Notes from Kai Wu on Flirting With Models

From Flirting With Models host Corey Hoffstein:

My guest in this episode is Kai Wu, CEO and founder of Sparkline Capital. Kai is a pioneer in the measurement of intangible value.  Using machine learning, he tackles unstructured data sources like patent filings, earnings transcripts, LinkedIn network connections, and GitHub code repositories to try to measure value across the four key pillars of Brand, Intellectual Property, Network, and Human Capital.

We discuss why intangibles are important, how they differ from the traditional factor zoo, the opportunities and risks of unstructured data, and how even big data can have small data problems within it.

Finally, we discuss Kai’s most recent applications of his research to the world of crypto.

Link: https://podcasts.apple.com/us/podcast/kai-wu-mining-unstructured-data-for-the-intangible-s5e6/id1402620531?i=1000568607975

A word on my notes:

These are just interesting bits that stood out to me, not a comprehensive summary. Kai and Corey pick over many nuanced questions related to unstructured data, meta-problems in data analysis, distinctions between Kai’s “4 pillars”, and techniques. I encourage you to listen to the whole episode to appreciate the depth that both of them are able to bring to the discussion. Kai has thought about these problems deeply and Corey, despite being an outsider, asks extremely poignant questions reflecting his own deep appreciation for the pitfalls of number-crunching.


Challenge of Machine Learning In Investing:

To take advantage of machine learning truly requires rather large investments, alternative data and the infrastructure required to support it can be very expensive. And even worse is that you know, the prohibitive item here really is getting the right people to run it. Machine learning is complicated and has many pitfalls. And it’s also a relatively new field so that the pool of experienced folks is pretty small.

I actually wrote a paper in May 2019, called machine learning in the Investment Management age. And so in this paper, I outlined three ways to apply machine learning to the industry:

  1. Use of machine learning to transform unstructured data into the investment process
  2. Data mining. And this is the idea of taking hundreds if not 1000s of features or signals and allocate capital across them deciding which ones you want to invest in and what you want to ignore.
  3. Risk models.
  • In the quant world, we’ve seen the most effort applied to the second use case, in other words, trying to figure out how to allocate capital across these 1000s of futures. And this has had actually significant success, but mostly at higher frequencies. For capacity reasons, most capital is managed on lower frequencies. So of course it doesn’t matter as much for the average investor. And then the problem is at the lower frequencies, we have sort of like a small data problem. For example,  every decade there are 10 annual filings, and these are often serially correlated. So the true dimensionality is actually quite a bit smaller.
  • I think we haven’t seen as much innovation on the risk model front. This is an underappreciated dimension. Quants use risk factor models such as Barra and US equities. Barra works by identifying industry factors like “tech” and “consumer discretionary”and a few dozen style factors, value growth, etc. The Barra model has been largely unchanged since becoming the industry standard several decades ago. And I think the biggest weakness of the model was actually its reliance on the GICs industry classifications. These are binary definitions, there’s like 11 different sectors. So firms like Tesla can’t be both tech and auto. They’re also very static. So if a company like Amazon starts investing in a new business like AWS, that doesn’t kind of get incorporated into the risk model. We’ve actually shown that natural language processing models can be used to create superior text-based industry definitions that can capture part of the greater richness and nuance of the business landscape. So in this framework, for example, Tesla will be considered similar to both GM and Ford, then also to Apple.
  • The final area which I think has the most room, which has yet been kind of fully realized, but has the most potential is this idea of unstructured data. The best way to define unstructured data is by opposition to structured data. Structured Data is the information you find in Excel spreadsheets and SQL databases. Its price volume, and financial ratios like P E ratios. Unstructured data, on the other hand, is everything else. It’s text, images, audio, video, anything else any visuals, information, and unstructured data is 80% of outstanding data, and it’s growing exponentially. It’s doubling every one to two years. Importantly, it’s also being created faster than it can be structured meaning that 80% of the data is underestimate because as we move forward through time, it’s only set to increase. And of course, it’s not just quantity, right unstructured data can also contain a lot of valuable information about companies. At Sparkline, we look at like LinkedIn to measure human capital. We look at Glassdoor to measure culture patterns for innovation, Twitter, for brand. And for the most part, investors are not using this data at least in a systematic way.  We’ve seen some unstructured data be adopted, such as news sentiment, become popular but I think it’s really only scratching the surface on what this dataset can offer.

“Value is not dead, it just needs to be reformed”

The father of value investing Ben Graham wrote Security Analysis in the 1930s. The world was very different. The big companies were railroads and industrial firms. Buying stocks below book value was a reliable way to make money. Fast forward to today. We have Google and Apple which don’t use tangible capital to generate earnings. They rely on intangibles. We have these four pillars at Sparkline:

  1. intellectual property
  2. brand
  3. human capital
  4. network effects

These are the pillars most firms rely on today. Our research has shown that intangible capital has grown from basically 0% to 60 to 80% of the capital stock of the S&P 500. Meanwhile, the efficacy of traditional value metrics like trailing earnings or book value has declined. So Baruch Lev and Fong Gu in their excellent book, The End of Accounting show that the R squared of using book value and earnings to explain market caps across nationality used to be 90% in 1950, and it’s fallen to around 50% in 2010 and this was 10 years ago. So I’m not the first person to argue that value investors need to incorporate intangible assets into their assessment of corporate value. But as far as I can tell, we are the first firm to use machine learning and unstructured data to measure this value. For example, we use live data to track the flow of human capital from company to company or Twitter to measure the brand perception of firms. These datasets require using machine learning to take the unstructured data and form them into factors which we can then use to trade like each of these four pillars. So basically, we have two big insights at the firm.

  1. The economy is becoming increasingly intangible, but investors and accountants are failing to adapt.
  2. Unstructured data is exploding and it contains valuable insights on the intangible economy that can be unlocked using machine learning.

By combining these two insights, we hope to help investors access the opportunities in these undervalued intangible assets.

The state of research around intangible assets

There are a dozen or so researchers who have written about how to incorporate intangibles into measures of book value. While they each have slightly different approaches, the common theme is that they all rely on accounting data to measure intangible assets. To be more specific, they focus on two particular line items in the accounting statements.

  1. R&D
  2. SG&A (selling, general, administrative expenses.  SG&A is kind of a catch-all idea that captures many things including sales and marketing expenses.)

The idea is that R&D and SG&A are expensed rather than capitalized. For example, if I were to spend $10 million dollars building a factory to manufacture a new drug that I developed, that capex is capitalized, that goes on my balance sheet. On the other hand, $10 million of R&D to develop the drug that will then be manufactured is considered a cost that comes out of the income. This inconsistency means that investments in intangible capital are considered not an asset but an expense. So led by Baruch Lev who we mentioned just a second ago, a lot of different researchers have now decided to treat intangible investments the same way they do tangible investments, in other words, to build balance sheet assets for intellectual property and brand.

If you take price-to-book plus capitalized r&d you end up with this slightly more comprehensive version of a value factor. This adds somewhere between one to four points of excess returns each year to performance. And the problem though, for us, is that value still in a deep drawdown notwithstanding. So, while these are very sensible adjustments, they’re not a panacea. I think the limitations are twofold.

  1. There is a pretty weak relationship between the input costs and then the output value for any intangible investments. The goal of accounting is to capture historic costs, but the exposed value of intangible investment is very uncertain. The $10 million we spent on this new cancer drug could be worth a billion dollars or could be worth zero to market, this new drug could go viral or flop. So that’s the first problem.
  2. Accounting statements basically ignore the other two intangible pillars. All CEOs claim that their people are their greatest assets, but the only disclosure they put into the 10-Ks is headcount, which of course makes no distinction between the quality of employees or what functions they’re hired to do. And then finally, network effects. So when all is said and done, this means that we are forced to go beyond accounting data. And we believe that by using unstructured data, we can actually measure the output as opposed to the inputs of the R&D investment and the quality of human capital and network effects and brand. And this allows us to transcend some of these limitations.

Corey asks a brilliant question addressing the predator/prey dynamic of competitive markets

Corey: As more and more firms adopt NLP tools to rapidly trade news releases and earnings transcripts. How do you outrun the adversarial issue where CEOs may now get coached against using specific words and phrases or coach to use specific words and phrases?

Kai’s answer confirms just how much of an arms-race market communication can be!

I love this question. Look, investing is like poker. It’s a game theoretic endeavor. One of my favorite papers is actually called How To Talk When A Machine Is Listening. And it has a really interesting finding. So there’s this dictionary called the Loughran and McDonald dictionary. It consists of a bunch of lists of words. Like positive and negative keywords. And the key is that it’s adapted to the finance industry. It was created by two finance professors solely for this focus on trying to classify financial jargon. It was published in 2011 and quickly became widely used in natural language processing. The paper How To Talk When A Machine Is Listening found that companies started to avoid using the negative Loughran and McDonald words in their 10-Ks and 10-Qs after this dictionary was published. So yeah, this is a very real thing. As investors watch and try make sense of unstructured data and deceit in general,  CEOs will try to manipulate the narrative to their advantage.

How Kai’s team zeros in on actions not words to defend against CEOs that learn the right things to say

The way we deal with this is we define three buckets of data with varying levels of susceptibility to such a manipulation.

  1. Company communications. So this is your 10k earnings calls, press releases, and anything coming directly from the mouthpiece of the company.
  2. Third-party information. Media blogs, sell-side research, and company reviews (ie Glassdoor)
  3. Ground truth. So I would classify human capital and passions in this category. A good example is to go back to our culture thing. We wrote a paper called Measuring Culture where we started off by showing the famous slide about how Enron its leaders went to jail for fraud. They proudly displayed the values of integrity on their office lobby. Most CEOs invariably just love talking about how great their culture is, but this is no correlation with the true culture of a company. So to get around this problem, we don’t look at the CEO interviews. Instead, we look to the opinion ranking of all employees. These are the opinions that on a day-to-day basis constitute the culture of a firm. Again, we use Glassdoor. The website allows individual employees or former employees to review their employers. We find this data is a much more reliable source in particular. We find that it’s not the quantity of the story that matters, but the information contained in the freeform text associated with each of these reviews. It gives us interesting clues about the facets of each company’s culture. A similar example would be that all CEOs just love talking about how they’re embracing innovation and digital transformation. But talk is cheap. So instead, we look at job postings and LinkedIn to see if companies are truly hiring talent in these areas. It’s easy to say you’re investing in innovation, but do you actually go out and spend the extra money to hire top graduates from  Carnegie Mellon computer vision PhDs? Is it actually going to be the case that your employees have skill sets such as TensorFlow and PyTorch on the resume? Are you really investing in AI?

Because crypto’s value is entirely intangible it’s fertile ground for Sparkine’s methods

Porting our model into crypto was actually pretty seamless. Brand new human capital matters just as much for Web3 as Web2 organizations. So we were really able to just apply the framework wholesale with no modifications. The big difference in crypto is the data sources are different. But because Web3 is being built in the open, in many ways, crypto is actually an even more attractive area to apply this framework. So we focused on three different data sets.

  1. Blockchain data. By definition, we can see the history of a blockchain all the way back through time it is publicly available is immutable. This allows us to form metrics for the adoption of a protocol. For example, we can calculate the number of daily active users or the dollar volume of transactions over any kind of arbitrary time period. And this, of course, maps back to our pillar of network effects.
  2. GitHub. The really cool thing about crypto is that it’s all built on open-source principles, which of course is key for us. We see the source code of 1000s of crypto projects today, as well as yesterday and each point back in time to inception. So this allows us to form metrics for human capital and intellectual property. So for example, we can see the number of repo changes as a proxy for iteration over a period of time or we can look at the growth of the developer community over the years.
  3. Social media data. While social media is of course important for all firms, it is especially important for Web3, which are digitally native and involve the coordination of online communities across the globe. We can look at datasets such as Twitter, Reddit, Telegram, and Discord, to track the growth of these online communities and brands. So now with these measures of fundamental value in place, we then compare them to the price you pay.

I think what makes us confident in this strategy and gets us all excited about it is this is an inefficient frontier asset class, and very few other investors, if any, are approaching it with systematic valuations. So it just stands to reason that there might be some alpha here.

Does the 4 pillars of intangibles approach apply to assets that might never spit off a cash flow?

You’re right that in general, the token economics are a bit different from that of equities… Many of these projects are using tokens as a method of financing their growth, but they want to avoid technically calling them equity securities from like a regulatory standpoint but it doesn’t diminish the actual value in these tokens. Let’s take the example Ethereum.Eth is a utility token. It is required if you want to use the Ethereum network. Therefore, the value of Eth is a function of the demand for the Ethereum network. This logic applies to any other token, whether it’s a video game, a decentralized exchange or a blockchain. The value of tokens will be a function of demand for the underlying project. So our framework attempts to establish what is the fundamental attraction of these underlying projects. So in this way, we’re actually much more similar to venture capitalists. We think about these projects as early stage startups. They may not have monetized their projects or their users or whatever yet, but if we have a lot of users, we have a robust development community and a strong brand, it certainly does bode well for their ability to flourish ultimately, which of course, would somehow filter down to the token investors profiting.

[Kris: This response sparked a thought for me. A casino requires its chips to be able to play. But the chips themselves never increase in value even though they provide utility in the form of “access to entertainment and gambling”. And for poker pros, the chips are literally an on-ramp to their professional “business”. And still the chips do not increase in value. The analogy is weak since the casino can always produce more chips but it’s just a reminder that the value of a “token” is not just a function of its user base, but its supply, the incentive to increase its supply, and the alternatives. If a user can just cash out because there’s a quality competing casino or blockchain it acts as a limitation on any token’s value]

Identifying the 4 pillars in crypto

  1. Brand

    Dogecoin, which is a joke, has its main value on its brand. A lot of people think it’s funny, they like it. It’s kind of fun to play with. So its primary pillar is brand.

  2. IP

    On the infrastructure side, you have things like Filecoin for decentralized storage.

  3. Network Effects

    Decentralized exchanges. Similar to how the NYSE and CME derive value from the fact that you have many buyers and sellers who want to aggregate liquidity on their platform. Same thing for uniswap and sushi.

So yeah, very much the same concept here. What we’re trying to look for, same as with equities, are firms where you have a bit of everything. What we’ve discovered is that simply having one pillar is generally insufficient for success. I always give the example Wozniak & Jobs. You have technology and IP, but you really need marketing as well. So what we’re looking for is crypto organizations, stocks, whatever, asset class doesn’t matter, is strength on all of the advantages, or as you know, as much as possible.

David Senra on Invest Like The Best

Patrick O’Shaughnessey interviewed David Senra, the host of the outstanding Founders Podcast. I love David’s passion and storytelling. This interview was the best one I listened to this year. I listened to it several times and it was the first time I asked my son (now 9) to listen to an interview with me. It felt like one of those chats that could inspire an impressionable mind.

They discuss the premise, motivation, and lessons from David’s podcast. The premise of Founders is David studies famous entrepreneurs, scientists, artists or really any creatives that made a large impact and distills pitfalls and lessons from their stories. It doesn’t sound novel, except David’s personality and enthusiasm make you feel like you are hanging out listening to a friend tell a crazy about another friend (except that last “friend” is a historical figure)

The following notes are what stood out to me.

My son Zak also took notes (we made this an exercise because in 4th grade this year he’s learning to take notes). It was fascinating to discover where he wanted to pause the interview to jot something down that stood out to him. One of the reasons the episode might have been especially fun for him is we just finished watching The Men Who Made America series on the History Channel and Senra discusses many of the “captains of industry” or “robber barons” featured on the TV series.

Link: https://www.joincolossus.com/episodes/85503387/senra-passion-pain?tab=transcript


Books as mentors

Senra came from a challenged family. He wasn’t only the first male to graduate HS, he was the first to not go to jail! When he studied Warren Buffet, he recalled that Buffet said, “One of the best things ever happened to me is I picked the right heroes.” I think that is extremely important. So that is the role that books play for me.  I don’t have access to these people, I didn’t have mentors. I didn’t have anybody.

Senra’s career is the embodiment of what I described as The Engine Model

  • There are four passions in my life, entrepreneurship, reading history and podcasts, so Founders sits in the middle of that.

  • People say “Founders is podcast, Founders is business.” Yeah, but it’s an obsession first. It’s an obsession disguised as a podcast in a business.

  • The reason I’m so obsessed with just studying people that got to the top of their profession is because one third of your life is going to be spent working. Half of your conscious life, half of the time you’re not asleep, is going to be spent working. For a certain personality type, to not excel at that, to not be really good at that means that life is not going to be an enjoyable experience for me. If I had to guess, which comes up a lot, I think there’s some kind of deep-rooted fight against a sense of inferiority that is underneath it.

  • It’s interesting, this comes up a lot, there’s a line in the Francis Ford Coppola biography that I read, because I really love reading biographies of filmmakers, that’s the closest analogy to what I’m trying to do at podcasting. I read their words and I’m like, “That’s how I think about podcasting. That’s fascinating.” And there’s a line in the Francis Ford Coppola biography where, embedded in the story of the son is the story of the father. And his dad was this guy, he wanted to be a musician. He never made it, was super bitter. So he raised Francis Ford Coppola and they would just talk shit, his dad would just talk about anybody that was successful. And Francis is like, “Well, I don’t want to be the person criticizing the successful person, I want to be the successful person.”

  • And I think a lot of that came from how we started the conversation, some people have to say, “Hey, I want to be like that guy.” Other people have, “I don’t want to be like that guy.” And those are equally powerful motivators.

[This reminds me of Ambition As An Anxiety Disorder]

Originality and ego

  • To be an investor, to be an entrepreneur, it doesn’t work if you can’t trust your own judgment. So what kind of person who’s willing to take that risk? I know a ton of entrepreneurs that could even make more money, if they went to go work for Google or something like that. They’d rather make less money in their own business, than work for somebody else. But there is something bizarre that I don’t think you can explain. All you can do is notice it in other people, and then seek those people out like, “Oh, I’m not weird. There’s a ton of people just like me.”

  • But Edwin Land said that there’s no such thing as group originality or group creativity. He goes, “I do believe wholeheartedly in the individual capacity for greatness.” And he says, “Originality are attributes of a single mind, not a group.”

  • I actually don’t think that you build a great company without a giant ego. I don’t think that exists. Sam Walton has a good idea about that. He’s like, “Listen, your ego should use to drive you, but you should not be on public display.” And he’s like, “I hire people at Walmart with big egos, that know how to hide it, because there is some weird thing where it drives you.”

Confusing people liking the work for liking you

We talked a little bit about ego before we started recording, where it’s very prone to let your ego get the best of you. People admire you because the work. What happens is, you usually isolate yourself. You’ll work really hard. You’ll do a lot of work. That work draws the attention of other people because it adds value to their life. And then suddenly, over time, you confuse us. It’s like, “Oh, they don’t like the work. They like me. And then I could just show up without having to do the work and everything will be fine.”

[Reminds me of the Asimov line: Past glories are poor feeding]

On constant learning

The reason I say that Jordan’s biography changed my life is this idea of practice. How many people want to get to the NBA? A ton, millions. How many get? 400 maybe. How many people get to the Dream Team in Barcelona in ’92, which might be the greatest basketball team of all time? 15 people. A subset of a subset of a subset. Michael’s tired. He’d been playing nonstop, back-to-back. He’s like, “Man, I really want to take some time off. I don’t want to spend my summer for the Olympics, but I’m going to go.” He goes, “I want to see their practice habits. We’re all the best of the best, what am I doing that’s different than what they’re doing?” What happened was he goes, he watched the way they practiced compared to the way he practiced. The main theme of Jordan’s book is I believe in practice. I would rather miss a game than miss practice. That’s insane. He said something that gives me chills to this day. He goes, “I watched their practice habits,” and he goes, “they’re deceiving themself about what the game requires.”

Obsession and endurance

“If anything is worth doing, it’s worth doing to excess” – Edwin Land, Inventor

  • On my phone, my lock screen, is a picture of Ernest Shackleton, the famous polar explorer, who looks like hell. He’s got a huge beard covered in ice. He looks like he’s about to die. And his family motto was, “By endurance, we conquer.” Which is why I told you earlier, I’m only interested in people who do things for a long time. Because at every single step, these people are presented with opportunities to quit and they don’t. So he’s like, I don’t have to be the smartest. I don’t have to be the best. I don’t have to be the talented. This is what I believe in myself. I don’t have to be the best. I don’t have be the smartest. I don’t to be the most talented…if you do something for three or four or five hours every day that most people don’t do, you’re going to develop a value for other people in the world, and that’s all a business is. The best description of a business I ever heard came from Richard Branson. He’s like, “All businesses, it’s an idea or service that make somebody else’s life better. If you make other people’s life better, you’ll capture that value in return.”
  • I’m not a fan of moderation. I’m attracted to extremes. What do you want your life experience to be? Do you want to be exceptional? Do you want to push the boundaries of your capabilities? Do you want to walk around in a fog butting up against your potential but never actually realizing it? Then knock yourself out. Be moderate. I’m not interested in that. (Zak loved this!)

Understanding what you want — the soul of a business

I read this great book called Masters of Doom, which is obviously about the video game Doom. There’s John Romero and John Carmack, and John Carmack said something in what causes the rift of their partnership. He’s like, “Romero wants an empire. I just want to make great games.”

Senra relates to Carmack:

Founders is like a handmade product. And I was like, thank you because that’s what I think about. It’s a handmade product at scale because of the miracle of podcasting. I can do everything myself. I don’t have anybody helping me…role of the founder is the guardian of the company’s soul. There’s a cult around In-N-Out because the expression of the founder’s soul is manifest in the product. People have In-N-Out tattoos. Who are your entrepreneurial heroes? Everybody copies somebody, dude. You’re a human. I always have a maxim by saying in my podcast that the mind is a powerful place. What you feed it affects you in a powerful way.

The culture of a company as a reflection of the founder

The quote that comes to mind when I think of the founder as the guardian of the company’s soul is actually a quote about Steve Jobs. It’s in one of the books I read about him and he says he made and remade Apple in his own image. Apple is Steve Jobs with 10,000 lives. That gives me goosebumps because that’s exactly what a founder should be doing. It’s impossible to build a company, to spend all your life energy on it, and not have it imbibed with your personality, with your ethics. Everything that you think about your business and your life is going to seep into it. The good and the bad parts.

Patrick: It reminds me of a conversation I had with Tony Xu who started DoorDash. Tony’s a very mild-mannered, very humble, almost quiet person, which is why this quote from him stands out in my memory so strongly, which is I asked him something about culture.  How do you think about constructing the culture of a company? His answer is basically, “I think a culture of a company should be like 80 or 90% just the personality of the founder. That’s it. It should be the extreme characteristics of the personality of the founder. Because if you try to make it generic, nothing stands out and there’s no progress and inertia dominates.

Process as art (and marketing)

Patrick: It sounds like a common theme in all these stories, is process as art by revealing the process behind the product, because they’re so obsessed with that. That is a common marketing story. Do you see that over and over?

There’s no such thing as a business that is boring. Listen, it’s boring to you because you do it every day. If you explain to the customer the process, they’ll find it interesting. If there’s any part of your product that seems banal or ordinary to you, I promise you, no one is thinking about your business as much as you. The favorite business of mine in the world, you think about it less than probably five minutes a week. Nobody is thinking about it. You have shit in your brain that is interesting to customers, and then you could package that up and use that as marketing to get more customers.

The most recurring theme in Founders stories

  • We may or may not have talked about the most important, and that’s the best maxim in the history of entrepreneurship was said by the founder of Four Seasons, that “excellence is the capacity to take pain.”…Anybody that’s ever done anything difficult, whether it’s a company, anything, knows the euphoria and terror. It’s the entrepreneurial emotional rollercoaster. The reason that I think it’s so important to talk about is because it is supposed to be hard. There’s not a book you’re going to pick up where the guy or woman’s like, “Hey, I had this idea. I started it. Everything went great,” and the end of the book. It doesn’t happen.
  • James Dyson. It’s hard to find, but if you can get a copy, order it. He says, “Listen, it’s easy for me to celebrate my doggedness now. I made $300 million last year, but I’d be lying to you if there wasn’t times where I went inside my house, had my wife look at me in the face like I’m a failure and I’d cry myself to sleep, and I got up and did it again anyways.” [Dyson made over 5,000 prototypes in 14 years before landing on the bagless vacuum that made him a household name]

Because excellence is the capacity to take pain:

  • I apply this to like, “I don’t really feel like working out right now. I don’t feel like doing cardio.” I don’t give a shit, David, how you feel. How you feel is irrelevant. That’s an idea I got from Henry Ford. You read his autobiography, he goes, “I feel sorry for these soft and flabby men that can only do great work when they feel like it.” Essentially, Henry Ford is saying “fuck your feelings.” Henry Ford’s point was a business exists to serve other people. There are going to be days when you get out of bed and you cannot wait to get to work, and that’s great. There are going to be days when you don’t want to go to work, and that is irrelevant because the business is not about you. The business does not exist for your pleasure. The business exists to serve other people. [Kris: this is why you should probably care about the customers]

The kindest thing anyone has ever done for David

The kindest thing anybody’s ever done for me happened a few decades before I was born. My grandfather on my dad’s side was living in Cuba. He was just 38 years old. He had a wife and a newborn baby when the Cuban Revolution happened and Castro took power. He didn’t understand the language, had no money and no education, and yet took the gigantic risk … and the complete correct choice at that time in his life … to flee Cuba to go to America, to give his family a better chance and a better opportunity. That one decision changed the entire trajectory of my life. None of my interests that I happen to be naturally born into, the passions that chose me, that I did not choose, would make a lick of difference if I grew up in Castro’s Cuba as opposed to America. As somebody that studies dead people for a living, it really resonates how our decisions not only affect our loved ones now and our family now and our friends now, but they reverberate through the generations. If you think about it not in the context of what’s going to happen in your life this year or next year, but how the decisions you’re making will affect people that aren’t even born yet, you’ll make your decisions differently.


My 9-year-old Son’s Takeaways

  • David only had books as a kid. NOTHING ELSE
  • David’s extended family is all EVIL
  • “Many people can run a company but not many can create one”
  • In every one of Rockefeller’s biographies, J. Gould always pops up.
  • Jordan joined the Dream Team just to see how other countries practice.
  • ” I’m not a fan of moderation. I’m attracted to extremes. What do you want your life experience to be? Do you want to be exceptional? Do you want to push the boundaries of your capabilities? Do you want to walk around in a fog butting up against your potential but never actually realizing it? Then knock yourself out. Be moderate. I’m not interested in that.”
  • “Nobody can think clearer than Steve Jobs”
  •  “Hey, those are good ideas. Human nature doesn’t change. Let’s use them.”
  • David reads his highlights 5 times.
  • What I like about podcasting is it is completely permissionless.
  • Dyson:  “Listen, it’s easy for me to celebrate my doggedness now. I made $300 million last year, but I’d be lying to you if there wasn’t times where I went inside my house, had my wife look at me in the face like I’m a failure and I’d cry myself to sleep, and I got up and did it again anyways.” Excellence is the capacity to take pain. I apply this to like, “I don’t really feel like working out right now. I don’t feel like doing cardio.” I don’t give a shit, David, how you feel. How you feel is irrelevant. That’s an idea I got from Henry Ford. You read his autobiography, he goes, “I feel sorry for these soft and flabby men that can only do great work when they feel like it.” Essentially, Henry Ford is saying “fuck your feelings.” Henry Ford’s point was a business exists to serve other people. There are going to be days when you get out of bed and you cannot wait to get to work, and that’s great. There are going to be days when you don’t want to go to work, and that is irrelevant because the business is not about you. The business does not exist for your pleasure. The business exists to serve other people.
  • In every episode, Patrick asks “what is the kindest thing anyone has ever done for you?” [I told Zak that fact, I guess he thought it was worth writing down]

Founders Podcast Reads Ed Thorp’s A Man For All Markets

On the Founders podcast, host David Senra distills stories and lessons from Ed Thorp’s biography A Man For All Markets. 

Link (with transcript): https://www.joincolossus.com/episodes/63171342/senra-ed-thorp-my-personal-blueprint?tab=transcript

A thought before I get to my notes:

Senra’s outstanding podcasts are thoughtful Cliff notes to the biographies of successful business founders. It’s a great series because the same themes keep popping up. The repetition is a great way for having the common threads that bind these founders stick. (In fact, “repetition” itself is such a common theme. Most of the founders are extremely focused, taking a small set of ideas to their logical extremes. There is a focus and lack of distraction. Many founders understand the importance of branding which entails “repetition”. Having your product synonymous with quality, or low cost, or prestige, whatever it is. Repetition is a cornerstone to establishing a brand.)

An oft-repeated theme on Founders is that the subjects are deeply flawed, often miserable. You are warned to not glorify them but instead extract their deep but narrow wisdom, instead of copying their lives. This episode is special because Ed Thorp is the one person, Senra uses as his own personal blueprint.

And I agree. Thorp in his entirety (or at least what we can know from his public action and writing) is an admirable and impressive individual.

I strongly recommend listening to the podcast.

The following are my notes. They are bits that stand out to me and not a summary. They are for my future reference and of course, shared for anyone else who cares.


On mediocre people

“I would learn to avoid them when I could and finesse them when I couldn’t”.

That’s one of the most important sentences in the entire book.

“I would learn to avoid them when I could and finesse them when I couldn’t”.

2 simple guiding questions

If I do this what do I want to happen and if I do this what do I think will happen?

Expect corruption

If there’s a way to make money, the larger the stakes, the more corruption you will find

Ed found patterns of corruption from a young age:

He’s in high school, he realizes, “Hey, the student government is corrupt. It’s just a bunch of the popular kids. Popular kids are not doing anything that can actually help”. He is probably the smartest kid in school. I mean, Ed is no doubt a genius. So he figures out a way. He’s the one leading the charge, and he winds up installing people that think like him in like 13 of the 15 positions. So this made him an enemy. He says, “A couple of the candidates realized I must be behind the change, so they’re doing advertising”.

They’re doing basically a bunch of things to remove people he felt were in unjust positions. “A couple of the candidates realized I must be behind it and spent their campaign speech time attacking me personally”. The social click had always run the student government. They were entitled.

When he starts counting cards he realizes that not only are the casino’s all “mobbed” up to keep people like him out. He was poisoned and later after he gets the gaming commission to send an inspector he learns that the inspector is in the casino’s pocket. It totally backfires, as the inspector is able to fiinger Ed out to the casino whose mobsters cut his car’s brakes to kill him!

Senra compares this to the drug trade in Miami in the 1980s:

There’s a great documentary called Cocaine Cowboys, and in it, they talk about how corrupt the ’80s Miami was. You have a cocaine boom. The richest person in the world at that time was considered to be Pablo Escobar. They’re just printing money. The local Federal Reserve branch in Miami was taking in more in cash than all the other Federal Reserve branches in the United States combined.

And so you have this huge economic incentive. If you’re a drug dealer selling a ton of cocaine, these pesky cops keep catching your guys. They wind up pulling them over, taking drugs, money, essentially costing you an expense, like “I’m losing my product, I’m losing money. So what do you do”? You fill the entire police force up with your people. “So from the outside, it looks like all these cops are there against me, and they’re actually on my team”. And in that documentary, he talks about, “There’s at least 1 graduating class in the 80s, if not more, where every single person, every single new graduate from the police academy was eventually tied to the drug dealers, the cartels, whatever you want to call them” They owned every single cop. And why did they do that? Because they were making tons of money, and money corrupts.

Ed finds Wall Street unsurprisingly more corrupt than the casinos. Bigger stakes:

Eventually, his hedge fund, the East Coast offices, gets raided by the IRS. Rudy Giuliani, who is — this is before he was the Mayor of New York City, he is the lead, what is it, the prosecutor of the Southern District of New York. And this had nothing to do with Ed. Every single thing was wind up being dropped against them. “Rudy Giuliani wanted my partner to give him dirt on Goldman Sachs and Michael Milken. My partner wouldn’t cooperate , so Giuliani raided our office. The trial dragged on for years at a great expense. The government ended up dropping prosecution for most — of most people on most counts”

So it says the case against this hedge fund appears to be a federal prosecution of securities violators. It’s on superficial level, right? To understand why it really happened, you need to go back to the 1970s when first-tier companies could routinely meet their financing needs from Wall Street and the banking community, whereas less established companies had to scramble. Seizing an opportunity to finance them, a young financial innovator named Michael Milken built a capital-raising machine for these companies. This is the invention of junk bonds.

“Filling a gaping need and hungry demand in the business community, Milken’s group became the greatest financing engine in Wall Street history”.

“Such innovation outraged the old” — this is the history lesson, “Such innovation outraged the oldline establishment of corporate America who were initially transfixed like deer in the headlights, as a hoard of entrepreneurs funded with seemingly unlimited junk bonds, began a wave of unfriendly takeovers. Many old firms were vulnerable because the officers and directors had done a poor job of investing the shareholders’ equity. With subpar return on capital, the stocks were cheap. A takeover group could restructure, raise the rate of return, and make such a company considerably more valuable”.

But here’s the thing, the people you’re now attacking are the people they have all the money and the power, and they don’t want you to do this. The officers and directors of America’s big corporations were happy with the way things had been. They had enjoyed their hunting lodges and their private jets. They granted themselves generous salaries, retirement plans, bonuses of cash, stock and stock options, and golden parachutes. All these things were designed by and for themselves and paid for with corporate dollars.

The expenses routinely ratified by a scattered and fragmented shareholder base. Economists call this conflict of interest between management and the shareholders who are the real owners, the agency problem. It continues today. The newcomers were knocking the more vulnerable managers off their horses into the mud. Something had to be done. Government ought to be sympathetic. The old corporate establishment had most of the money, and they were the most politically powerful and influential group in the country. Their Wall Street subdivision might sustain some damage, but one could expect the fall of Michael Milken to release, as it did, a huge honey pot of business to be taken over by everyone else.

The old establishment of financiers were lucky in that prosecutors would find numerous violations of security laws within the Milken group. So he’s not saying that Michael didn’t do anything wrong. His point was that the people that he was overthrowing had sway over with the politicians and used their money in power to say, “Hey, go after that guy, even if we’re doing some of the same shady stuff, okay”?

This is where Ed is going to give us his thinking on this with the — like a story, a metaphor. “It’s like the case of a man who’s been cited 3 times in a single year for driving while intoxicated. His neighbor would also drink and drive but was never pulled over. Who’s the greater criminal? Now, suppose I tell you that the man who did it only 3 times and was apprehended every time, whereas his neighbor did it 100 times and was never caught. How could this happen? What if I tell you that the 2 men are bitter business rivals, and the traffic cops’ boss, the police chief, gets large campaign contributions from the man who gets no traffic citations? Now, who is the greatest criminal”?

Madoff

And so this kind of echoes Ed’s experience with Bernie Madoff in the SEC when he discovered there’s a ton of people, Ed just being one of them, that knew Madoff was running a Ponzi scheme had told people about it. So he’s asked the question, “Did you ever think you should go to the authorities with this”? And then this is Ed’s response, “Bernie Madoff had been a Chairman of NASDAQ. He was the third biggest market trader in the U.S. He was on all types of committees. He was the establishment. The SEC checked him every year and gave him a rubber stamp of authenticity”.

Ed’s schooling us not on how we think the world works or how we think it should work. He’s telling us how it does work.

[This section was resonant because I’m currently watching the History Channel’s The Men Who Built America series which is littered with stories of corruption…manipulating stock prices, collusion, Carnegie/Rockefeller/JP Morgan buying the 1896 election by supporting pro-industrialist monopolist McKinley over threatening populist William Jennings Bryan. Teddy Roosevelt’s eventual anti-trust campaigns were a direct retaliation on behalf of downtrodden workers. Even the Edison/Morgan vs Tesla/Westinghouse battle over the electricity standard led to Morgan/Edison muscling out Tesla/Westinghouse whose AC technology triumphed by threatening lawsuits they knew Westinghouse could not afford to fight even though Morgan knew he would lose in court]

Share in public

The importance of like putting your work out there, putting your thoughts out there and sharing them because it leads to all these unexpected opportunities. He winds up being like first LP in Citadel as a result of this.

The people that are interested in learning what you’ve learned also happen to be people that are lifelong learners. And those are the kind of people that get themselves involved in very interesting activities in the future. Many of those interesting activities can have a financial benefit to them.

Status

Acknowledgment, applause and honor are welcome and add zest to life, but they are not ends to be pursued”.

“I felt then, as I do now, that what matters in life is what you do and how you do it, the quality of the time you spend and the people you share with”

“Chance and choice”

“Life is a mixture of chance and choice. Chance can be thought of as the cards you dealt in life. Choice is how you play them. I chose to investigate blackjack. As a result, chance offered me a new set of unexpected opportunities”.

Heraclitus, said, “Character is destiny”

“The path I would take was determined by my character, namely what makes me tick”

Voracious consumer of information

A lot of the stuff you’re going to read is not useful, but it’s all the little bits that you pick up that lay the foundation that are actually useful in the future. “Much of what I read was dross, but like a whale filtering the tiny nutritious krill from huge volumes of seawater, I came away with a foundation of knowledge”

Ed and Warren Buffet meet as Buffet starts Berkshire and Ed starts Newport Princeton

As Warren and I talked, the similarities and differences in our approach to investing became clearer to me. He evaluated businesses with the aim of buying shares of them or even the entire company, so cheaply that he had an ample margin of safety to allow for the unknown and the unanticipated. His objective was to outperform the market in the long run, and so he judged himself largely on the performance relative to the market.

“In contrast, I didn’t judge the worth of various businesses. Instead, I compared different securities of the same company with the object of finding relative mispricing from which I would construct a hedged position. Long, they’re relatively undervalued; short, they’re relatively overvalued, from which I could extract a positive return despite stock market ups and downs”.

So his entire life, he operated a market-neutral hedge fund, and I’ll get to more of his numbers and stuff later on. His goal was to accumulate the most money. Warren began to invest while still a child and spent his life doing it remarkably well. My discovery is fitting with my life path as a mathematician and seemed much easier, leaving me largely for you to enjoy my family and pursue my career in the academic world.

And what’s crazy is he’s going to start the world’s first quantitative hedge fund, it’s called Princeton Newport Partners. He’s still working as a professor, for like the first like 10 — even though he’s rich — or he started — like starts to get really rich, like 10 or — I have to know in the book, it’s like a dozen years into it. He’s like, “All right, I can’t do both. I got to finally give up. I’m sad to give up my academic life, but I’m clearly on to something here”. It’s just amazing how long he stuck with it.

So this is the result of — they wind up spending — I think they meant like 2 or 3 times, and this is where he realizes that Warren Buffett is an intelligent fanatic. And so the crazy thing is not only did Ed Thorp make a ton of money, but like I said, he winds up buying Berkshire, starting investing in Berkshire stock. It was like $900 at the point when Ed Thorp starts building position. And then he tries to get other people to buy and he tells them, don’t ever sell this, this will make your family rich…

Impressed by Warren’s mind and his methods as well as his record as an investor, I told Vivian that I believed he would eventually become the richest man in America”. Buffett was an extraordinarily smart evaluator of underpriced companies, so he could compound money much faster than the average investor. He could also continue to rely mainly on his own talent even as his capital grew to an enormous amount. Warren furthermore understood the power of compound interest and clearly planned to apply it over a long time.

The intelligent fanatic is extremely important, and hopefully, you are one in your own business, and if not or you don’t have a desire to, then find somebody who is and let your money ride with that person.

Hiring and management

4 different ideas – one, management by walking around; two, hire for intelligence and enthusiasm over experience; three, hire on a trial basis; and four, talent is expensive and worth every penny.

“Now, I had to learn how to choose and manage employees. Figuring this out for myself, I evolved into the style later dubbed management by walking around. I talked directly to each employee and asked them to do the same with their colleagues. I explained our general plan and direction and indicated what I wanted done by each person, revising roles and tasks based on their feedback”.

“For this to work, I needed people who could follow up without being led by the hand as management time was in short supply. Since much of what we were doing was being invented as we went along and our investment approach was new, I had to teach a unique set of skills. I chose young, smart people just out of university because they were not set in their ways from previous jobs. It is better to teach a young athlete who comes from his sport fresh than to retrain one who has learned bad form, especially in a small organization”.

“It was important that everyone worked well together. I was unable to tell from an interview how a new hire would mesh with our corporate culture. I told everyone that they were temporary for the first 6 months, as we were for them. Sometime during that period, if we mutually agreed, they would become regular employees”.

“In order to attract and keep superior staff, I paid wages and bonuses well above the market rate. This actually saved money because my employees were far more productive than average. The higher compensation limited turnover, which in turn saved time and money otherwise you used to teach my one-of-a-kind investment methodology”.

First LP in Citadel

“What would have Princeton Newport Partners been worth 25 years later? How could I possibly have any idea? Amazingly enough, a market-neutral hedge fund operation was built on the Princeton Newport model, the Citadel Investment Group”.

“It was started in 1990 in Chicago by a former hedge fund manager named Frank Meyer. When he discovered a young quantitative investment prodigy, Ken Griffin, who was then trading options from his Harvard dorm room. I met with Frank and Ken outlining the workings and profit centers of PNP as well as turning over cartons of documents outlining in detail the terms and conditions of all their outstanding warrants and convertible bonds. These were valuable because they were no longer available”.

“Citadel grew from a humble start in 1990 when I became its first limited partner, that’s insane by the way, with a few million dollars and 1 employee, Griffin — with 1 employee, which is Griffin, to a collection of businesses managing $20 billion in capital and having more than 1,000 employees 25 years later. Ken’s net worth in 2015 was estimated at $5.6 billion”. I think today at the time I’m recording this, his net worth is over $20 billion, if I’m not mistaken.

[Really interesting insight that has implications for markets]

Though the institutions of society have difficulty learning from history, individuals can do so.

Why is lifelong learning so important?

“Education has made all the difference for me. Education builds software for your brain. When you’re born, think of yourself as a computer with a basic operating system and not much else. Learning is like adding programs, big and small to this computer. From drawing a face to riding a bicycle to reading or to mastering calculus, you will use these programs to make your way in the world. Much of what I’ve learned came from schools and teachers. Even more valuable, I learned at an early age to teach myself. This paid off later on because there weren’t any courses in how to beat blackjack, build a computer for roulette, or launch a market-neutral hedge fund”…I found that most people don’t understand the probability calculations needed to figure out gambling games or to solve problems in everyday life. I believe that simple probability and statistics should be taught in grades kindergarten through 12.

The best jobs are neither decreed nor degreed, they are creative expressions of continuous learners in free markets.

Notes From An Interview With Serial Entrepreneur Keith Schacht

Link to Founder’s Mindset Podcast episode: https://pod.co/the-founders-mindset/s2-e4

About Keith Schacht:

What are the psychological building blocks that support a serial founder’s journey from ideation to massive growth to acquisition, to building again—and again?

On this special episode of The Founder’s Mindset, Dr Gena Gorlin is joined by serial Silicon Valley entrepreneur Keith Schacht, who has founded and sold 4 technology companies. His latest, Mystery Science, was being used in over half of American elementary schools at the time of its acquisition by Discovery Education. 

Now, he’s working on world-changing venture number 5.

He joins Gena for a candid discussion of how he stays anchored to reality during that elusive, early search for product-market fit; why and when he made the decision to sell his company; and how he approaches starting all over again. Gena and Alice then debrief to explore what other founders can learn from his experience.


These are some of my favorite insights or inspirations from the interview:

Building companies as an instance of building things

As long as I can remember basically, I’ve been interested in starting companies, although I didn’t initially conceptualize it as starting companies. I just I just thought of it as building things. I like to build things and companies ended up being another kind of thing I like to build and a vehicle, for building more things. So I mean, really, when I was in high school, even I discovered the internet and I’m younger than that I discovered programming. But when I discovered the internet, I discovered that people would pay me real money to build things on the internet.

Me: Note that it has nothing to do with making money. In fact, if one’s goal was to just make money you could make the case that entrepreneurship is one of many, and possibly, inferior paths

Keith’s response to the struggle and curveballs native to entrepreneurship

I think it’s not smooth but I just never expected to be smooth so so you’d I don’t get upset when it’s not. So it’s like when you’re off-roading you expect lots of bumps.

An example

An example from my previous company Mystery. I had a very specific idea about something that I thought would be good and it was basically a line of science kits for kids that would help them explore the world.  I remember very specifically the spark of that idea came when I was walking through a toy store. I like toys as a product category. And I noticed that there was a particular aisle like the science toy aisle, and it struck me how familiar it was. There was like a two-liter bottle tornado and a crystal growing kit etc. “Wow, this is a pretty stale product category.” I had a lot of experience building these kinds of toys myself just for fun so I thought it would be a really interesting business opportunity here.

That led to conversations with a friend of mine,  a science teacher at the time. And so we started this business with this sort of clear idea of maybe we’ll do a lot of science kits, but the broader opportunity was helping kids understand the world. My co-founder and I were both new parents and this is a classic case where I was excited about something particular, but I had a conviction about a broad space. And, you know, we quickly tested this particular idea and it turned out to not be a good idea. We built prototypes and put them in the hands of parents. Multiple parents told us how “we’ll do it this weekend” and then we checked them in with them on Monday. “How was it?”

“Oh, we didn’t get to it.”

And then weeks go by. So we pivoted and was like, maybe we’ll do a different idea. And it was a classic example of having strong conviction about sort of a broad area of opportunity and specific ideas but sort of flexible on whether that particular idea was the right one. It was many iterations later before we finally got something so we ended up building — instead of a line of science kits for kids to do a home, we built a set up for digital resources for elementary teachers to use in the classroom to teach science to kids. We solved the real problem for elementary teachers. [He previously gave some background that before high school, general elementary teachers teach science and many find it daunting.]

Keith, without meaning to probably, reveals how his approach actually looks like science

I think one of the most important things at every step of this discovery process is to be really clear on what you know, and what you don’t know. And not to ever confuse the two.

We prototyped a line of science kits and put them in the hands of a bunch of parents. And it’s very easy, after the moment it didn’t work to conclude “Oh, no one wants a line of science kits” or some broad generalization like that. This is too general.

The right way to hold it is “the particular prototype I built, that I put in the hands of the six parents wasn’t used by any of the parents.”

And when you hold the conclusion that way, it leaves the door open to “maybe it was the wrong set of parents, maybe there’s a different group of customers with the exact same product or maybe the idea of lighter physical science kits was a good idea, but those three that we made were bad for a particular set of reasons.”

And so that’s it’s such an important part of the journey. Be really clear on what you know, what you don’t know what to kind of hold those conclusions in the right way.

And I think that’s what makes the journey feel, you know, bumpy and circuitous but not frustrating. It’s just the process of coming to understand the nature of the world and your customers and your idea.

Product-Market Fit

How did we finally know [when we were on to something]? On prototype number six, we had built something that we tried on parents and a number of parents gave we gave it to their kids’ teacher. We thought that was an interesting clue since didn’t immediately jump on elementary teachers at that point. When we did finally decide to build a prototype for teachers. We initially built one for middle school science teachers because we want to help them teach science. That one didn’t work, either. They didn’t use it. I had a friend of a friend who was an elementary teacher and happened to show her one of these prototypes. And she was excited about it. One of the breakthrough moments was she told us about a set of lessons that she needed to teach soon.

We just offered to help her. “So what’s this particular lesson? Okay, well, what if we prepared the following things for you and sent that over within a couple days? Would that be helpful to you?”. And we sort of followed her lead in a really concrete way, like a specific day a specific lesson, a specific problem, and we helped her and that’s that was sort of like big clue number one. She got really excited about what we gave to her use quickly and asked for more.

You’ll know when you have it

Yes, it’s very abstract to tell someone “make something that people want, and you’ll know when they want it.” But I have built things before that people didn’t want and I built things before that people really wanted. You can really see the difference. People use lots of different analogies like “customers actually wanting something from you and pulling it out of your hands instead of you calling them ‘would you like to try this? Oh, sure. I’ll try it. I sent it over. You don’t hear anything for 48 hours. Did you get a chance to try it? Oh, I haven’t gotten to it yet.’

But you can tell what it feels like when you are the one providing the energy to push this product forward versus your customers bringing the energy and sort of pulling it out of you in those early days. Many times Doug, and I would have the conversation. “Is this one what product market fit feels like?” And I would say to him “Oh no, you’ll know.” You could tell the difference. And when we finally got this first elementary teacher who was excited and asking for more, and then we got a few more elementary teachers, I remember Doug remarking “Wow, this feels so different than those other prototypes we built where no one really seemed to care and we got 200 signups, but then no one would use it.”

There’s a meta-discussion linking back to 2 Y Combinator principles:

  • This was an example of “doing things that don’t scale”
  • This is what it looks like to try to build something people actually want.

    It’s so easy to make something you want people to want, but they just don’t want it. Just the other day I got an email from a friend who has built a prototype and wants to show it to me to see what I think. And just based on the email my first reaction after reading this email was”it doesn’t really matter what I think” because I’m not the customer. I wonder if this person has shown it to five customers by now before building the whole thing. And that was my feedback on this. Because so often people miss that step. And so I really don’t care what anyone thinks except the potential customers that we think we’re going to be serving with these particular ideas.

Excerpts From Benn Eifert on the Odd Lots Podcast

Link: https://www.bloomberg.com/news/articles/2022-08-01/benn-eifert-on-the-mania-that-was-even-bigger-than-meme-stocks?srnd=oddlots-podcast#xj4y7vzkg

About Benn: Founder of QVR Advisors specializing in option-based strategies

I found the transcript here.


The craziest aspect of the investing mania of the last few years was the role of sophisticated instituitions

Benn: I would say actually I found the sizes of the unsecured loans that very large, and you might have thought sophisticated, investors and credit organizations were giving to Three Arrows Capital, two and a half, you know, two and a half billion dollars for Genesis alone with like no collateral. I mean, you come into this just thinking, look, these are big boys. These are wealthy people who’ve created a tremendous amount of money and they wouldn’t just do completely, obviously crazy stuff like that. And then it turns out that the answer is, of course they do…I think retail gets all of the attention and you know, we can talk about that all day and there’s all kinds of interesting stuff there, but I think people forget that the role of institutional investors in this process and the way that institutional investors start to buy into narratives and start to, you know, start to develop this fear that they’re missing some huge technological revolution, and then do incredibly crazy things in huge size, is almost a more interesting story

 I think a big part of the institutional role in that really came from this huge psychology around private assets and private investments being this fantastic place to be, you know, big sources of innovation, stable returns, because, you know, without mark to market volatility, right, you saw just really in the last few years, you see the formation of VC growth funds, right? So you always used to think of venture capital as, you know, these nerdy, weird engineers doing cool science experiments and backing these early stage companies to do really disruptive stuff.  Whereas growth funds were all about raising mega institutional scale capital at full fees with long lock and plowing that into companies that were already valued at $200 billion and just had a completely different asymmetry to the return profile.

And you had corporates like SoftBank and hybrid public private hedge funds like Tiger, you know, coming in to compete for deals, to get those deals with startups, by saying, ‘look, we have bigger checks and we’re not gonna ask you any annoying questions. We’re not gonna do due due diligence. Like, I want you to sign the term sheet in 24 hours that I just sent you.’ And that was really, you know, alot of that came from, I mean, and I think I had a Twitter post about this, but you know, 2019, 2020, I would go to conferences with big institutional investors. And the only thing that you would hear about was how big asset owners were taking money out of liquid alternatives type of investments and moving them into privates because the returns in privates had been so high and there was such a perception of such limited risk in practice.


The role of narratives and how the ability to spin them about the future can become a gray area or market failure

Benn: Just to be clear, technology itself is not the problem, right? I mean disruptive technological innovation is what drives the world forward. And, you know, Silicon Valley and venture capital plays a really important role in that. And that’s great, but that technology inherently has this characteristic, right? That you’re not selling a current set of cash flows or a well-trodden path of how, you know, that can be valued by people with spreadsheets in some kind of relatively formulaic way. It’s about selling a vision of the future and a vision of what could be and how that can play into future economics and trying to relate that to past innovation. And that’s a very nebulous thing in the end. And it’s something that is inherently susceptible to hype and narrative, particularly when the, I think, as you’ve seen in recent years, particularly when financial markets set up ways for people to get actually paid and to monetize that kind of narrative and hype, right? As opposed to, ‘Hey, I finished building this company and then it becomes a big company. And then I get really rich,’ right?

When it becomes, ‘I sell this vision of a future that’s really disruptive. And then I can issue a token and I can sell it to retail and I can make a billion dollars just by doing that without actually building anything.’ Or similarly, you know, in technology, if I can create a startup that gets valued at $300 billion, and then I can go into the secondary market and I can get liquidity as a founder and sell a lot of my shares to like institutional investors that want to get some, right? And I think that’s the inherent trick with technology is that it is inherently by its nature, much more susceptible to narrative-driven, you know, valuation and narrative-driven thinking.

And that is what it is, right? That’s not something that’s gonna go away, but it’s something that investors, you know, have to be really cautious about how to differentiate. And you get, it’s like the early phases of a technology cycle. You get those nerdy engineers building really cool stuff in the garage, but then the MBAs start to show upright? That’s kind of a classic line in Silicon Valley. And you end up with a lot of huckster types coming in to kind of ride along the wave because there’s so much money involved and that’s where you get the trouble.

[Me: There’s a bit at the end of the podcast that ties back to this in which crypto which is intellectually seated in unfettered free market ideology ironically self-skewers that ideology]

Benn: But crypto, I think at the core of it, crypto really owned and brought to the forefront, this idea that financialization is first, right? And the use cases sort of follow and that you’re supposed to have, it’s this very like pure Chicago Department of Economics, efficient markets idea, right? That like, if everything is priced a priori, the market is sort of all knowing and all seeing and people will identify the things that are gonna work and they’re gonna finance those. And like the world is gonna be utopia. And it’s completely ridiculous.

It, you know, what actually happens in practice is that if you can create a narrative and create a hype cycle around your company and you get the right VC backing and whatever it is, and then you can create money by issuing a token and you can sell it to retail n humongous size and you can make hundreds of millions or billions of dollars for doing absolutely nothing. And that happened over and over and over and over again. And it was sort of institutionalized as a business model by certain venture capital firms that, you know, are big backers of this space. And I think that’s the core issue.

Joe: Well, I forget who made this point, but yes, you might say that crypto has attracted the best and the brightest of the last several years, but if they’re the best and the brightest, they might be the best and the brightest at figuring out how to make life-changing amounts of money in six months, which is not necessarily the foundation of a sound new industry.

Benn: Yeah. You give people really strong financial incentives and it’s really hard to resist, right? It’s easy to obviously point fingers at the most egregious people in the space and Do Kwon, and all these guys, but like if you create a world in which it’s really easy for charismatic hustle-type people to get really rich by scamming people, they’re gonna do that. And you have to expect that, like, that’s just how the world is gonna be. And I think that’s what the incentives that we’ve set up in crypto have really done.


The challenge of separating hype from real change is hard but it’s easier to rule out than rule in

Joe: How do you know who’s just a storyteller in real time versus someone who is actually correctly identifying a new trend because, you know, you mentioned Warren Buffett in the beginning, he was wrong. Not all of the curmudgeons in a certain area, get vindicated in the end, he was wrong to dismiss the Googles and the, you know, the Facebooks in 2010…so in real time, investors really are faced with a tough decision because sometimes the world changes and it can be really hard to disambiguate in real time between who is a huckster, trying to, you know, sell their token or whatever, versus someone who’s identifying a real change that’s happening.

Benn: It’s really, really hard in real time — to your point. And I think that the reason it’s really, really hard is because again, we talked about momentum is a real phenomenon and structural change in the world. And technological change is a real thing, right? And so you have to keep an open mind and you can’t take the curmudgeon approach, right? Where anything that’s new or anything that people are excited about or that’s going up in price sort of must be wrong. And you see a lot of that kind of thinking, kind of behavior. That’s the wrong mental frame, right? I think it’s easier to think about identifying and screening out the stuff that has a lot of red flags and is fairly clearly actually a bunch of hucksters, as opposed to on the margin, solving the Warren Buffett question. Was there a path for Warren Buffett to figure out that Google and Amazon were real things back in 2010, 2012? There there might not have been. I think that identifying red flags of very likely problems.  I mean, I think you get into things like, okay, do we have projections of returns that are way, way above historical equity returns or based on, you know, nonsensical statements like the Cathie Wood one that we talked about, right? GDP growth of 50% because of artificial general intelligence. You can fairly quickly say, ‘okay, I don’t know exactly what’s going on in the world, but like, that’s not real.’

I think another one, and this I think is very important and hits institutions more, but claims of returns significantly exceeding, you know, the risk free rate but with little or no risk. And that’s the one I think that ends up leading to much bigger problems in financial markets and much bigger problems in the global economy, right? Because people with nice suits and ties and very big offices look at an 8% or 9% or 10%, relatively low risk return. And they think about how they can put leverage on that. And they think about how they could have a five year run making really good money and get paid a lot. And that’s incredibly appealing. And that’s actually the nature of a lot of the biggest losses that you saw in crypto and so forth. It wasn’t necessarily folks buying, you know, Dogecoin and losing a catastrophic amount of money. It was people saying, wow, this anchor protocol, this thing yields 20% and there’s like a Harvard professor that wrote the white paper and, you know, there’s all these credible VCs talking about it. And if I can get 20% on that, and then if I can borrow $10 billion to do that, like I can get really rich, really fast…

I think that the things that I always come back to are to really look out for people trying to credibly claim these astronomical return profiles or pretty high returns with very little risk, because you just have to think of it as the world is full of a lot of very smart, very competitive sharks who run very big businesses that really like getting rich. And if there was an opportunity to make 10% or 20% risk-free in front of you, they would’ve already taken that away from you and done it first. And what it means if you see something like that is that it’s not real, you know, and there’s either some kind of fraud or there’s some kind of extraordinary risk that you’re not seeing. You have to be really wary of extrapolation.

You have to really be very skeptical of overly complex investments with non-transparent sources of return, right? Where people are trying to tell you, this is really good, because it’s really smart and it’s really complicated. And I know you don’t totally understand it. And you have to also be ready to recognize the psychological tricks that the investment world plays on you. Again, a lot of these things, it seems like it should be so obvious, but it’s not, right? There’s a lot of laundering of credibility, right? Legitimization of investment schemes by the backing of authoritative people or people you feel like you should trust. Because especially at peak cycle, people are very willing to lend their credibility to, you know, things that are gonna get them paid. You know, think of, again, the Harvard business school, professors writing the white papers for Ponzi schemes, like Anchor. Using social consensus and group psychology to normalize ideas and narratives and to pressure people to stop asking questions, you know, big Twitter mobs telling you you’re an idiot and you’re not gonna make it, right? And then very much so kind of scarcity or immediacy, like, ‘look, you’re gonna miss the boat. You don’t get it. And it’s like time to get on board or miss the boat.’ 


Despite the “money printer goes brrr” meme, low rates are not just a “dial that determines the level of speculation”. Although the narrative effect of the meme itself may have been a contributor

Benn: I think there are a lot of different contributing factors. And I think this is usually how things go. So I would say commentators tend to focus very, very heavily on low interest rates and quantitative easing and so forth. I mean, I think there’s a role for cheap money on the margin, especially in areas like real estate. But I think that really the direct role of low interest rates or QE here is very overstated. I mean, you look at the history of interest rates and quantitative easing geographically around the world for the last 20 years. Japan’s been doing QE for a very long time. I mean, we had low interest rates in the US for a long time. Previous manias weren’t necessarily associated with low interest rates. And one way to think about it is like with tech stocks going up a hundred percent a year and crypto tokens paying 20% yield. Like if you have to pay 3% or 4% to get leverage versus 1%, I mean, it just doesn’t matter if you are in the frame of mind, but like you want to do those kind of investments. I mean, the idea, and I joke about this on Twitter a lot, but yeah, the idea that like the Bitcoin folks would’ve just bought a bunch of Treasuries if Treasuries paid 6% or 7% is, on its face, ridiculous. And they would all tell you that.

It’s much more about the collective perception of relative risk and return and the growth of narratives justifying that perception, and then the broad socialization of more and more people into that perception. I do think where rates and QE comes in is perceptions of the role of cheap money coordinating investor expectations or kind of the ‘money printer go brrrr,’ you know, ‘buy everything’ meme. I think that’s actually important. That’s probably much more important than the direct impact of rates being a little bit lower and being able to get leverage, right? Is the contribution to the narrative that like all of this stuff just has to go up.

And I do think, I come back, you know, ultimately, and you pointed out other phenomena, I do think what has been important when you look specifically at retail options trading and a lot of the aggressive market participation that has showed up over the last few years, I do think the pandemic played a real role. I think that there’s a self-reinforcing dynamic to the social internet aspect to it, right? It’s not just people sitting at home in their brokerage account doing stuff by themselves. They’re increasingly in Discords or on Twitter or in some kind of social group or Reddit’s WallStreetBets. That’s like a community that’s fun where people talk about investing and they teach each other stuff and they, you know, they overcome the activation barrier of like, ‘how do you open a brokerage account? And how do you put money in it? And how do you actually click a button to trade?’ and all this stuff. And like once that’s there and once it’s a fun entertaining social thing, and it has a group gambling component to it, it becomes much easier to kind of get out of control and much longer lasting, right? Then, you know, it has all the power of the engagement, you know, clickbait of the internet associated with it. And I think that was really important.


The froth probably isn’t over

Benn: I think there’s plenty of craziness left. So I think both in crypto and in tech, there are many funky crypto tokens that are down 90%… but whose market cap is still billions and billions of dollars. And you know, they’re just jokes, right? So I think, you know, it’s hard to argue that that stuff doesn’t eventually go to zero. And then within what you would think of as like the ARK basket and, you know, the Goldman Sachs index of speculative software stocks, again, there were a lot of companies that experienced valuations in private markets and sometimes eventually in public markets of $30, $40, $50 billion, that just, it’s very hard to see them ever being worth anything. And a lot of those names are down a lot. They’re down 90%, but they’re still worth $5 billion or $3 billion. The things that have gone down the most are not always the cheapest. Right?

Sometimes they are, but in this case, I think that’s not obvious at all. I think there’s a great Kindleberger quote that the period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and mass panic and crashing, driven by the insiders having exited, but the suckers/outsiders hanging on and hoping for a revival and then finally giving up. And it feels like that’s where we are. Sort of the insiders have been kind of quietly and steadily getting out. There’s apparently still quite a lot of demand, for example to sell shares in the secondary market of startups that are down 90%, right? You’ve got founders that on paper briefly were worth $20 billion, and now they’re worth $2 billion. And they’re like, you know what? That’s still pretty good. I want to see if I can turn that into cold, hard cash.


Are you optimistic that there will be like a cohort of you know, people who maybe got scarred or burned, but also learned some sophisticated stuff that will have a good combination of skills and knowledge coming out of this period?

Benn: I really hope so. I mean, I’ll tell you 10 or 15 years ago, I remember working with a good friend who’s now a VC on ideas for investor education. And how do you get people to even care about financial markets and investing and pay attention? Because back then it was totally impossible to get the young generation to even think about this stuff. And it’s really good that individual investors have gotten interested in investing. And I feel like, you know, sometimes I hope I don’t give the opposite tone, right? Because it’s so easy for people to get tricked and all this kind of stuff. But I think a lot of times people have to learn from their own experience. It’s just really hard. I mean, you know, Hegel said we learn from history that we just can’t learn from history. People have to one way or another go through their own experiences of mistakes and things not going well to really internalize lessons. And what I really hope is that people are able to take hold of those lessons and, you know, stay interested in financial markets and stay interested in investing and learn how to make good decisions as opposed to feeling so scarred by it that they just walk away.

5 Ideas By Matthew Clifford on the Infinite Loops Podcast

Introduction by Infinite Loops host Jim O’Shaughnessey:

Matt is the Co-founder & CEO at Entrepreneur First, and Co-founder & NED at Code First Girls. We talk with Matt about:

  • Internet in an era of “dampened variance”
  • Increasing democratic participation
  • Bull and Bear case for creativity
  • What Matt looks for in people before investing
  • Role of geography in entrepreneurship
  • And MUCH more!

Episode link

(Bold is mine)


  1. Variance dampening institutions

    Matt flips Jim’s question by explaining that “weird” has been the default until the last few hundred years

    Jim O’Shaughnessy: Why has the world gotten so fucking weird? So, I like weird. I’m an anomaly, I guess, and because I’m 61 and I love weird, but I’m super excited about what’s going on. I think that we are on the cusp of a golden age, not just in one sector, but in many, many sectors. But to get there, you have to go through some turbulence. You basically tell us that we are in the middle of this turbulence. And so what I’d like you to do is explain your thesis for what got us here, what should we expect?

    Matt Clifford: That’s a big question. I think the way I would think about this is if you zoom out, maybe the first question should be, how did the world get to be not weird? Why should we take that the natural state of affairs is non-weirdness? One way of thinking about this is to say that modernity, however you want to define that… let’s say the last 250ish years, is really about the triumph of non-weirdness. It’s about constant or apparently constant, apparently unstoppable motion towards the reduction of variance in our lives. And if you want to get out of that Hobbsian nightmare, you need to find ways to reduce variance. Liberal democracy, incredible reducer of variance. No longer do you hand over power by having a war or an assassination, you have an election. It’s reduced variance. Monetary economics is a way to tame the business cycle over some period of time. Reduced variance, reduced variance… we’ve developed all these institutions, the rule of law, constitutional rights, all these things make life somewhat more predictable. And so for most of, let’s say, the second half of the 20th century post Second World War, anyone who lived in, for one of a better term, the west, had a life of far less variance than say 3, 4, 5, 10 generations before that. You could call that the triumph of modernity. And then something happened in the midst of these fantastic variance dampening institutions, we somewhat accidentally unleashed the mother of all variance amplifying institutions, and it’s called the Internet. And what the Internet does, is it selects the weird and amplifies it. And so I’ll stop talking, but I think the brief history of the last decade is that we suddenly introduced this variance amplifying institution right into the middle of our somewhat peaceful variance dampened lives and chaos has ensued.

  2. The internet as variance amplifier and ambition

    Matt Clifford: One slightly provocative framing would be that the rise of modernity, the rise of variance dampening institutions was really bad for ambitious people. It was really good for the average person and if you’re a utilitarian, maybe on balance, that’s a trade that we want to take. But why is it bad for ambitious people? Because one of the main ways to reduce variance is to stop a Napoleon invading Europe every time they want show you how smart they are. Insert your favorite example here. And so the apotheosis of this, if you like, is the idea of the career. Napoleon, didn’t set out to have a career. He wasn’t looking to impress his boss. And yet if you look at what the 20th century was about from the perspective of work and ambition, it was really about having these more or less formalized tracks for ambitious people to climb. And it doesn’t mean that if you got to the top of that, you couldn’t be wealthy, powerful, insert your favorite adjective here. But what it did mean was that we more or less knew what someone at the top of that hierarchy could do and what they couldn’t do. In the age of variance amplifying institutions, what you see is the Internet selecting for people that are not willing to have careers. Like if you take Donald Trump, Elon Musk, these are people that were not built to have 20th century careers. They were not built to make their boss look good, to fill in the engagement performance review card at the end of every project and climb up the ladder. And so, one of the reasons… it’s a slightly different point, but one of the reasons I think there’s been such an enormous Renaissance of founding entrepreneurship. I mean, it was partly technologically determined. Partly it’s just that if you’re a super ambitious person today, you actually look back historically, I think, and look, well, actually it was possible to do more as an ambitious person. It was possible to find more leverage, to have fewer constrains in the past. It was then a period of about 50 years, like the great moderation, if you’d like, where a lot of that was constrained. And again, I’m not totally against that, despite both being an ambitious person and spending my entire career, trying to amplify the ambitions of ambitious people. I think in some ways it’s a good thing for the world, but we’re now in this new era where Elon Musk can tweet what he likes and send the pigeons flying and several regulatory agencies flying. Or Donald Trump can be the most powerful man in the world and do what he likes. And these are examples of the Internet as sort of a anti-career institution. An institution that breaks a lot of the assumptions of what ambition should look like.

  3. Bull vs Bear view of the internet as a net good

    Matt Clifford: You can make a bull and a bear case for where we are today in terms of how do we think about allowing each human to fully express all aspects of who they are as you were describing in this sort of internet age. I think the bull cases, well, actually, what you’re talking about, you already alluded to this earlier in the conversation you’re talking about. How do you let each person find hierarchies in which they are comfortable in which they can express who they are, but they have a chance to compete and to rise given that in the world at large, it’s very hard to do that. It’s most of us, if we constrained to the physical world, we’re just going to be in state hierarchies where we always feel unhappy. One of the great things about the internet is it allows these extraordinary niches of interests to come together where, I could be working minimum wage in a job that I hate, but maybe I’m in the top three, most celebrated commenters on this sub Reddit for this interest that I have. And I’m not trying to pretend that we don’t need to do something about the material conditions that person’s life, right. That’s clearly a different question, but there is an extraordinary, if you think about almost the equivalent of biodiversity for ecosystems of interest, genuine hierarchy, diversity, you can be someone within a particular group. I think the internet is the greatest force for that, that there has ever been. And you can even extend this idea into this very fashionable idea of the Metaverse. We can imagine and creating world, whole worlds in which people can fulfill their ambitions and like the fullness of who they want to be in a way that is less damaging to others potentially. I mean, again, like you could say, that’s a very bullish case. There’s lots to critique in that, but there is something about the idea of virtualization as a way to enable many more people to achieve what they want to achieve, because we move from scarcity to abundance or potentially to abundance. Again, lots of footnotes on that, whether actually the metaverse as it is to actually emerging will permit that. I think the bear cases well, actually what the internet does is exposes us to, as you’ve already said, like a global competition where previously there was a local one, it sort of amplifies inequalities rather than dampening them. And so, really, I think the question is, can we get to material abundance quickly enough that the sort of satisfaction of people’s holistic needs beyond the material world is enough where actually being, finding your tribe on the internet is enough because we have co selected, successfully created enough material, abundance that people aren’t worried about where the next meal is coming from. I think if we can, I actually feel very optimistic about the internet as a way of providing outlets for exactly what you’re describing.

  4. This bit reminded me of the efficiency vs equality trade-off in economics (see tweet)

    Jim O’Shaughnessy: That’s just the way networks work. It’s not just human beings, it’s any complex adaptive learning system. The nodes that are finding the right answers, get the most connections and the nodes that are not finding the right answers die. And so, I’ve really had to sit and think about that one for a long time, because, so for example, I changed my opinion about universal basic income, because I think for the first time, really in human history, there is going to be a group of people, and the part I underline is through no fault of their own, who have a harder time adjusting and thriving in this new environment. And so your point that you just made, we can’t have them worried about where their next meal is coming from, because that human is a desperate human and desperate humans are destructive humans and violent, and listen, you don’t really even have to know too much about history to understand that [Kris note: notice this is a pragmatic not moral argument]. So there’s a lot of reasons why, universal basic income is not liked by both sides of the political spectrum in person. But I think that the term that I’ve often used is symbol manipulators. So I am a symbol manipulator. I don’t make anything with my hands. And so if you look at the Forbes 400, the list of the wealthiest people, if you look at the original one in 82, it was all physical things. That generated wealth, it was real estate, it was steel. It was, shipping and or inherited. In fact, I think the majority of the list was inherited sort of this dynastic wealth being passed down and down, which creates an aristocracy, whether you have a formal one or not. Look at the list today, there are, there’s virtually no one on that list who is not a symbol manipulator. Right. I personally think that’s great. You know what? I love Amazon. I love the fact that I can get any (beep) thing I want in at most two days. And if I’m in the city in 15 minutes, right. So I like that, but we do have to figure out a way, which, and I guess maybe it’s just like these conversations bleeding into higher conversations, bleeding in, because without that there could be chaos that we don’t come back from.

    Matt Clifford: Totally. Well, I think its worth sort of thinking about what are the objections that we might have to growing economic inequality and I’m not going to be comprehensive because I’m sure there are people who would have others, but I think one is actually political as though with great economic inequality, be kind of calms, great political inequality. And most of us have an instinctive sense that how rich you are, shouldn’t be the measure of political power that you have. And most of us have a pretty intuitive affinity for the idea of one person, one vote. And so, I think there’s like a set of things that we should worry about as people gain wealth, particularly extreme wealth, does it mean too powerful? And there’s then like a sort of almost like aesthetic thing of what do we do about a world where, like Bezos can fly to space and there are people that can’t eat or whatever. I call that aesthetic because I think it’s, you could frame it as justice, but I think it’s just, for most of us, the idea of sort of waste or maybe that’s actually a bad example that, but frivolous consumption versus like people not being able to eat that feels wrong. And then I guess there’s a thing about sort of lock-in, does it get to the point where a sufficient level of economic advantage closes off the ability for others to ever compete. Because I think most of us have an instinct that dynamism is good and mobility is good. Now I think what’s interesting about all those three things is they’re not actually in my view, objections to economic inequality per se. They’re actually to the conditions within which it occurs. So if we can find ways to have our politics less influenced by economic power, if, as you’ve already said, we can get to the point of economic abundance that no one starves however many rockets, Elon and Jeff flying to space, whatever. And if we can figure out what are the rules of the game, that means that however wealthy people become, you don’t have to be them or be related to them to be successful. Now I’m not saying they’re easy problems, but I think that sometimes, you see people default, the idea that we have to break the underlying creators of variance, the underlying economic engine, that’s allowed people to build in Amazon or a Microsoft or an apple or whatever. I think that’s the wrong instinct. I think it comes back to this, how do we make sure error correction actually functions? Well, we can’t have any of these things that are irreversible, we don’t want to have a static society. And so I would, I think people like you and me should be using our energy to think about how can we craft the rules of the game, such that we still allow people to build enormous companies and therefore enormous fortunes, but they don’t break the system. And it’s the second bit that I think we sort of let go of and I think they’re, without getting too political, I think we are missing a trick. If we jump straight to the idea that there’s something intrinsically broken, if someone becomes a billionaire that that’s not what we should care about, what we should care about, or what are the consequences of that. I don’t think every billionaire is a policy failure, but I do think that if only the children of billionaires can become billionaires, as you were saying, if it, then that’s a policy failure. And so I think it’s how do we harness wealth creation in a way that doesn’t violate those things that we kind of, most of us in intrinsically care about.

  5. Moral luck (a parallel to kindness as epistemic humility)

    Matt Clifford: The idea of moral luck, meaning I think it’s very easy to go through life feeling that you deserve kind of various things, although you don’t deserve various things. Most of us have an intuition that we want to live in a world where people get their just desserts one way or another. But I think, we’ve talked a lot in this conversation about sort of epistemic humility, the idea that we don’t really know anything. I also feel there’s a kind of moral luck humility, which is like, we don’t really get to choose who we turn out to be in many, many ways. And I think if that makes us a little bit more humble in the face of the suffering of others, the success of others, the ups and downs, a little more tolerant of like, what are the, you know… Go back to this idea of error correction. What are the systemic things that we need to prevent anyone falling too far off the edge in one direction? I believe in a world where, to my innovation point, anyone should be allowed to try anything. And if they build something phenomenally valuable, they should be allowed to reap the rewards of that in a pretty unconstrained way. And I think the offsetting force of that is the reminder that the fact that they were the person that could do that, that’s nothing they deserved. And it doesn’t mean that they shouldn’t benefit from it, but it should bring with it a humility that allows us to design institutions and systems that mean that none of us can fall too far. [Kris: Super resonant because you know how I feel about the word “deserve”].


The rest of the interview talks about qualities Entrepreneur First looks for when funding founders. The qualities themselves are not surprising but the list is surprising because of how mundane it is. And that is actually uplifting. They have tremendous data on founders and are quite certain it takes at least 6 months of close observation to actually know if a founder will be effective (even after 3 months the data is noisy!). The implication is you should widen the top of the funnel, make low cost bets on many founders which is in direct opposition to overly strict selection criteria. I’ve written about this idea and the math behind it in:

  • There’s Gold In Them Thar Tails: Part 1 (13 min read)
  • There’s Gold In Them Thar Tails: Part 2 (24 min read)

Part of widening the funnel is by expanding geographic search. Matt shares this story of Iranians in Singapore:

It’s an amazing story is that if you look at the list of nationalities by how frequently we’ve invested in people of that nationality, it’s quite surprising. I guess in some places, not that surprising. Like in Bangalore, it’s nearly all people who are Indian. But in Singapore, it’s quite surprising. So, actually in Singapore, the number one nationality we fund is Indian. The number two is Singapore. I think third might be Indonesian. I forget. But in the top four is Iranians, people from Iran. That’s kind of crazy, right? Because how come there are so many Iranians in Singapore? And the answer is there aren’t. I think there’s only about 250 Iranians in Singapore, and we funded about 50 of them. Why is that? Well, basically because if you are an incredibly smart, ambitious Iranian, the single biggest drag on your life outcome, sadly, is that you were born in Iran. And so getting out is very important for a certain type of person. And in particular, if you skew technical, which is a lot of what we do, good luck getting a visa these days to study, I don’t know, nuclear physics in the US or whatever. Maybe slightly facetious, but not very. If you write a list out of the world’s top universities and start to cross off the ones where Iranian grad students will struggle to get a visa, the number one university left in the world is the National University of Singapore, which is actually a very good university anyway. It’s top 20 globally even before you do the crossing out, but it’s the number one that’s very accessible to really smart Iranian science grads. And so there’s this very tight knit community of exceptionally smart graduate students from Iran in Singapore. And we’ve ended up funding as a sort of nontrivial proportion of them. Now, why do I tell that story? Because to me, it points to the ability to overcome geography without remote. Now, actually I’m very bullish on remote as an overall system. Lots of our companies are remote first. I think it’s very possible to do. But I think for the act of building, co-founding teams from strangers, which is the core of our IP, if you like, we really believe in the power of the physical for that, at least for now. So I think watch this space, probably some experimentation to come on that, but we think there are lots of ways to transcend geography while retaining the sort of physicality of what we do.

5 Ideas by Eric Crittenden on the Mutiny Investing Podcast

Mutiny founder and host Jason Buck’s introduction:

In this episode, I talk with Eric Crittenden, Founder and Chief Investment Officer of Standpoint, an investment firm focused on bringing all-weather portfolio solutions to US investors. Eric plays an active role in the firms’ research, portfolio management, product innovation, business strategy, environments and client facing activities. He believes using an all-wealth approach is the most effective way to prepare for a wide rage of market environments, while producing meaningful investment returns with limited downside risk.

Eric has over 20 years experience researching, designing, and managing alternative asset portfolios on behalf of families, individuals, financial advisors, and other institutional investors. Eric and I talk about circuitous paths with multi-year dead-end rabbit holes, simplicity can be the ultimate sophistication, what clients want, what’s wrong with the investing industry, and strategy scaling.

Episode link

All bold emphasis is mine.


  1. Investing opens your mind

    Jason Buck: Well, like you said, you don’t have to be overly prescient to talk about negative oil or negative interest rates. What I’ve always loved about macro trend is that you just follow price, right? And so if price goes negative, you just keep following it negative if that’s the direction of the trend. You don’t have to have any global macro narrative. And that’s the point, is you’re just offsetting narratives and people love narratives, so they didn’t like the idea that you said it could potentially go negative. You weren’t calling for it. You’re like it’s just within the realm of possibility. And I wonder, do you think that following trends for so long just opens up your mind that anything’s possible?

    Eric Crittenden: I think doing the research around it and seeing what actually happened. I mean, you can see with your own eyes what happened historically, like the sugar trade in the 1980s, where the price was below the cost of production. And the price didn’t actually go any lower, but you made a boatload of money being short because of the contango and the futures curve. Right? So today, you fast forward to today, and I talk to emerging CTAs or people that want to start trading their own account, they’ll do the same thing over and over. It’s always the same thing. They come up with all these filters to filter out trades and they say, “Well, if the price is too low, it won’t go short. If the price is too high, it won’t go long.” Well, okay, so one of these days you’re going to experience this phenomenon, and the greatest trade of the decade will be the one that your filter filters out.

  2. Breakouts vs moving averages

    I looked at many, many different ways to measure and identify a developing trend, and what I found, and you know this, is that they all basically pick up on the same thing. They’re just different ways of measuring the same thing. It’s like if there’s a wave coming in and you’re in Santa Barbara and you’ve got a guy from Hawaii and a guy from Oregon and a guy from California, and one guy says it’s four and a half feet, the other one says it’s five feet, and the other one says it’s four, they’re all measuring the same thing, they’re just doing it the Hawaiian style or the Oregon style or whatever.
    So there’s not a lot of benefit from diversifying your entry/exit style, moving average crossover, breakout. There’s a whole bunch of different styles. That being said, you could develop a strategy that uses a moving average crossover that doesn’t have a lot of … in other words, they’re not all created equal.

    I like breakouts. So I’m kind of in the minority there. I like breakouts because they’re pure trigonometry. They’re just triangles, essentially. And you know the price that would force you to get in, and then your stop-loss is some other price, and you know what that is. And you know what both of those prices are every single day. And that means you can calibrate your risk. You can lean on that. We call that the risk range. So I know approximately how much risk I’m taking to market because I know what both of those prices are. When it comes to a moving average crossover, I don’t know what price is going to force those two moving averages to crossover without doing some really advanced, or not advanced but tedious math to come up with a bunch of different scenarios about how they might crossover in the future. So because they all basically pick up on the same thing, but the breakout approach is very clean from a risk management perspective, I gravitate towards that, and I didn’t see a lot of benefit from diversifying meaningfully beyond what I’m already doing when it comes to entries. [Kris: This is resonant with what I saw at a fund that ran a breakout trend strategy.]

  3. Approach to risk management depends on whether you come from the relative vs absolute return crowd

    Jason Buck: Is like CTAs have always been pointing out, or macro trends specialists, have always pointed out that this is what actually matters is your aggregate drawdown risk, not your volatility metric. But that just doesn’t seem to translate well to everybody else, and everybody still seems to care most about sharp ratios versus max drawdown.

    Eric Crittenden: I think in the securities world, stocks, bonds, mutual funds, it’s historically been a relative game rather than an absolute game. In a relative game, anytime you sell, you’re putting yourself into a position to get left behind. If you get left behind, it’s game over for you, everyone loses confidence in you. Futures guys, derivatives guys, live in a very different world or grew up in a very different world where it’s all about survival. Some of these guys are using leverage and quite a bit of it, so it really was essential that they control the amount of risk they’re taking. So, and when CTAs is drone on, and on, and on about risk management, it drives advisors crazy, because they don’t even really know what you mean when you say that.

    [Kris: I’m biased but I agree with this from my life as a derivatives trader. Risk management is the #1 focus, but I had never thought about why the beta world might not think that way]

    It’s not that important in their world, because a balanced portfolio of stocks and bonds, it’s more important to not manage risk, because you don’t want the taxes, you don’t want the turnover, and you don’t want to get left behind. You can look at these psychological studies, and I’ve had people tell me it’s okay to be down 50% once every 10 years, as long as the market’s down 45, or 50, or 55%, I won’t lose my clients. But if I manage my risk along the way, the way you guys do, and I’m up 20 when the market’s up 25, and then the next year I’m up six when the market’s up 11, it’s game over for me. That’s unfortunate, but that’s how it is in the securities industry. So, but when you’re looking at alternatives, and in particular all-weather investments, frame the right way, that all goes away.

  4. “All weather” and uncorrelated risk premia

    Dalio coined that term or made it popular and he sometimes will say, “You need upwards of 16 uncorrelated return streams,” do you think that’s even possible?

    Eric Crittenden: No, it’s not, and I like Dalio, I like his writings, I modeled a lot of what we do off of what their firm did in the ’80s. So, I have a lot of respect for what he achieved, and how he did it, the how is very important. That being said, anyone with a plain vanilla copy of Excel can use a random number generator and realize that three uncorrelated variables are pretty much all you need to be the best money manager out there. So, I don’t know where the 21’s coming from. I’ll tell you hit on something though that there’s only one thing in this world that actually that I’m jealous of right now. There’s one risk premia out there that I can’t source, but it would be so valuable if I could.  So, I’m really just getting three, and I feel like that’s all we need, it’s the best I can do. I think it solves a lot of problems for people, but there’s one more out there that I think is big and sustainable, but you can’t get it from Phoenix, Arizona, and that is the market-making style risk premia. Where you need economies to scale, you need poll position, co-locate your servers, you got to be big, and have a solid network. You got to be basically like Amazon or Costco, where you can just muscle your competitors out of the way. You’re like, “Nope, get out of here, this is my real estate, and I’m doing…” It would be so valuable, but there’s just no way we could pull it off.

    Jason Buck: You said three return sources, so eliminate the three return sources that you believe you have?

    Eric Crittenden: So, I feel like there’s capital formation markets, like stocks and bonds, which are kind of a one-way street, the risk premia is kind of a one-way street. I mean, the bulk of the risk premia is your long stocks. The futures, whether it’s metals, grains, livestock, energy, these are risk transfer markets and risk transfer markets are different than capital formation markets. I feel like risk transfer markets, you need to be symmetrical, you need to be willing to go long or short, because they’re a zero-sum game. They have term structures, so they’re factoring expectations, storage costs, cost of carry, all that stuff. And then there’s the risk-free rate of return, which used to be a great way to kind of recapture inflation, it’s not so much anymore. We can get into that later on, it’s a fascinating time to be managing money, because there’s a huge gap between inflation and risk-free. But, historically speaking, those are the three that I think makes sense, especially in the context of an all-weather portfolio that uses futures to get its commodity and derivative exposure, because it leaves a lot of cash lying around. So, to go source that risk-free rate of return costs you nothing, there’s no opportunity cost, because you were going to be sitting on that cash anyways.

    When I look at all the different risk premium on this computer or the one behind me, historically, I see those three blending together more beautifully, and there’s other ones out there, they just don’t move the needle for me. Things that are related to real estate, credit, they just all have that same trap door risk that the equity market has when the equity market’s going down. So, and then the rest of the time they’re expensive, they’re tax inefficient, they’re illiquid, and then they disappear on… Sometimes they get crowded, I mean, they just cause more problems than they solve. That’s how I feel about corporate bonds, credit, all that stuff. I mean, I wish there was something there, I know other people strongly feel that there is, but I’ve looked at the data until my eyes are blurry, for decades, and I don’t see it.

  5. Capital formation vs risk transfer markets

    This is an important concept to me, because it goes to the point of why I do what I do, or why I think that macro trend oriented approaches expect a positive return over time, because the futures markets are a zero-sum game or actually, a negative-sum game after you pay the brokers, and the NFA fees, and all that stuff. So, in a negative-sum game, you better have a reason for participating. For you to expect to make money, you better be adding something to that ecosystem that someone else is willing to pay for, because somebody else has to mathematically lose money in order for you to make money. So, in studying the futures markets, and I’ve been on both sides, I’ve been on the corporate hedging side, I’ve been on the professional futures trader side.

    I believe I understand who that somebody is, that has deep pockets, and they’re both willing and able to lose money on their future’s position. A trend oriented philosophy that’s liquidity weighted is going to be trading opposite those people on a dollar-weighted basis through time. It does make sense that they would lose money on their hedge positions, I mean, in what world would it make sense for people who hedge, which is the same thing as buying insurance, to make money from that? It makes no sense, that would be an inverted, illogical world. So, anyone who’s providing liquidity to them should expect some form of a risk premia to flow to them. It’s just up to you to manage your risk, to survive the path traveled, and that’s what trend following is. I don’t know why that is so controversial, and more people don’t talk about it, because I couldn’t sleep at night if I didn’t truly believe that what we’re doing deserves the returns that we’re getting.

    Jason Buck: CTA trend followers, or whatever, just they don’t really know how they make money. They’re like, “It’s trending, it’s behavioral, it’s clustering, it’s herd mentality, and that’s how we make money.” You’ve accurately portrayed it as these are risk-transfer services, speculators make money off of corporate hedgers. But the only thing I would push back, and I’m curious your take on this, is like you said, zero-sum game or negative-sum at the individual trade level. But when we look more holistically, those corporate hedgers are hedging their position for a reason, and it’s likely lowering their cost of capital for one of the exogenous effects. So, my question always is, is it really zero-sum or negative-sum, or is it positive-sum kind of all the way around? In a sense that the speculator can make money offering these risk transfer services that the hedgers are looking for that liquidity, and then the hedgers are also… If we look at the rest of their business, they’re hedging out a lot of their risks, which can actually improve their business over time, whether that’s cost of capital, structure, or other exogenous effects.

    Eric Crittenden: Absolutely, I wish I had… You did record this, so I’m going to steal everything you just said. In the future’s market, it’s negative-sum. If you include the 50% of participants that are commercial hedgers, it’s no longer zero-sum. But most CTAs, and futures traders, and futures investors don’t even concern themselves with what’s going on outside the futures market. So, but if you pull that in and look at it, you can see, or at least it’s clear to me, we’re providing liquidity to these hedgers. They’re losing some money to us, and the more money they lose to us, the better off their business is doing, for a variety of reasons. Tighter cash flows, more predictable cash flows results in a higher stock price, typically. But you brought one up that almost no one ever talks about, and that is if they’re hedged, their cost of capital, the interest rate that they have to pay investors on their bonds is considerably lower. Eric Crittenden: Oftentimes, they end up saving more money on their financing than they lose on their hedging, and they protect the business, and they make Wall Street happy at the same time, so who’s really the premium payer in that, it’s their lenders? So, by being a macro trend follower in the future space, the actual source of your profits is some bank that’s lending money to corporations that are hedging these futures. So, it’s the third and fourth order of thinking, and you can never prove any of this, which is great, because if you could prove it, then everyone would do it, and then the margins would get squeezed.

    [Kris: As a commodity options trader, this framing is spot on. I was typically trading with flow that was constrained or price-insensitive. Corporate hedgers must hedge because of the covenants in their loan financing. I had never thought about the edge being spilled in the option market is coming from the lenders ultimately! I guess if we follow that logic even deeper it’s the bank shareholders that are giving up expectancy by requiring less loan defaults and it’s an open question as to whether the hedging activity is worth the lower cost of capital at the bank share level]

15 Ideas From Morgan Housel’s Interview with Tim Ferriss

Morgan Housel is one of my favorite finance writers who happened to make it to the mainstream with his massive hit book Psychology of Money. It’s a book I like to gift people even though I haven’t read it myself. That probably sounds weird, but I’ve read almost every blog post he’s written in the past 5 years and cite his writing in my newsletter constantly. I am just bad better at buying books than reading them. My nightstand has more than 50 books on it. That’s not a typo, it’s a problem (since I moved to CA I read about 5 books per year which is about 1/3 of what I used to back when I had an NYC subway commute).

Anyway, Morgan is great and his big-time interview with Ferriss is worth the 3 hour listen (transcript).

Here are 15 parts I felt like sharing. Bold is my own emphasis.

  1. Who’s the greatest investor of all time?

    It doesn’t seem like a hard question to answer. It should be an analytic answer, it’s just like a number who’s had the best performance, but then you can split this different ways. So who is the wealthiest investor of all time? That answer is Warren Buffett. Who’s the greatest investor of all time in terms of like long term average annual returns? It’s Jim Simons by a mile. And like it’s not even close. Warren Buffett’s long term average annual returns are about 21 percent per year. Jim Simons’ are like 66 percent per year after his ridiculous fees. He’s like in a different universe, but Warren Buffett is like way wealthier. And Jim Simons is like a deca-billionaire himself. And to say like he’s not as rich sounds crazy, but to parse out the reason that Warren Buffett has earned one third of the returns, but he’s like 10 times as wealthy, is because Warren Buffett has been investing for 80 years.

    And so even though he’s not the greatest investor of all time in annual returns, he has so much endurance in terms of what he’s done that by a mile. He’s the wealthiest, which to me, that gets into a really interesting point, which is how do you become a great investor? And most people when they hear that, what they think of is like, how can I earn the highest returns? What are the highest returns that I can earn this year and over the next five years, and over the next 10 years. And that’s not bad, that can be a great thing to do. But to me, if the goal is to maximize the dollars that you have, just like what’s the way that maximize the amount of dollars I accumulate over the course of my life. Then the answer to that question, the huge majority of the time is not earning the highest returns.

    It’s what are the best returns that you could earn for the longest period of time, which usually aren’t the highest returns that are out there because maybe you can double your money this year, but can you do that for 50 years in a row? Like probably not, but could you earn 10 percent annual returns for 50 years? Yeah, you can totally do that and generate an enormous sum of wealth. All compounding is, is returns to the power of time, but time is the exponent. So that’s to me what you want to maximize and that’s why Warren Buffett is in my mind, and it seems like an easy answer, the greatest investor of all time, even though his returns are probably not even in the top 20 percent of annualized returns among professional investors.

  2. Investors Morgan admires besides Buffet

    John Bogle, who started Vanguard, I think is probably the most admirable because it was so selfless what he did.

    A lot of people don’t even know this, Vanguard is owned by the people who own Vanguard Mutual. There’s no Vanguard shareholders. There’s no profits. There’s no dividends that are played to the owners. Vanguard was made for the benefit of the people who own the ETFs, the people who own the mutual funds and John Bogle did not make that much money for himself because of that. And you could almost think that Vanguard’s low fees, all of that is — the amount that you saved in fees is money that could have gone to John Bogle and John Bogle’s estate that didn’t. He’s like this undercover philanthropist of finance that I really admire just because there’s so few other people like that.

    And I think someone like James Simons, who we mentioned earlier. I think in every field, there’s only one person who’s claimed a fame, who’s competitive advantage is “I’m smarter than everyone else”. In tech, for 20 or 30 years, that person was Bill Gates, and I think in finance for the last 20 or 30 years, that person has been James Simons. The only person in the field who can say, if you ask them the question, “What is your competitive advantage?” They can say, “I’m just smarter than everyone else.” Only one person can say that, and it’s James Simons. If you look at what Renaissance Technology has done and just the results that they’ve accumulated and the consistency of what they’ve done, it’s like LeBron James times Michael Jordan times Tiger Woods to the power of Mikaela Shiffrin. It’s just such a different universe compared to what anyone else has done that it’s just, it’s astounding to watch.

  3. Admiration but not copying

    So I think most of the people who I really admire as investors, it’s more that I admire just how they’ve lived their lives, and their general life philosophies, and their investing philosophies stems from that. That’s true for Buffett as well. Actually, there’s an interesting thing about Buffett, which is that it was so easy to admire him and still is. But when the book The Snowball came out, which is a biography written about Buffett by an author named Alice Schroeder, and it came out, I want to say 2009, something like that. It really makes clear the case that Buffett has not lived a perfect life by any means. And in a lot of instances, his family life has been a disaster. I think that’s the right word to use. It’s kind of rude to say that, but I think it’s really true. In some ways, it’s good to hear that, that like everyone puts their pants on one leg at a time in the morning. Everyone is human. Everyone deals with the ups and the downs of living a life. And that he’s a human.

    And also that a lot of the reason that his family life was troubled at times is because he was, had a singular devotion in life, which was picking the best stocks and everything else came second to that. Everything from his family on down came second to that, in a way that a lot of people, including myself at one point said, “I want to be Warren Buffett. I want to be the next Warren Buffett.” But then you read about what it took to get there, and I’m like, “No, I want to stay 10 miles away from that.”

    …In The Making of an American Capitalist, and I read this decades ago, but the story that really stuck out to me and I’m probably getting this wrong, but someone on the internet will correct me. I remember his meeting, Warren’s routine was to work at the office and then come home and basically just walk straight upstairs, and begin reading like S-1 filings or annual reports of one type or another, quarterly reports. And that was his routine.

    And one day, he came home after work and I want to say his son, but one of his kids was like splayed out at the bottom of the stairs and had clearly like fallen down the stairs, and he just stepped over this child and walked up to his office to read reports. Like it didn’t even register to attend to his child.

    That’s a really important insight to learn is that a lot of these people who you admire, the reason that you admire them is they’re so successful, and that success that they had had enormous costs associated with it that are easy to ignore. And when I look at that, it’s like, I can look at pieces of Buffett’s life that I admire and pieces of Jim Simons’ life that I admire, but I don’t want to be them. Because that mega success had so many costs attached to it that I want to avoid in my life. That’s been an important observation too, for me.

  4. Compounding

    [Kris note: A reminder that geometric growth is N² and exponential growth is 2ᴺ…compounding deals with exponential growth. For example, if you grow at 10% per year for 30 years you end up with 1.10³⁰ = 17.4]

    The math behind it is 99 percent of his wealth was accumulated after his 50th birthday and 97 percent came after his 65th birthday, which is a really obvious thing. If you think about how compounding works, like it’s always in the extreme later end of year, is that the numbers just start getting ridiculous. Compounding is just like, it’s just like, it starts slow and then it’s boring. And for 10 years it’s boring, for 20 years it starts to get pretty cool. And then 30 years you’re like, wow. And then 40, 50 years, it’s like, holy, like it just explodes into something incredible. There’s a friend of mine named Michael Batnick, who its explained compound growth, I think the most easy way to comprehend, which is, if I ask you: “What is eight plus eight plus eight plus eight?” you can figure that out in your head in three seconds, like anyone can do that.

    That’s no problem. But if I say, “What is eight times eight times eight times eight times eight?” Like, your head’s going to explode trying to think about it. All compounding is never intuitive. And that’s why, if we look at someone like Buffett, we in the financial industry have spent so much time trying to answer the question: how has he done it? And we go into all this detail about how he thinks about moats and business models and market cycles and valuations, which are all important topics. But we know that literally 99 percent of the answer to the question, how has he accumulated this much wealth, is just that he’s been a good investor for 80 years. It’s just the time. And if Buffett had retired at age 60, like a normal person might, no one would’ve ever heard of him. He would’ve been like one of hundreds of people who retired with a couple hundred million bucks and like moved to Florida to play golf.

    He never would’ve been a household name. He would’ve been a great investor, of course, but there’s a lot of great investors out there. The only reason he became a household name is just his endurance and his longevity, that’s it. And that’s why if you go back to like, even the late 1990s, not that long ago, Warren Buffett was known within circles. Like within investing circles, people knew who he was. He didn’t become a household name until the early and mid-2000s, which is that’s when the compounding took his net worth to become worth 20 billion, 50 billion, a hundred billion where he is right now. It’s just the amount of time he’s been doing it for.

  5. Tim describes the letter Morgan wrote to his son while the boy was still a child

    “You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does — especially from the people you want to respect and admire you.”

    Here’s the paragraph that stuck out to me:

    “When you see someone driving a nice car, you probably don’t think, ‘Wow, that person is cool.’ Instead, you think, ‘Wow, if I had that car people would think I’m cool.’ Do you see the irony? No one cares about the guy in the car. Have fun; buy some nice stuff. But realize that what people are really after is respect, and humility will ultimately gain you more of it than vanity.”

    Now the last sentence has some counter examples maybe. But the point that we rarely look at the person in the cool car and say, “Wow, that person must be cool.” Rather, we apply it to ourselves is I think a very profound observation.

    …Morgan adds:

    I was a valet at a high-end hotel in Los Angeles. So I was in my early 20s and there were people coming in in Ferraris and Lamborghinis and Rolls-Royces, like the whole thing. And it dawned on me one day that when those cars pulled in, that I had really admired, I’m a car guy, I love that. Never once did I look at the driver and say, “That guy is cool.” What I did is I imagined myself as a driver and I thought people would think I’m cool. And this was like, I was in my early 20s, but I’m just thinking like that was my first kind of light bulb into how wealth works, that everyone thinks that they want to be the driver, but no one actually is paying attention to the driver.

    They’re imagining themselves. People think about themselves way more than they think about other people. But we all think that everyone’s looking at us, I think that’s like a universal thing. Everyone thinks like, oh, this person’s looking at me, they’re impressed with me. By and large they’re not, they’re thinking about themselves and how other people might want to be impressed with them.

    [Kris note: I describe this effect as the “bad hair day”. The ratio of people noticing someone else’s hair is messy divided by people mentally derailed by their “bad hair day” is indistinguishable from zero]

  6. Purpose of wealth

    I think if there is a universal trait of money that’s true for like not a hundred percent of people, but let’s say 90 percent of people, is that, what people really want in life is independence and autonomy. I think no matter where you’re from, what you do, your aspirations are, that’s a common denominator. That people just want to wake up every morning and do what they want to do on their own terms. And whether they’re able to do that, whether they can actually do that today, or that’s a goal. I think that’s a universal trait among people is just independence and autonomy. And so to the extent that we can use money to gain that, to gain independence and autonomy, that is, I think, as close as it comes to a universal want and thing that we can use money for. The interesting thing to me is that among huge numbers of people, educated people, financial professionals, the purpose of money is to buy stuff. It’s to accumulate more stuff, bigger house, nicer car, whatever it might be, which is great.

    I love all that stuff too. But to me, the most powerful thing that money can do and the most universal benefit that it can bring us is systematically overlooked, like using it for independence and autonomy is so overlooked. And that to me has always been kind of a sad thing that we are so accustomed and attuned to just wanting to use our money, whatever money that we have, whatever savings that we have, to go out and buy more stuff when we could be using it for freedom and autonomy. And then when you come to a period like in March and April 2020, or October 2008, when millions of people lose their jobs and you see during those periods, like the early day of COVID, how many people are just on the razor’s edge of insolvency. And it does not take them much, one or two weeks of unemployment to be in a really bad financial spot, whether that’s for an individual or a small business, it does not take them much to be thrown over the edge.

    And you realize how dependent so many people are on their jobs, their salaries, their theirs customers in a short period of time. And there’s just not a lot of room for error throughout most of the world. And I think for the huge majority of people, not everyone, but for the majority of people, there could be a lot more. And the reason that they don’t want to have more savings is because to them, the knee jerk reaction is “Why would I just keep my money in the bank or even invest it? Like, the purpose of money is to go out and buy more stuff to enjoy my life.”

    I get that, I understand it, but it’s usually once every five or 10 years that people realize how important independence and autonomy is. And having that wealth that you have not spent, having the money that you haven’t spent that was just lying around doing nothing, becomes the most valuable thing in the world when it lets you gain control of your time and just wake up every morning and say, “I can do whatever the hell I want today.”

    I want to wake up every morning and hang out with my kids and I want them to be happy and I want to do it on my own schedule. If it’s a Wednesday morning and I don’t want to work, then I’m going to sit on the couch all day and watch Netflix. And if it’s a Sunday and I got a good idea, I’m going to spend all day working. It’s all my own schedule on my own time, whatever I want to do. It’s that independence and autonomy.

    Tim Ferriss: Can you not do that right now?

    Morgan Housel: Yes. Yeah, I can. There was a point when I couldn’t and that’s why I feel like I’m pretty happy, and I feel like I’ve done a decent job of doing that. Now I do have, as a lot of people would, a tendency to be like, “Oh, what if I got that Porsche? What if we got the bigger house? What if we did this? What if we did that?” And it’s fun to think that because I love nice cars, I love all of that. It’s just so easy to realize. There was a great quote that I love that’s, “The grass is always greener on the side that’s fertilized with bullshit.” I think that’s really what it is. That’s the accurate phrasing of that well-known quote, and I think that’s really what it is. The idea that all that nicer stuff is going to make you necessarily happier, I think is just so easy to disprove.

    Especially once you’ve experienced a little bit of it yourself and that actually what is going to make people happy is that independence and autonomy, that once I remind myself of that, I’m like, okay. And then the game of earning more just becomes a game, it’s less about like, oh, if I have more money, I’m going to be happier. No, if my net worth is 10 X what it is today, I’m not going to be any happier. That was not true at one point in my life, but I think it’s true today, it’s probably true for you right now, it’s true for a lot of people listening. And therefore you can admit that a game is fun and a game is fun to play, but just admit that it’s a game and it’s actually not going to make you happier.

  7. Risk is personal

    The takeaway from that is most investing debates, where people are arguing with each other, is this a risk? Is that a risk? Should I buy this stock? Is the market going to go up next week? By and large, those debates are not actually debates. It’s people with different risk tolerances and different time horizons talking over each other, talking over one another. And that’s why. I think to me, the most important part about risk is that the definition is different for everyone. My definition’s going to be different from yours, which is different from anyone else who’s listening.

    And it’s not because we disagree with each other. It’s just because we’re different people, with different goals and different ages and different family situations, etc. And so, risk is a very personalized calculation for everyone whether that’s in investing or other areas of your life.

    [Kris: I always say that if you need $1mm tomorrow, the biggest risk is not flying to Vegas and betting 500k on red]

  8. “Tails drive everything” demonstrated without math

    Tim: Am I recalling correctly that a bulk of his career returns came from concentration in GEICO? Am I getting that right?

    Morgan Housel: That’s true. The last page of Benjamin Graham’s book, The Intelligent Investor, tells us little tale about an investor who earned basically his entire career success off of one investment. And that one investment broke every rule that this investor had laid out. And then kind of in the last paragraph on the last page of his book, he says, “By the way, that investor is me.”

    And if you look at Benjamin Graham’s track record, his career track record is incredibly good. And if you remove GEICO, it’s average. And like I mentioned, GEICO by Graham’s own saying, breaks every rule that he just laid out in that book to buy it. And so that’s a really interesting thing is like, not only was it one company, but it’s a one company that broke all the rules. So if you’re reading that book and looking for rules to follow, like by definition, you are not going to achieve Benjamin Graham’s success.

    And so, I think that’s really telling, and I don’t know what the takeaway from that is. If you could say, “Well, then clearly he’s just lucky.” If all of the success was due to one company that broke the rules, you could say, he’s just lucky.

    The other thing you could say is that’s just how capitalism works. And that’s true for Buffett. It’s true for a lot of people. That if they make a hundred investments, you’re going to make the huge majority of your money on probably five of them. That’s true for anyone. That’s even true if you’re investing in an index fund. That within the index, most of the games are going to come from five percent of the companies that you invest in. That’s always the case.

    I think it just kind of changes how people view success though. Like if your view of success is that every stock that Warren Buffett or Chamath or Jim Chanos or all these big name investors, that every time they make an investment, then it’s clear that, that company’s going to be a winner.

    And that’s just not how this success plays out at all. That even among the top names, the best investors over time, the majority of the picks that they make do not do very well. And the reason that they’re so successful is because one or two or maybe five investments they’ve made are ultra home runs. People associate that with venture capital. That’s how it works in NVC. But it’s actually true in all stages of investing.

    The stat that I’ll share with you here is that if you look at the Russell 3000 index, which is an index of large public stocks in the United States, over time, from I think, 1980 to 2010, 40 percent of the stocks in this large cap, like mom-and-pop index, 40 percent of the companies went out of business, not merged, not BAPA, but they went bankrupt, 40 percent of them.

    But the index did very well because seven percent of components were huge winners. It was like Amazon, Microsoft, Netflix, those companies. So even in a boring old index fund, almost half the companies are going to go out of business. But you’ll still do well because a few do very well. And so that was true. And I think the more successful you are, the more you see that.

    Even at a company like Apple or whatnot, what percentage of Apple success is the iPhone? It’s enormous. But they’ve experimented with dozens of different products over time. Amazon has experimented with the Fire Phone, which is a total flop, and they’ve done things in music which were flops. They’ve done all these flops, but they’ve also done Prime and AWS, which matters more than anything else. So almost anywhere you look, you will see that a tiny number of activities, apply for the majority of success. And it’s so hard to wrap your head around that when you’re trying to emulate these people who you look up to and admire.

  9. Safety net vs fuel approach to inheritance

    I’m quoting Buffett again, I don’t want to do this ad nauseam for the whole podcast, but he has a great quote on wealth where he says he wants to leave his kids enough money that they can do anything, but not so much money that they could do nothing — I think that’s really the key. And that’s how I think about my own kids who are very young, but when my wife and I think, how do we want to use whatever savings that we have to benefit them? Giving them a safety net, but not a fuel is a — that’s what my parents did for myself and my siblings, I always knew — when I was a teenager and in my early 20s, I always knew they would be there if I fell on my face and they would — I would never just completely fail, I’d never be homeless, I would never — they would always catch me, but they were never going to be a fuel. They’re never just going to give me money just to make my life better, that was never going to be the case.

  10. Against optimization

    Even if you look at the periods that in hindsight we think were the greatest that existed, which for most Americans is the 1950s and the 1990s, that’s what we remember as the golden age of prosperity and happiness and peace. Even if you look at those periods, like in the 1950 people were high, kids were doing nuclear bomb drills under their desks, and there was a lot of pessimism and negativity. Even if we know in hindsight, it was great at the time, by and large, they did not know that maybe it was good economically, but there was a lot to be worried about in the 1950s. Same in the 1990s, which we today it’s like, oh, the booming 1990s, the bull market. But even people forget in 1994 there was a big interest rate calamity where a bunch of bond interest rates rose and then the stock market crashed.

    And then in 1998 a big hedge fund went out of business and almost took the whole global economy down with it. There was a lot to worry about during these periods, so how do you protect yourself from that? How do you actually become buy and hold? I think there’s one thing to do here, there’s a friend of mine named Carl Richards, who’s a financial advisor, and he has a quote where he says, “Risk is what is left over when you think you’ve thought of everything.” And I think that’s the definition of risk is whenever we’re done planning and forecasting, everything that’s left over that we haven’t thought about, that’s what risk actually is. And the takeaway from that, the actual practical takeaway is that if you are only planning for risks that you can think about and you can envision and you can imagine, then 10 times out of 10, you’re going to miss the biggest risk that actually hits you.

    The biggest risk is always something that nobody sees coming, including something like COVID where it’s actually not fair to say no one saw it coming, but by and large — it’s like in financial circles, not a single investor in 2019 in their economic outlook had a viral pandemic as something that they were worried about, not a single one, or 9/11, or Lehman Brothers going bankrupt, all the big events that actually mattered, it’s pretty much true to say no one saw them coming. I think that’s generally true. And therefore, the takeaway is you have to have a level of savings in your asset allocation that doesn’t make sense. You have to have a level of conservatism that seems like it’s a little bit too much. That’s the only time that you know that you are prepared for risks that you cannot envision.

    And if you are only prepared for what you can imagine, again, you’re going to miss the biggest risk every single time. Whenever people look at my asset allocation, if I share that with them, it looks a little bit too conservative and they say, “Ah, you could be taking a little bit more risk,” and they’re right. I probably could, but I want to be prepared for the risks that I can’t imagine, or the risk that is possible but I don’t want to even think about it, it’s too painful to think about. That’s the only time that you can be prepared for the surprises in life. And I think most people, not all investors, but the majority of investors are not conservative enough. And I know whenever I say that they shake their head like, “Come on. Why don’t you want to take risk?” And once a decade you learn why, once a decade. Whether it’s COVID, or 9/11, or 2008, once per decade, you’re like, “Oh, okay, I get it now. I didn’t see this coming. It was a calamity and I either ground myself into the floor and I got wiped out, or I had a little bit of extra savings that got me through.” So that’s how I think about how to stay in the game in a long term history where history is a constant chain of surprises. That’s the only way to do it.

  11. Framing: Understanding when volatility or pain is a “fee or a fine”

    The way that I’ve phrased it in the book was “understanding the difference between a fee and a fine,” which seems like they’re really similar but there’s a very important difference which is, a fine means you did something wrong like, “Shame on you, here’s your speeding ticket. Don’t do it ever again, you’re in trouble.” And a fee is just a price of admission that you paid to get something better on the other side. Like you go to Disneyland, you pay the fee, and then you get to enjoy the theme park. You didn’t do anything wrong, it’s just that’s the fee.

    I think if you could situate your life to where you view a lot of the ups and downs, not all of it, but a lot of the volatility in investing, a lot of the volatility in your career, as a fee instead of a fine, then it just becomes a little bit more palatable. And when the market falls 30 percent, it’s not that you enjoy it, you don’t think it’s fun, but you’re like, “Okay, I understand this is the fee that I have to be willing to pay in order to do well over a long period of time.” Most investors don’t do that. When their portfolio falls 30 percent, they say, “I fucked up. I did something wrong. I clearly made a mistake. And how can I make sure this never happens again?” And that’s the wrong way to think about it. And I think if you view it as a fee instead of a fine, it’s just much more enjoyable. It’s much more realistic to deal with.

    Now, I said earlier that there are some areas in life where it’s like that. If you’re talking about a death in the family, a divorce, there’s things that’s like, “No, that’s not — that’s just a straight negative.” Like no silver lining to some of these things in life so I want to be careful at parsing that. But particularly investing, the huge majority of the pain that people go through and put themselves through is just the fee for earning superior returns over time. And if you’re not willing to pay that, then you’re probably not going to get the reward on the other side. And that’s why you can see so many people who at the first experience with being uncomfortable in investing with a loss, they view it as they screwed up and then they want out. They want to move on to something else.

    And of course, they’re not going to get the rewards over time. Nothing in life is going to give you those rewards for free. There’s a cost to everything. And just identifying what the cost is then realizing that the cost is not on a price tag, you’re going to pay for it with stress and anxiety, and dopamine, and cortisol, like that’s how you pay for these things, I think that’s the only way to deal with those big ups and downs.

  12. The optimal amount of bullshit

    You had Stephen Pressfield on your show, and he was talking about a time when he lived in a mental institution. He was not a patient himself, but he lived there and he starts talking to all these people. And he made this comment that a lot of the common denominators of these people who lived in a mental institution was they were not crazy, they just could not handle or put up with the bullshit of life. They just couldn’t deal with it. And that was kind of why they ended up in the mental institution. And he said all these people were the smartest, most creative people who he had ever met, but they couldn’t put up, they had no tolerance for the bullshit of the real world. And that to me, just brought this idea that there’s actually an optimal amount of bullshit to deal with in life. If your tolerance for bullshit is zero, you’re not going to make it at all in life…

    I listened to that [interview] and it was like, “Oh, see, these people could not function in the real world because they had no tolerance for bullshit.” The second step from that is, there is an optimal amount of bullshit to put up within life. And that was where this article, “The Optimal Amount of Hassle,” came from.

    And I remembered I was on a flight many years ago and there was this guy in a pinstripe suit who let everyone know that he was a CEO of some company, and the flight was like two hours delayed, and he completely lost his mind. He was dropping F bombs to the gate agents and just completely making an ass of himself because the flight was delayed. And I remember thinking like, “How could you make it this far in life and have no tolerance for petty annoyance, like a delayed flight?”

    And I just think like there’s a big skill in life in terms of just being able to deal with some level of bullshit, and a lot of people don’t have that. There’s another great quote that I love from FDR, who of course was paralyzed and in a wheelchair. And he said, “When you’re in a wheelchair and you want milk but they bring you orange juice instead, you learn to say, ‘That’s all right.’ and just drink it.” And I think that just having the ability to put up with that kind of stuff is, I think, really important and often lost in this age where we want perfection. We want everything to be perfect, and it never is.

    [Kris: I have a good friend who is insanely smart and well-traveled (top 1% in both categories of everyone I know). He has a  brother who is not conventionally successful and I’ve asked him about what that brother is like. His brother is also very well-traveled in part to choosing a life in the armed forces. But my friend has also described is brother as also extremely smart. But he’s incapable of tolerating the b.s. that defines the ladder-climbing world. The military life is simple in the ways he prefers. It has always stayed with me, that my friend quite explicitly described his brother as being unwilling to suffer bullshit. I really think about this a lot (too much if I’m being honest), since I often feel that “getting ahead” is really just climbing sedimentary layers of compressed bullshit.]

  13. The durability of value investing with a lower case “v”, not the investment category

    Value investing will always work in terms of, if you buy an asset for less than it’s worth, you’ll probably do pretty well over time. But the actual formulas that you use to determine value, those have always evolved and always changed. And formulas that people use, whether it’s price to book value, the P/E ratio. Whatever formula it is that may have worked at one period of time, those always evolve. That’s always been the case. I think it always will be the case that there will be people that will be stubbornly attached to the metrics and the formulas and the valuation techniques that worked perfectly in the previous era that now outdated and outmoded.

  14. Incentives

    If I was selling products by commission, if I was a financial advisor selling by commission, I would probably be much more into active investing and active strategies than I am right now. I think because I’m not a financial advisor, I’m not giving people advice, I can just view it as an outsider and be like, well, this is what makes sense to me so that’s what I’m going to do.

    Whereas I know that if I was in the trenches so to speak and had to make a living doing this, I know I would’ve very different views about what strategies you should pursue. And I know that the strategies that I would lead towards would be higher fee higher commission. I just think that’s the reality of it. Most people who work in finance are good, honest, noble people. Not all of them, but most of them are. But to the extent that is bad advice that gets perpetuated, I really just think it comes down to the incentives that are in the industry. The perfect example of this is that the only firm that’s really been able to make a good business out of selling passive funds is Vanguard and they’ve done it by becoming a nonprofit. That’s the only way that you can do it. You can’t make a good business out of selling the lowest fee funds that are out there. You just can’t do it. So I know that if I had a different compensation structure, I would think differently as an investor.

  15. I couldn’t help mentioning this section. Do what you will with it

    Tim Ferriss: Yeah. I am going to try to find this. There it is. It is a tweet from Jason. So a few years ago, Naval Ravikant and I were having a conversation on the podcast and he talked about the asymmetric costs of offense and defense in a world where drones are weaponized. Meaning if you have a drone or a bunch of tiny drones that are weaponized, and this is being developed all over the world, of course. You have sophisticated attacks where they can be coordinated with software to say all land on a given tank and explode at once. They can be used in more ad hoc, improvised ways.

    But I’ve been tracking this space because a number of my friends are involved. Some of them design and manufacture predator drones, for instance. So a drone that would kill or capture other drones, and they use netting that is shot out like Spider-Man to catch drones and they’re used by different major league sports franchises, because that’s a non-trivial threat to say an arena would be drone attacks. And Jason has a tweet, this is from December 7th, 2021. “Saudi Arabia is running out of the ammunition to defend against drone and missile attacks from rebels in Yemen…” I can’t pronounce, the Houthi it might be, I’m sure I’m pronouncing that incorrectly, ” …rebels in Yemen is appealing to the US and its Gulf and European allies for a re-supply.” This is in The Wall Street Journal and the lead, or at least the teaser sentence that I see presented by Wall Street Journal, is, “Saudi Arabia’s defense against the rebels’ drones pits $1 million missiles against $10,000 ‘flying lawn mowers.’” In quotation marks.

    Morgan Housel: I remember that. Yeah. That’s a great way to phrase the problem that you’re dealing with and who has the edge here? It’s crazy.

    Tim Ferriss: Yeah. The future of warfare is here. Not to beat poor William Gibson’s quote to death, but the future’s already here, it’s just not evenly distributed. But this is something that I’ve been watching very closely because the potential consequences and the implications are so terrifying. So not to end on that, but I only saw that tweet today from Jason and it served as a reminder to me that I think in a year, particularly with the technological development cycles that we’re seeing, how compressed they are, and the innovations that we’re seeing from drone manufacturers. I recently had some interactions with the newer drones and drones with flir technology and infrared tracking capabilities. It is incredibly impressive. Compared to drones from even 18 months ago, they are worlds apart. It is shockingly impressive.

    Morgan Housel: Here’s what’s scary to me about that too, is that when the nuclear bomb came about, there was obviously fear that this is the future of war and knock on wood, fingers crossed, it has not since 1945. Because the consequences of a nuclear war are so catastrophic, that everyone who has them up until this point has said it’s not worth using them because the consequences are so severe. I almost think drone war is the opposite where it’s like there’s no skin in the game, you’re not sacrificing any soldier’s lives. You’re sacrificing civilian lives, of course, on the other side. But there’s so little skin in the game and it’s so easy to just flip these things up in the air and go for it, that it makes starting a war, progressing a war so much easier than it’s ever been. It’s the opposite of what happened with nuclear war over for the last 80 years.

    Tim Ferriss: Yeah. If people want to make an attempt at looking around some corners, also from a technical perspective with respect to AI and cyber warfare, highly recommend listening to my recent podcast with Eric Schmidt, it is mind-boggling. What else? I think that within a year we will have things like GPT-3 at a point where we can generate probably, I would say within a year might be aggressive, but within 18 months, with figures who have enough audio on online that you can really deep fake effectively. You’ll have synthetic interviews with people alive and dead that are convincing enough that they can’t be distinguished from live interview. I could see that being graspable in the next 12 to 18 months.

    Morgan Housel: And that just torpedoes trust even more than it’s ever been. You hear a quote from Tim Ferriss, and you’re like, “That’s probably not even Tim, so I don’t even take it serious anymore.” There’s no trust anywhere.

    Tim Ferriss: Election cycle 2022. It’s going to be exciting.

    Morgan Housel: I got my son in Oculus for Christmas and there’s a thing where you can do a tour of the White House with Barack and Michelle. It was filmed back then. And just sitting at a table in VR, having a conversation with Barack Obama, it was so shockingly realistic. And you know where that’s going, the VR headsets that we have 10 years from now are going to make this look like a complete joke. If you mix that with the ability to deep fake, we’re heading into a world that’s going to be so wild.


    Kris: As I was pulling insights from the transcript this was a timley news event:

Notes From Todd Simkin On The Knowledge Project

Link: https://fs.blog/knowledge-podcast/todd-simkin/

From the description:

Todd Simkin is Associate Director at Susquehanna International Group, a privately held trading and technology firm. During his 25 years with the company he has held a variety of roles, including responsibility for SIG’s firm-wide education and trader development, where he taught the company’s new traders what questions to ask and what criteria to weigh before making hugely impactful decisions for the firm.

He calls on experiences from his lengthy career in financial services and educating traders to help Shane understand how to make better decisions. On this episode Simkin breaks down all the influences that go into how and why we make decisions, why financial decisions are different than inter-personal ones, the strategies involved with teaching other people to make better decisions, what he looks for when he’s hiring, the value of asking the right questions, and so much more.

[FD: I started my career at SIG eventually spending 8 years there. I’m living proof of what Todd says in the interview: Traders are made not born. A statement famed Turtle Trader Richard Dennis, and Trading Places’ Mortimer Duke would agree with. So it must be true.]

This interview lifts the veil a bit on SIGs trader education program, but is more broadly a statement of SIG’s culture. We get things wrong all the time but we need to make decisions. SIG is like a think tank on the subject of decision-making. It’s a popular topic these days, in fact many of Shane’s prior guests have been experts in the field. SIG was an early adopter of institutionalizing concepts from behavioral science. And as we’ll see, this is really a team effort. Isolated attempts of correcting one’s own cognitive biases have shown to be nearly futile and Daniel Khaneman has himself lamented how awareness of bias doesn’t seem to inoculate us from it.

In addition, to the decision ideas Todd talks about, I found this to be a masterclass in communication. If you are a parent, this episode is full of gold.

These are my notes organized by theme. You can find my Otter transcript here.


Decision-Making

SIG’s approach starts with humility

Our approach is to recognize that we, we are often on the bad end of informational asymmetry, that other people who are looking to trade in the markets frequently no more than we do. And as a as a result, we don’t want to back our own limited opinion against a more informed counterparty. Instead, what we want to do is take the information that we have coming from outside sources, and there are multiple outside sources, different types of products that are being traded, different options series, if we’re trading derivatives, and use that information to improve our own information set to then be able to allocate our capital in a way that we think will lead to a return.

How to manage information asymmetry — start with reasonable priors then update hard

There a few ways that we’ve tried to handle it. One is to is to build out research capabilities internally so that we do have sort of some basis for our initial opinion. But the most important thing, from our perspective, is to be willing to update that opinion, in a Bayesian way to use approaches that are that are going to be inclusive of all the information available to us. And only when we get to mutually exclusive information, or mutually exclusive signals. Can we say something here doesn’t jive right? It’s totally fine. If somebody says they think that the stock price is greater than 100, no, nothing else, I think the stock price is going to be greater than 100. Somebody else says they think the stock price is going to be lower than 105. I say, Okay, now I’ve got a market. Now I’ve got two sides. And then someone else says, Do you think the stock price is going to be lower than 97? Now we don’t have information that can coexist in the same universe. I don’t need to know who’s right. But I do know that it can’t both be above 100 and be below 97.

I have used a similar analogy. Trader’s are not acting on some thesis or worldview about the future. They are simply looking for contrary pieces of information that are unlikely to be simultaneously true, and take counterparty to both sides. If the Warriors are 20 bid to win the NBA Championship and the field is 85 bid this is a strong-form example of “can’t simultaneously be true” aka arbitrage. In reality, the process of finding opposing propositions requires:

a) casting a wide net for information

b) normalizing the information (see Measurement Not Prediction)

c) communicating & outputting the cleaned information back to decision-makers

This process underpins many business flows. Trading is just one example of a type of business. Performed methodically, what SIG is doing is a business not an investment strategy.

Bayesian Updating Applied To Trading

Options derive the value because the future stock price is not going to be the same as what it is today. And there’s some probability that it’s going to be higher or lower. And knowing what that forward looking probability distribution function looks like, leads to the ability to price the options to come up with the fair value based on their expectancy. And one of the determinants of sort of how much a stock can move is what we call its volatility. The volatility is just the annualized percentage return on the stock in any given year, or really for a time slice because it can change that can change over time.

So if I think that the fair value of an option is say, $3, because of all of the assumptions that I have built into that, and then someone comes and wants to buy 10,000 options from me for a price of $3.10. There are two things I could do one, I could say, well, I know that all of my assumptions are grounded in truth, I know the future better than anybody else. So I know that over the long run, if I sell these options at $3.10, I’m going to make 10 cents in an expected return over and over and over again, that is not the approach that we take at Susquehanna.

Instead, I would say this option can be worth more than $3. Given some some possible sets of information about the future. Maybe this person knows something about the fair value of the underlying of the stock that’s different than what I know, looking at the stock market. And I can test that by going out and trying to trade stock. Maybe they know something about the forward looking volatility, the forward looking probability density function. And I can say, Well, if that’s the case, how wrong would I need to be to now be losing if I if I entered this trade? And this is where where Bayes Theorem comes in. Because I can say I have my prior assumption set, my prior probability distribution. Now, how much do I want to weigh this new information to come up with a new a new distribution that will allow me to come up with a fair value.

And again, in isolation, it’s really hard for me just to say this person’s wrong. But if I have a similar looking option similar because it’s the same expiration, or because it’s the same strike and a different expiration, or that there’s something about the option that looks close enough to this, I can say, I can find disconfirming information. And only when I find disconfirming information, can I feel more comfortable about taking the other side of this trade

 

Confirmation and Attribution Bias Example In Discourse

There are lots of other things in your life, where you’re you’ve got ego tied up, you’ve got some part of your personality benefits from sort of the truth value of whatever position it is that you’re taking. So when you get disconfirming information, you’re going to discount it. I’ve been thinking so much about tribalism lately, like this is just something that’s been showing up in conversations I’ve been having all around. The thing that that’s very clear is that when people hear information that comports with whatever their tribe believes, or whatever their tribe supports, they’re willing to accept it without doing a lot of digging into the quality of the source, the quality of the information, the sort of the implications of the rest of the information that goes with it. And anything that challenges their tribe believes they are going to be more dismissive of whether or not it comes from a quality source. I’ve got children that that feel very strongly aligned with political parties. And, and I also have a quote on the wall in my office that I think is just such a good important quote, to, to help remind me about the importance of habits leading to, to behaviors, I shared the quote with with one of my daughters, my 16-year-old, and, and she said, that sounds kind of interesting. Like I sort of like that. And then I shared with her who the quote was from, and she’s like, alright, I don’t need it. And it was because it was from somebody in the other camp, it was from the wrong political party.

[Me: Reminds me of Paul Graham’s Keep Your Identity Small]

If you’re curious about the quote it was from Reagan espousing good habits. It’s an articulate way to say that “you’ll play like you practiced”:

The character that takes command and moments of crucial choices has already been determined. It has been determined by 1000 other choices made earlier in seemingly unimportant moments, it has been determined by all the little choices of years passed. By all those times when the voice of conscience was at war with the voice temptation, whispering the lie that it doesn’t really matter. It has been determined by all the day to day decisions made when life seemed easy and crazy seemed far away. The decisions that piece by piece, bit by bit developed habits of discipline or of laziness, habits of self sacrifice, or self indulgence. Habits of duty and honor and integrity are dishonor and shame.

Tribalism is the negative expression of an otherwise useful shortcut:

Heuristics are shortcuts that we take that are mentally freeing, right, it will be really hard to always work from first principles. So it’s so much easier. If you can have a heuristic that you can fall back on, that just sort of tells you what to do next, without having to stop and  think through the process. When your heuristic is, “I’m going to find people who are like me, and if I do what they do, then I’m going to sort of maintain my integrity, I’m still going to be like me, because this is what people like me do”, then it’s very easy to fall into the trap of not sufficiently contemplating each of those, each of those actions, each of those different behaviors.

 

Rules vs Principles: It’s not cut-and-dry. Context matters. Rules are amazing shortcuts for some things.

It’s so much easier if you have a rule than if you tried to have a principle. “I don’t eat dessert” is so much easier than each time that you have the opportunity to have dessert to say, well, I don’t eat a lot of dessert is this one of the times that I’m better making a change there.  I get up and do some type of exercise every morning. And I find it easy to exercise seven days a week, I found it really hard to exercise five days a week. And the reason was every morning the alarm goes off at 5am, it’s really easy to not have your feet hit the ground and get going. It’s really easy to say, well, I need to take two days off anyway, this can be one of the days that I take off. So on the “I don’t eat dessert rule”, I think that’s a great way to pre-decide. Lazy has a lot of value laid in it, to lighten your cognitive load. I don’t have to stop and think about everything if I’ve already spent the time thinking about it.

But you’re not part of a group of non-dessert eaters, right? This isn’t part of a broader identity that you’re now wrapped up in, where if you decide to change that rule and have dessert, you don’t have other people calling you a dessert denier, right? Who cares, right? Okay, so she used to eat dessert or used to deny dessert, and now he’s having an ice cream sundae. Good for him. Maybe it’s his birthday, whatever it is, this is a decision, that’s totally fine with him. And you don’t have to worry that you have now also contradicted all of the other tenets held by the people in the non-desert eating group.

If it’s something that is more tribal, where we are the type of people that do this and don’t do that, then a violation of one part of that removes you from this group.

Shane points out a paradox in cognitive science. Knowing our biases doesn’t seem to help us overcome them. This is a topic the brilliant Ced Chin has studied in depth. Ced told me that the literature suggests the only way cognitive bias inoculation works is via group reinforcement. I told him that was exactly the cultural DNA when I was at SIG which makes me believe there is a lot of value in being aware of bias. Anytime you replayed your decision process, it was a cultural norm to point out where in the process you were prone to bias.

Todd addresses why this works:

It is definitely true that it is sort of descriptive of the past. A lot of these heuristics and biases are things that we can see when we after we’ve already identified that a mistake has been made. And we say, Okay, well, why was the mistake made? Say, oh, because I was anchored, or because of the way the question was framed, or whatever it might be, we have a really hard time seeing it in ourselves.

But here’s the key:

We have a really easy time seeing when someone else is making that type of stupid mistake. A big part of our approach to education is to teach people to talk through their decisions, and to end to talk about why they’re doing what they’re doing with their peers, the other people on their team. If we can do that real-time, that’s great. Often in trading, you don’t have that opportunity, because things are just too immediate. But certainly, anytime things have changed. If you’re doing things differently, it’s a really good time to turn to the traders around you. And the quantitative researchers around you and the assistant traders and your team and say, Hmm, it looks like all the sudden Gamestop is a whole lot more volatile than it was a week ago. Here’s how I’m positioning for this trading. What do you guys think? And have someone say, oh, it seems like you’re really anchored to last week’s volatility. If things have changed that much, you need to move much more quickly than you’re moving right now.

So you don’t realize that you’re anchored, that’s the whole nature of being anchored, is that you don’t recognize the outsized importance that the anchor has on your decision, but somebody else who’s a little bit more distant from it can. So if we’re good at encouraging communication, then we’re going to be really good at getting other people to help improve your decision process.

[Me: There it is. The key — communication. It’s not some magic formula. Even after I left SIG I spent my whole career working with SIG alum. This culture and these types of communications happen all day on the desk. Despite the common perceptions of “trading”, I have always found it to be a team game and communication skills are paramount.]

Speaking of teamwork, the next quote is money:

I know that you are fond of pointing out that you are the sum of the five people that you spend the most time with. So if the people that you’re spending the most time with are your co workers who are thinking about trading the same way you are, then maybe you’re going to combine the same types of errors, it’s certainly better than then trying to act on your own.

But even better is if you have a culture that rewards truth finding, as opposed to rewarding action.

If nobody feels personally attacked, because of somebody else pointing out their error, but instead feels like we together have now done more to get closer to, to some truth to the better way to act or the you know, the more accurate, fair value of this asset that we’re trading, then everybody feels like it’s a win. And they will therefore encourage the involvement of the people around them.

Shane asks what the most important variables are for being a better decision maker. He expects Todd might say probabilistic thinking but Todd’s answer was fast and blunt.

Talk more is number one, that beats probabilistic thinking that, that beats sort of anything else.Truth finding is, is being able to bring in other people in the decision process in a constructive way. So finding good ways to communicate to improve the input from others. 

Thinking probabilistically I think is definitely a very, very important piece of trying to diagnose what works by trying to think of where where things fall apart, where people fail.

The other place that people fail is falling in love with their decision process and not being open to being wrong. So in openness to to feedback to finding disconfirming information to actively seeking out disconfirming information, which is really uncomfortable. But that that I think is the other piece that is is super important for being a good trader.


Education

In 2009 Todd moved over to the education side of SIG where he focused on teaching decision-making under uncertainty, option pricing, finance and how to apply this knowledge to markets. SIG’s training is legend for good reason. In hindsight, I recognize just how  well-designed it was. It felt intense yet forgiving, competitive yet nurturing.

When I went to SIG “class” as it was called you’d spend 3 months at the headquarters. 20 years ago, it was a bootcamp that included:

  • 4 weeks of theory (including 4 hours of deriving Black Scholes assumptions and 4 hours of deriving the formula. Went mostly over my head)
  • 8 weeks of mock trading in an on-site simulated options pit.
  • Interspersed where lectures by various business heads
  • You were also required a minimum of 100 hours of poker and the class winner was chosen by Sharpe Ratio

Todd pulls back the veil on SIG’s education philosophy:

Susquehanna has always had a very growth mindset perspective on teaching trading, you know, before Carol Dweck, had even shared her views on growth mindset. It has always been the company’s position that traders are made not born. We’re now over 2000 people worldwide, and we still have a small company mindset of we’ve got to make the best of what we have.

The way that we’re training people today is certainly changed from what it was originally, but there are a lot of things that have stayed the same. And among that is, is this idea that if we have smart people that are educable, and vocal about their thought process, so that we can improve it and willing to be wrong, then we can teach them about trading.

The principles from Todd’s background in linguistics and deaf education informed how SIG designed their training.

When I was originally studying education, I was thinking that I might be teaching sixth-grade deaf kids how to do math. Instead, I’ve got MIT graduates who certainly understand math, but don’t know trading. And I’m teaching them how to make these asset allocation decisions with imperfect information. But the approach is still the same.

The approach is still this one of modeling the process, finding out where somebody is, and finding out what they can grow to and providing the appropriate support so that they can grow to be a better decision maker. 

SIG rejected Piaget’s approach that suggests learning unfolds at pre-determined developmental stages.

Piaget had, you know, a pretty rigid framework for the stages that you move through how you move through them. And that education effectively ended at adolescence. And because he said, Now, that’s kind of bunk. That’s not how any of this works.

SIG’s approach adheres more closely to Russian psychologist Lev Vygotsky. Notice the engine at work:

All of education is socio-cultural, all of education comes from interaction with others. And those others in order for them to be educators have to be more knowledgeable than you are. And that when you have interaction with more knowledgeable others, what those people are able to do is recognize your zone of proximal development, you have a zone of things that you know, and then you’ve got a zone that is just too far out of your reach that, you know, no matter what if I were to sit down my six year old nephew, and try to explain linear algebra to him, he’s not going to get it yet, he just doesn’t have the fundamental tools to do that.

But somewhere outside of your zone of mastery is this zone of proximal development, the zone that that you can move into with appropriate support and that support in the Vigotsky literature is referred to as scaffolding. And you want it to be the minimal amount of support necessary to appropriately move somebody to be able to handle the next level of mastery. Over time, you can dismantle that support, dismantle that scaffolding and that zone becomes part of their zone of mastery, and you’ve just pushed out where their zone of proximal development is so that over time you can you can move them into an area where they’re learning more and more and they’ve got greater mastery and competence in whatever area is that that you’ve been teaching them. And eventually, they become more knowledgeable than other people around them. And they can provide the scaffolding as the more knowledgeable other for their peers as well.

[cross reference from ScienceDirect about the zone of prozimal development (ZPD) and the difference in approach between Piaget and Vygotsky:

This use of ZPD defines ‘teachability’ of the child in a specific activity or in problem solving. If an activity or problem can be accomplished by the child with the help of more capable others, this activity or skill is considered possible to teach the child. If, however, the activity or skill cannot be accomplished by the child with the help of more capable others, it is considered not useful to teach to the child.

Unlike Piaget, who believed that instruction should follow development, Vygotskij argued that guidance can, should, and does lead development. They would differently define what is currently called ‘developmentally appropriate curriculum.’ Piaget insisted that learning is essentially an individual endeavor and that adults can only facilitate by providing an enriched stimulating learning environment and opportunities for children to share and discuss their egocentric thinking with each other to promote disequilibrium in the child’s thinking. Adults should not interfere in the child’s individual thinking because it can only lead to imposition of the adult’s ideas onto the child—what Piaget called ‘sociocentrism.’ In contrast, Vygotskij encouraged adults to provide guidance and help and to engage students in activities that are beyond their individual levels of competence (‘performance before competence,’ Cazden 1992)…
A student’s teachability depends not only on the student but also on the teacher (and broader communities in which the child participates). Thus, no test of the child alone would accurately determine the child’s teachability—the teacher always counts.]

How SIG mitigates hindsight bias and “resulting” which is the practice of having an outcome dictate whether you made a good decision at the time with the information you had at hand:

We do everything we can to shield, the person we’re giving feedback to from knowing the results. I’m not going to tell you whether or not this trade worked out, I will tell you the information that was available to me at the time that I made the trade, and then what I did, and you can give me feedback on that process. So the identification from this less formal setting comes from from knowledge about about how trading works, or how this particular risk taking works. In our education setting, it’s something that we control a whole lot more cleanly. We don’t have to present a very complex trade and see who can figure out the pieces of it until everybody in the trading class is ready to get there.

In Being A Pro And Permission To Be Serious I argue that a hallmark of being a professional is the equivalent of “watching film” to get better.

Here is Todd describing a Socratic learning process:

We can build from from smaller pieces up to up to the larger concept, and see who along the way, isn’t processing that smaller piece appropriately. And a big part of how information is passed from the mentor to the mentee is by modeling the decision process, it is not enough to say you should have raised the vol by two points when this trade came in. Instead, it’s so much more important to say, okay, when this trade came in, I remembered that earlier in the week, somebody had traded this other structure. And when they did, I updated my possible outcome space to look different. This trade confirmed with that other trade did so so now I was I just more heavily weighted this other outcome. And the result was that I took volatility up two points, then someone knows not only what to do, which is really not the important thing to take away. But how to do it, which is very much what we’re looking to teach…

We’re really discussing how we would behave in a situation and modeling what the conversation should look like and will disagree with each other. The answer to just about every trading question is “it depends”, which is a really hard thing for someone to hear when they’re first learning because they want the answer. They want to know, when I’m in this exact situation, again, what is the optimal thing to do?

The interesting part of the conversation comes in the what it depends on. All of these questions lead to the some type of answer of what you could do. And there’s some things that are clearly wrong. And it’s important to talk about that, too. So when we’re talking about it in a trading context, it’s really nice that one teacher can say, “I think that I probably would have shown a bid for this price and this amount”. And someone else says, “Well, I don’t know that I would because this broker has behaved this way before. So I think that this might be a time where I’d be afraid that I’m opening myself up to selection bias if I if I were to price it that way, so I would do this.” And you have these senior traders who are disagreeing. And so there’s this really nice modeling of how to think about how to improve the process, so that you can reach an answer that you are tentatively more comfortable with.

His technique for extracting the most out of an interview is clearly influenced by SIG’s educational approach. I’ll let you see the quote first then explain my experience when I interviewed there.

The best outcome for me in an interview, is if the candidate walks away, and wishes they could have part of the interview back. That means that I did not spend the entirety of the interview in their zone of mastery, where they just got to show off  in front of me. Then I’m left to decide whether or not they would have the skills to do more. And I did not spend the entire time in the zone of frustration, where they couldn’t do anything. And it’s like, “okay, I didn’t expect you to know how to do that anyway but if you could, that would have been great to see” and still make a hiring decision.

Instead on on multiple dimensions, I’ve been able to find the place where, with a little bit of support, they could do a little bit more. A big part of the reason I like that is exactly this thing that we’re talking about, which is this openness to feedback.  I’m giving them feedback, because I’ve successfully mapped out their zone of proximal development, and now I’m providing a little bit of scaffolding to see what they can do with support.

You will find that some people embrace it and say, Oh, I think I see where you’re going. Let me see if I can take it from here. That’s a great answer.

You will find some people who are just waiting for you to give them more of the answer. Who will just wait for you to map out the entire selection process and then they’ll just fill in the numbers.

I think you’ll find some people who are totally resistant to it, who will shut you up, who will put their hand up and say, no, no, no. Let me work on it my way. And they’re always not working. Yeah. And I know why it’s not working. And I can help direct them away from it. But they don’t take the feedback. I don’t want the person who doesn’t take the feedback. And I don’t want the person who’s waiting for more feedback. I want the person who is hungry and eager to use the tools that are presented and available to them to then do the work themselves. That’s what’s going to be successful when they’re trading. And they get to have a small opportunity of doing that in the interview process.

In my first round, on campus interview, I struggled with 2 out of 3 questions. You can see the types of questions they ask in Interview Questions A Market Maker Gave Me in 1999. But I’m almost certain the only reason I was asked back for another round was because I was fascinated by the questions and asked what I could read to learn more so I would better prepared. Quantitavely I was a below-average hire but knowing that probably help me take learning more seriously. I don’t think I ever took learning very seriously in school (I took grades seriously). But trading sounded so interesting, I really wanted that job (see For Fun, My Career Origin Story).

As Todd was preparing to go on Jeopardy, we get this entertaining story that epitomizes SIG’s values and culture.

Before I went on the show, I knew that there were some things that I needed to really brush up on. Shakespeare comes up in ways that I knew that I didn’t have a deep enough knowledge of. I wanted to make sure I knew all the presidents and vice presidents in order, things like that. And Jeff Yass, one of the founders of Susquehanna, the Chief Risk Manager at Susquehanna, came into my office before I went, and he said, “Todd, nobody cares if you know anything about American history. But if you screw up the the betting on the Final Jeopardy and Daily Doubles, don’t even bother coming back.”

This was a lovely reminder that I couldn’t embarrass myself by not knowing trivia. And a very good reminder that what I do as a profession is put money at risk. So I should probably make sure that I’m thinking pretty clearly about about how I’m gambling in the game. And when I got back, he came in my office, close the door behind me said, “I know that you’re not supposed to share the results until the show airs but tell me how much money you had, how much money everybody had in Final Jeopardy, and I’ll tell you what you should have wagered”

And that’s all that he wanted to talk about when I when I got back. I won one night, so made it back to Final Jeopardy and he approved my wagers on both. 

 


Communication

On being a more constructive communicator:

Adam Grant recently was talking about how to get feedback from people who are lower on the the corporate echelon, direct reports or their reports. And one of the things that he talked about was to lead with an honest acknowledgement of your shortcomings. That’s really constructive, because that allows for feedback. It invites it in an open way where you’re clearly challenging behaviors and not the person and then has the open ended piece of asking the important “what else?” question.

Non-constructive ways are seeking out “Yes, man” answers. Like, “Hey, I just won $10,000 on that last trade that I did, seems like that was pretty good. Can you think of any ways I could have improved that?” It’s really hard to follow that up with, “Yeah, I think you probably should have won a lot more. Or you could have done it in a much less risky way. Or you won because you flipped the coin and it came up heads. Stop patting yourself on the back, this was not all that impressive.”  You haven’t really opened up for [constructive criticism] if you frame it as “why my trade was good.” Instead, tell me why this piece of my decision process was good.

The other important thing is to actually change your behavior when you get the feedback. If you get feedback, and then don’t do anything with it, people are going to stop giving you the feedback. It’s not just not helpful to ask for feedback and not change. It’s actually hurtful.

The theme of modeling behavior as the key to learning recurs throughout the interview. I’m also a strong believer in this idea (I don’t remember it being explicitly discussed at SIG, but it’s quite apperent that we learned by breathing in the culture). I am extremely concious that my kids learn from what I do more than what I say. 

I was delighted to hear Todd’s approach to teaching his children and it’s the primary reason to return to this episode. 

“You’re not going to get this unless you hear how I’m approaching this decision”.

I think about this a lot more with my own children, that this is something that I think about a lot as I’m, as I’m raising adults into the world, they frequently come to me and my wife and ask for advice. The important thing for us to show them is not what the answer is, because we’re going to be wrong. But how we think about the answer which is probably going to be much more important for them as they go forward making decisions when I’m not going to be standing next to them, but they can have sort of the proverbial dad on their shoulder whispering in their ear. “Have you thought about this? Did you consider it this way? What is the cost of this? What are the benefits of this? Is this a decision that you can change after the fact?  Or is this one that you’re sticking with?”

All those questions that I would ask in trying to reach a decision, instead of just sort of asking it to myself and then and then handing over the the outcome? I share the process and sharing the process leads to more constructive conversations with my children and with and with our traders.

Reflective listening:

Something that I learned while I was in college, from a book called Teacher Effectiveness Training. When I read it in the book, and we talked about it in class, I said, this is the dumbest piece of advice anybody’s ever put down on paper. And it was around reflective listening. And the idea was that instead of trying to step in, and problem solve, instead of trying to reframe instead of trying to provide context or or dig deeper, all you do is tell the person what you heard them say.

So that night, a friend of mine was over at my apartment for dinner. And she was talking about a problem that she was having with a roommate. And I was like, just for kicks, I’m going to give this a shot. And she’s, you know, salting the chicken or whatever it was, and she’s like “my roommate never puts her dishes away, and it bugs the hell out of me.” I reply, “So it sounds like you’re really bothered when she doesn’t put away your dishes.” She says, “Yeah, and it’s not just that, it’s also that she doesn’t appreciate it. When I do clean up.” Then I said, “So it sounds like you know, part of the problem here is that you’re not feeling appreciated.”

She’s gonna think I’m the dumbest guy that she’s ever known, right? Like, all I’m doing is, is repeating what she’s saying. And I was like, well, this, this certainly feels dumb. And I guess at some point, I got to call myself out on and point out that I’m just doing this stupid thing from the stupid book. And that’s, and then she turned to me and said, “Todd, this is the most beneficial conversation I’ve had about my relationship with my roommate ever. I feel like I’m coming away with this understanding myself better and her.”

Her experience was totally different from mine! She felt heard, she felt seen. And she felt like she now had the power to make a better decision about her relationship going forward. And I thought, Okay, well, maybe this guy’s not so stupid. Maybe this book isn’t so stupid. And maybe these methods work in places that I wouldn’t have thought they would work. And it’s not always the solution. But it’s a much better solution than I would have thought it would be. And it’s something that I find myself doing with my kids all the time, and it no longer feels forced to me It no longer feels fake. To me, it’s very clear that what I’m doing is allowing the space for for them to finish their own thought. That’s one of the things that I do with my kids that I think has been been really beneficial.

“How do you feel about that?”

His daughter’s friend was venting to his daughter. Here’s what happened:

My daughter said, “Well, how do you feel about that?” And, and her friends said, “that is the most Simkin thing that I could hear you say at that point? Instead of asking what I want to do next, you start with, ‘how do I feel about it’, which is something that the friend and my daughter have heard from me and Shelly, my wife, over and over again.

Again, it’s really hard for us to jump in and start providing advice, if we don’t even know where the child is coming from. If we start saying “well, it sounds like that other kid was being a jerk?” and then your kid is like “no, that’s not what I was saying at all. How do you not get me? How do you not understand what this is just starting with?”

So we say “How do you feel about that?” It feels like the Freudian psychologist sitting back, you know, while you’re lying on the couch mumbling something, but turns out to be really helpful.

This is really very similar to understanding truth, that if you don’t have an understanding of what’s really happening as a starting point, if we can’t sort of agree on the facts, then then we’re not going to be able to reach a good decision trading or interpersonally.

The principle of charity in life and in trading [this principle is 1 of my 3 Simple Rules For Social Media]:

When I’m modeling decision processes for my classes or kids, I use the principle of charity. When somebody says something, assuming that they’re not an idiot, assuming that they’re coming from from a place of sincerity and good intentions, and giving them the benefit of the doubt.

On the trading side, this principle of charity is really giving somebody credit for knowing what they’re doing when they’re trading against you. This is what sort of protects you from from being run over by somebody who has better information than you do.

On the interpersonal side, this gift to the other person, is an assumption that that they are well intentioned and smart and approaching this for the same purpose that you are, and therefore you’re going to end up being aligned in your process to reach a resolution to a conflict or to come to an agreement about whatever it is that you guys are talking about. Every single negotiation is a cooperation and collaboration.

We’re never in a situation where the person has to negotiate with you. They have some alternative, they can walk away, which means that the only reason anybody’s going to engage you in a negotiation is because by doing so they’re going to get a better outcome than by not doing so. If that’s the case, then every negotiation is collaborative. Having a favorable outcome for yourself means that you have to have a favorable outcome for them as well. Otherwise, they’re not gonna be part of this conversation, and definitely not future conversations.

It’s easy to see where Todd gets his approach to parenting. This story of how his father modeled decision-making is brilliant but also so loving a thing to do when it might have been easy to just roll over. The setup was Todd was frustrated with lacrosse in high school and decided to quit.

Let’s follow along:

My father said, to come into the living room sit down, I want to talk to you. So I sat down in my towel and thought that this was going to be a couple seconds of  “You can’t quit lacrosse”, which which would have made some sense. A sort of  heavy-handed edict.

But instead, he said,  “Yeah, I’ve been thinking about it. It’s really been bothering me thinking about the fact that you’re quitting. It really bothers me because I haven’t heard why you want to quit, other than the fact that you’ve been frustrated with your coach, there’s not enough here. Like it doesn’t make sense. So you’re gonna have to explain to me in a way that it makes sense in order for me to be supportive of this.

In hindsight, I recognize that this was such great parenting happening here, which was not saying, here’s what you have to do, here’s what you can’t do. But instead, it said, if this is a reasonable and rational choice, or even an emotional choice, which isn’t necessarily rational, but if it’s an emotional and consistent choice, I’ll back you up on on doing this.

If it’s not, if this is rash, and it’s going to have long term implications for you, which it is,  you can’t quit the team and then three days later, go back and say you’ve decided that you want to rejoin, then there are big implications here. So you need to make sure that you’ve given this appropriate weight and appropriate thought, before following through with the decision that you can’t change. Tell me what you’re thinking and tell me what your plan is. If you do this, you’re gonna have an extra two hours every afternoon, you have an extra 10 hours a week. What are you doing with that time? How are you better off having that time, not on the lacrosse field than when you were on the lacrosse field.

The way we left it at the time was with me feeling a bit frustrated that I was not able to convince my father that this was the right choice. And because I couldn’t, I realized that maybe it wasn’t the right choice. Maybe what I needed to do was wait, and waiting was the low cost option, right that at the time, I didn’t know what options were. But in the way I sort of frame and think about the world. Now I recognize that this is what we would refer to as a real option that that there is a cost to it. It does cost me something, it costs you something in terms of my frustration level. And the fact that I’m tired after running for two hours straight. And I’m not as fast as the other guys on the team. So I’ve got to play catch up a lot. But that’s day by day, and in return, I get this upside of maybe there’s some benefit to me sticking with this longer term.

I ended up reaching the conclusion, a couple weeks later, that I wanted that to be my last lacrosse season. But I would finish out the season I would finish out both the commitment to the team and also find the opportunity to fill that time with with something else that was going to also be productive and ideally more productive than playing lacrosse, which I couldn’t do midseason. I couldn’t switch over and start start playing on the baseball team midseason. But the process of having my father model, deliberate decision making for something that was consequential was really was really pretty beneficial early on.

How this still influences Todd:

I try to take the same care today that my father had then, which is that he never erupted, you know, his his reaction was never emotional. It was purely inquisitive. It was like, you know, help me understand better. And the question he helped me understand better is, is exactly the way I approach decisions that my children are making is to say, look, you know that I love and support you with whatever it is that you’re doing. But I can either provide context, or at the very least more support if I understand better where you’re coming from.

One of the one of the other teachers of the class at Susquehanna has such a lovely touch, he just says, Tell me more, and tell me more doesn’t have any value laid in it, it doesn’t have , any judgment in it. It’s just saying, go ahead and add more words to what you’ve already shared. You want to take this action against this type of order flow? Why? Tell me more. And effectively what my father was saying is the same as what as what Mike, my co- teacher says, when he’s talking to our students, which is just, I cannot reach a conclusion about what you’re saying, until I understand it better. So help me understand it better. Tell me more.

What stands out for me is the magic that can happen when we combine the principles of charity with a demand for mental rigor and vulnerability. 

This approach establishes very early, that we’re on the same side that we have, if not all of the same goals, we have alignment with our values and our goals, I want to support you says all I’m looking for is an excuse to make sure that you and I are facing the same direction and facing the world together. Help me get there bring me into alignment with you by by telling me more,

“I want to support you. I want to help you, but I need to understand you better”

 
 

 

 

Notes from Tom Morgan on Infinite Loops

Link: https://www.infiniteloopspodcast.com/tom-morgan-all-you-need-is-love-ep74/

Tom Morgan, Director of Communications & Content at The KCP Group, joins Jim O’Shaughnessy on Infinite Loops to discuss:

  • The trillion-to-one ratio of attention
  • “Love” as a compass for growth
  • Religions and Traditions
  • Enlightenment vs. Adulthood

On attention and the possibility that there is something beyond us:

Tom: I’m not going to paraphrase the whole thing [Usual Illusion], but the relevant piece that we probably are aware of 60 bits of information at any given moment, but there’s 11 million that are potentially available to us. If I say to you, “Wiggle your big toe,” you’re suddenly aware of your big toe. That information was coming to you all this time.

You are having a conversation with a cocktail party with one person, and you hear someone else across the room say your name and you swivel your attention to that. You were taking that information in some way, it just wasn’t being served to your conscious awareness. It’s a filtering process. That feels like something that’s intuitive and is easy for us to understand. The bit that took me a really long time to understand is the idea that outside of that million to one ratio, there’s a trillion to one ratio of things that we’re never aware of and never can be aware of.

When you think about an earthworm, an earthworm has never seen a sunset and it will never see a sunset because it has not evolved to see a sunset. We will never experience the way a Bloodhound does with 200 million receptors in its nose because it’s not relevant to us. So the reason why that’s important is that if you think about a trillion to one ratio of things outside of us, the things that we’re aware of, the idea that there wouldn’t be a force influencing us that was hidden goes from a possibility to, I think, a probability.

How the powerful were able to shut down threats with might and control of information in mid-sixties to mid-seventies

Jim: Watch the music videos from that time. Again the artists were at the forefront. They were the tip of the spear in this and the spear scared the shit out of the left-brained dominant society and the man, so to speak. Psychedelics were broadly being misused in many cases. But all of the elements required for a phase change to happen successfully were in place in the mid-sixties to the mid-seventies. The man in this case, Richard Nixon, but everyone in control, and I’m speaking pretty specifically about the US here. But it happened in the UK too. And it happened in Germany. It was a global phenomenon. They made drugs, almost all of which are the non-addicting drugs, illegal. Fed max prison for going. They made an example of Timothy Leary. He became the scapegoat for like, having a couple of joints in his pocket? They didn’t even get him with any kind of psychedelic. You got to remember this guy was a tenured professor at Harvard, who was a well-thought-of psychologist. And, so they made an example of him because, now this is getting into kind of my take on this, people are terrified of what the implications are for being free.

The conventional keepers of the social “truths” shut it the fuck down. And they did that because they could. They did that because back then there was no global communication network like we have today.

People, for example, didn’t know that Franklin Roosevelt was in a wheelchair. They did not know that. Can you imagine in our day and age? Even trying to comprehend that is wild. So they were the keepers of the “truth” and it was a narrative that everyone believed.

Bucky Fuller, on death and rebirth being a shocking or scary idea:

There’s nothing about a caterpillar that suggests the butterfly.

The balance of safety and vitality; bridging specific knowledge and control with the abstract

Tom: And at the moment we’ve optimized for safety at the cost of vitality. And if you want vitality, you have to give up certainty. You have to give up the certainty of what you want, and you have to give up all forms of security, but not all forms of security. I don’t want to overstate this. Everything’s a balance, right?  We’ve just gone too far in one direction. And I think that’s sort of the prescription. It doesn’t involve a huge societal meltdown. It just involves more of an awareness of our own vulnerability and our own holistic inclusiveness.

Jim: It’s not like we haven’t been thinking about this as human beings. Forever we have, and we let traditions, and I’m not anti-tradition, but I am opposed to traditions which have osified and are not serving us anymore. And it’s like our school system, it’s like every, this is the kind of the main central heart of the great reshuffle. All of those old systems are broken or breaking. And we need to make new ones. And making new ones is going to be scary, but the only way you do that is to understand vitality.

Tom: I think any kind of reductionist theory is always going to be incomplete. You can get to the Higgs boson, but the Higgs boson isn’t going to tell you how to live your life. Right? You need values for that. I think there are actual universal values. They may be expressed in a Ten Commandment or something like that. But there is some sort of metaphysical truth out there. But the root to that individual creativity. That way you co-create with the environment around yo is intrinsically unique. And that sounds incredibly saccharine. Because it’s like, everyone’s special. Everyone’s got creativity inside them. Again, terrible words, right. When I heard “creativity”, I think of finger painting. And when you talk about reading poetry and listening to songs that just annoys my intellect.

But you have to remember that your intellect is fiercely resistant to all of these ideas because it requires giving up the steering wheel.

[Still] you do need to be is actually practical, because spiritual regressiveness and spiritual bypassing gets us nowhere in the same direction. So you need to be looking for people that are building the bridge from science back to spirituality.

Intuition or wisdom as evidence of a good filter

Tom: I read a resonant quote, two days ago, wisdom is knowing what information is important. Well that’s simple and incredibly profound, right? And to go back to the Usual Illusion example: you can’t take in 11 million bits, you’d be burned out like a light bulb in a nuclear reactor. You can’t take in a trillion bits, you’d be jello.  So all this is about, is all we’re talking about is how do you calibrate your filter to get the full range of human experience, including the shit stuff, which is the problem. If you hide in your intellect, as a lot of people I know have, it’s typically a coping mechanism to prevent yourself from experiencing the full range of human emotion.

And if you do get blown open, a blowing open experience tends to be incapacitating and overwhelming. And that’s the point. You’re not supposed to have a direct experience of that, right? Too many crazy psychedelic experiences make you too open. You believe everything, you need a good filter.

And that’s the definition of wisdom. And I think that George Soros example is brilliant. So like, for those of you that don’t know the George Soros anecdote, it was that he used to give all these really clever, retroactive reasons why he did things and then his son gave an interview I think to the Irish Times where he was like “Oh no, it’s just his back hurts when his portfolio positioned wrong.”

I thought about that for a long time. And my interpretation of it, whether right or wrong is that, we lay down a whole bunch of information from pattern recognition and he laid down a whole bunch of information from seeing an enormous number of different trading scenarios play out. But those recognition patterns run in the background. Because if they’re running in the foreground, you’re not going to get anything done. You’re going to be using your 60-bit consciousness to act in the world. But when something trips that, because it’s not running in your intellect, it’s running in your unconscious, you’re going to feel it as a sensation first.

And that’s the point. You need to be in tune enough and embodied enough that when you feel that, you don’t just feel it and discount it, you feel it and know what it means. So you are serving the correct emotions, you’re serving the correct physical sensations to your consciousness. And then you are able to interpret them and act on them in the correct way. That is a well-calibrated filter. It’s not about feeling everything all the time, because then you’re just going to be mush.