
Nassim Nicholas Taleb sums it up even further in Fooled By Randomness -
“Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance.”
The future is unknowable, and thinking otherwise is folly. When people become certain that something will happen that is when they get into the most trouble. Indeed it is one of the most consistent market inefficiencies in history - People will treat as certain something that has a very high probability of happening, and treat as impossible something that has a very low probability of happening.
What is the consequence of being wrong?
I've had this post (A Long Chat with Peter Bernstein) by Jason Zweig saved because I think it is so fundamental on how people should be approaching the investment process. The late Peter Bernstein is one of my favorite financial writers (Against the Gods is a must read) and Jason Zweig is one of today's foremost investment commentators. You should really read the entire thing (and read again if you already have) but for our purposes, Peter Bernstein goes through the biggest errors investors make. The first one is 'extrapolation' (which is a topic that deserves it's own discussion ... another time perhaps), but the second one is Thinking of probabilities without regard for the potential consequence.
To quote Mr. Bernstein:
Pascal’s Wager doesn’t mean that you have to be convinced beyond doubt that you are right. But you have to think about the consequences of what you’re doing and establish that you can survive them if you’re wrong. Consequences are more important than probabilities.
Even if you have a very strong probability of being right, if the consequence for being wrong is unbearable, you should not take the risk.
Imagine you face a wager with 90% odds of paying you $1 million with a 10% chance you have to pay $750,000. That is an easy bet to take if you have the money. But what if your net worth is only $200,000 and you have three kids that play travel soccer and are enrolled in private school? You would face a 10% chance of losing your entire retirement savings, your house, any personal property of any value. The statistician would say there is no question you should take this wager. The estimated value is positive $875,000 (90% x $1m plus 10% x -750,000). C'mon! Take the bet! It is the mathematically appropriate thing to do!
But can you afford to lose? If the answer is no, walk away, avoid the possibility of ruin. That is appropriate risk management.
Are you thinking about folding those aces yet?
Tesla, that polarizing electric car company ;-), has been in the news a lot lately. The stock has a very large, and very loud, group of short sellers (betting that the stock will go down). The rationale is logically sound - the company cannot hit production targets, there is a huge amount of turnover among executives, they are burning cash at an alarming rate, not to mention the craziness of CEO Elon Musk.
However the risk of being in a short position was on full display in recent weeks. Even if all the arguments of the short sellers are ultimately true, there are still things that can happen which make a short trade disastrous. The following tweet was a case in point.
While this is tweet is now under investigation by the SEC (ultimately strengthening the short case), were he able to take the company private at $420, all the short positions would have locked in a loss. It is a case of being right in theory but wrong on the outcome.
Even still, the stock has dropped down to around $300, and the short sellers believe it has much farther to go. But the cult following around this company and their enigmatic leader, mean that there is a meaningful chance that even with the difficulties the company faces, it could still continue to rise - defying logic or financial common sense. It could simply rise on the faith and enthusiasm of its sycophantic followers.
I highlighted the risk of short selling most recently in this profile of Cornelius Vanderbilt's take-over of the Harlem and Hudson rail-lines. The point being that when you own a stock (are long) the most you can lose is your investment. When you are short, the stock could rise theoretically into infinity and cost you much more than your original investment.
Stocks that do not trade according to fundamental valuations are particularly dangerous. When the consequence of being wrong is unknown and potentially huge it is a dangerous risk to take.
Back to the Poker Game
First hand of your dream tournament. The bet is to you for all your chips and you have the best possible hand. You know your probability to win is very high, but your consequence of being wrong is to go home before you even get a chance to order a drink.
The poker players out there would say call. It's the right move and poker is a game of exploiting statistical advantages.
Me? Perhaps this reinforces why I would never be playing in a high stakes dream tournament, but I would probably fold them - face up just to let everyone know I was nuts. The pain of hitting a bad beat and going home would be far worse than the benefit of doubling my chip stack.
But then again.... it would be a good story to tell.
Until next time......
"The word ‘risk’ derives from the early Italian risicare, which means ‘to dare’. In this sense, risk is a choice rather than a fate. The actions we dare to take, which depend on how free we are to make choices, are what the story of risk is all about.” - Peter L. Bernstein
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