#93 Ed Thorp (A Man for All Markets)

What I learned from reading A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market by Edward Thorp. ---- [0:01] Ed Thorp’s memoir reads like a thriller—mixing wearable computers that would have made James Bond proud, shady characters, great scientists, and poisoning attempts. The book reveals a thorough, rigorous, methodical person in search of life, knowledge, financial security, and, not least of all, fun. Thorp is also known to be a generous man, intellectually speaking, eager to share his discoveries with random strangers. [1:23] Ed Thorp is the first modern mathematician who successfully used quantitative methods for risk taking—and most certainly the first mathematician who met financial success doing it. [3:19] Ed was initially an academic, but he favored learning by doing, with his skin in the game. When you reincarnate as practitioner, you want the mountain to give birth to the simplest possible strategy, and one that has the smallest number of side effects, the minimum possible hidden complications. [4:33] As Warren Buffet said: “In order to succeed you must first survive.” You need to avoid ruin. At all costs. [6:48] It is vastly less stressful to be independent—and one is never independent when involved in a large structure with powerful clients. It is hard enough to deal with the intricacies of probabilities, you need to avoid the vagaries of exposure to human moods. True success is exiting some rat race to modulate one’s activities for peace of mind. [7:51] Read the forward by Nassim Taleb [9:14] Ed’s 4 rules for learning First, rather than subscribing to widely accepted views—such as you can’t beat the casinos—I checked for myself. Second, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought—such as a formula for valuing warrants—and using it profitably. Third, when I set a worthwhile goal for myself, I made a realistic plan and persisted until I succeeded. Fourth, I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I also learned the value of withholding judgement until I could make a decision based on evidence. [11:15] I admired the heroes who, through extraordinary abilities and resourcefulness, achieved great things. I may have been inspired to mirror this in the future by using my mind to overcome obstacles. [14:29] They told us that my aunt Nona and her husband had been beheaded in front of their children. [16:45] At its core, this is a book about how to live well. [17:55] Ed develops simple systems for everything in his life. [20:37] If anyone knew whether physical prediction at roulette was possible, it should be Richard Feynman. I asked him, “Is there any way to beat the game of roulette?” When he said there wasn’t, I was relieved and encouraged. This suggested that no one had yet worked out what I believed was possible. With this incentive, I began a series of experiments. [21:15] “Try to figure out what your skill set is and apply that to the markets.” Thorp likes to stay within his circle of competence. This is a hallmark of people who are rational. In that sense, Thorp reminds me of Warren Buffett. A Dozen Things I learned from Ed Thorp [21:50] I also believed then, as I do now after more than fifty years as a money manager, that the surest way to get rich is to play only those gambling games or make those investments where I have an edge. [23:50] He wrote a book that sold over a million copies: Beat the Dealer: A Winning Strategy for the Game of Twenty-One [26:48] In the abstract, life is a mixture of chance and choice. Chance can be thought of as the cards you are dealt in life. Choice is how you play them. [27:52] Ed’s philosophy on life: My thoughts then were much like I expected his to have been: that 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 is what you do and how you do it, the quality of the time you spend, and the people you share it with. [30:01] Even though the Goliath I was challenging had always won, I knew something no one else did: He was nearsighted, clumsy, slow, and stupid, and we were going to fight on my terms, not his. [33:09] A good defense keeps other people from taking your money. [36:39] History doesn’t repeat, human nature does: The frauds, swindles, and hoaxes, a flood reported almost daily in the financial press, have continued unabated during the more than fifty years of my investment career. But then, hoaxes, scams, manias, and large-scale financial irrationalities have been with us from the beginnings of the markets in the seventeenth century. [40:24] You are unlikely to have an edge on anything you hear in the news. [46:24] As we chatted about compound interest, Warren gave one of his favorite examples of its remarkable power, how if the Manhattan Indians could have invested $24, the value then of the trinkets Peter Minuit paid them for Manhattan in 1626, at a net return of 8 percent, they could buy the land back now along with all the improvements. Warren said he was asked how he found so many millionaires for his partnership. Laughing, he said to me, “I told them I grew my own.” [52:07] How Ed selected employees: 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. Better to teach a young athlete who comes fresh to his sport than to retrain one who has learned bad form. [57:13] Life is really about spending time well. [1:01:45] When Princeton Newport Partners closed, Vivian and I had money enough for the rest of our lives. Though the ending of PNP was traumatic for us all, and the future wealth destroyed was in the billions, it freed us to do more of what we enjoyed most: spend time with each other and the family and friends we loved, travel, and pursue our interests. Taking to heart the lyrics of the song “Enjoy Yourself (It’s Later than You Think),” Vivian and I would make the most of the one thing we could never have enough of—time together. Success on Wall Street was getting the most money. Success for us was having the best life. [1:04:30] 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. [1:07:19] As Benjamin Franklin famously said, “Time is the stuff life is made of,” and how you spend it makes all the difference. [1:07:37] Whatever you do, enjoy your life and the people who share it with you, and leave something good of yourself for the generations to follow. ---- Founders Notes gives you the ability to tap into the collective knowledge of history's greatest entrepreneurs on demand. Use it to supplement the decisions you make in your work. Get access to Founders Notes here. ---- “I have listened to every episode released and look forward to every episode that comes out. The only criticism I would have is that after each podcast I usually want to buy the book because I am interested so my poor wallet suffers. ” — Gareth Be like Gareth. Buy a book: All the books featured on Founders Podcast

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Senra?

  Ed Thorp's memoir reads like a thriller, mixing wearable computers that would have made James Bond proud, shady characters, great scientists, and poisoning attempts. The book reveals a thorough, rigorous, methodical person in search of life, knowledge, financial security, and not least of all, fun. Thorp is a generous man, eager to share his discoveries with random strangers. Something you hope to find in scientists, but usually don't. Yet he is humble. He might qualify as the only humble trader on planet Earth. So unless the reader can reinterpret what's between the lines, he or she won't notice that Thorp's contributions are vastly more momentous than he reveals.

• 0:45David Senra?

  Why? Because of their simplicity, their sheer simplicity. For it is the straightforward character of his contributions and insights that made them both invisible in academia and useful for practitioners. My purpose here is not to explain or summarize the book. Thorp, not surprisingly, writes in a direct, clear, and engaging way. I am here as a trader and a practitioner of mathematical finance to show its importance and put it in context for my community of real-world scientist traders and risk takers in general. That context is as follows. Ed Thorp is the first modern mathematician who successfully used quantitative methods for risk-taking,

• 1:30David Senra?

  and most certainly, the first mathematician who met financial success doing it. Thorp's method is as follows. He cuts to the chase in identifying a clear edge that is something that in the long run puts the odds in his favor. The edge has to be obvious and uncomplicated. For instance, calculating the momentum of a roulette wheel, which he did with the first wearable computer and with no less a co-conspirator than the great Claude Shannon, father of information theory. He estimated a typical edge of roughly 40% per bet. The computer turned a 5.3% disadvantage into a 40% edge.

• 2:13David Senra?

  But that part is easy, very easy. It is capturing the edge, converting it into dollars in the bank, restaurant meals, interesting cruises, and Christmas gifts to friends and family. That's the hard part. It is the dosage of your betting, not too little, not too much, that matters in the end. A bit more about simplicity before we discuss dosing. For an academic judged by his colleagues, rather than the bank manager of his local branch or his tax accountant, a mountain giving birth to a mouse after huge labor is not a very good thing. They prefer the mouse to give birth to a mountain.

• 2:55David Senra?

  It is the perception of sophistication that matters to them. The more complicated, the better. The simple doesn't get you citations or some other metric de jour that brings the respect of the university administrators, as they can understand that stuff, but not the substance of real work. The only academics who escape the burden of complication for complication's sake are the great mathematicians and physicists. Ed was initially an academic, but he favored learning by doing, with his skin in the game. When you reincarnate as a practitioner, you want the mountain to give birth to the simplest possible strategy and the one that has the smallest number of side effects,

• 3:38David Senra?

  the minimum possible hidden complications. Ed's genius is demonstrated in the way he came up with very simple rules in blackjack. Instead of engaging in complicated and challenging card counting, something that requires one to be a savant, he crystallizes all of his sophisticated research into simple rules. Go to a blackjack table. Keep a tally. Start with zero. Add one for some strong cards, minus one for weak cards, and nothing for others. It is mentally easy to just bet incrementally up and down, bet larger when the number is high and smaller when it is low, and such a strategy is immediately applicable by anyone with the ability to tie his shoes and find a casino on a map.

• 4:23David Senra?

  Now money management, something central for those who learn from being exposed to their own profits and losses. Having an edge and surviving are two different things. The first requires the second. As Warren Buffett said, "In order to succeed, you must first survive. You need to avoid ruin, at all costs." Academic finance did not get the point that avoiding ruin, as a general principle, makes your gambling and investment strategy extremely different from one that is proposed by the academic literature. Thorp and Kelly's ideas were rejected by economists, in spite of their practical appeal.

• 5:04David Senra?

  The famous patriarch of modern economics, Paul Samuelson, was supposedly on a vendetta against Thorp. Not a single one of the works of these economists will ultimately survive. Strategies that allow you to survive are not the same thing as the ability to impress colleagues. So the world today is divided into two groups using two distinct methods. The first method is that of the economists, who tend to blow up routinely or get rich collecting fees for managing money, not from direct speculation. Consider that, long-term capital management, which had the creme de la creme of financial economists, blew up spectacularly in 1998, losing a multiple of what they thought the

• 5:47David Senra?

  worst-case scenario was. The second method, that of the information theorist that's pioneered by Ed, is practiced by traders and entrepreneurs and scientists. Every surviving speculator uses explicitly or implicitly this second method. I said "every" because those who don't will eventually go bust. Some additional wisdom I personally learned from Thorp. Many successful speculators, after their first big break in life, get involved in large-scale structures, with multiple offices, morning meetings, coffee, corporate intrigues, building more wealth while losing control of their lives. Not Ed.

• 6:32David Senra?

  After the separation from his partners and the closing of his firm, for reasons that had nothing to do with him, he did not start a new mega fund. He limited his involvement in managing other people's money. But such restraint requires some intuition, some self-knowledge. It is vastly less stressful to be independent, and one is never independent when involved in a large structure with powerful clients. It is hard enough to deal with the intricacies of probabilities. You need to avoid the vagaries of exposure to human moods. True success is exiting some rat race to modulate one's activities for peace of mind. Thorp certainly learned this lesson.

• 7:17David Senra?

  The most stressful job he ever had was running the math department at the University of California, Irvine. You can detect that the man is in control of his life. This explains why he looked younger the second time I saw him in 2016 than he did the first time I saw him in 2005. Okay, so that was an excerpt. It was written by Nassim Taleb from the book that I read this week, which is the autobiography of Ed Thorp. The book is called "A Man for All Markets: From Las Vegas to Wall Street: How I Beat the Dealer and the Market." You can actually read the entire foreword that Taleb wrote for the book for free. He posted it on his Medium page, and I will link to it in the show notes.

• 8:00David Senra?

  Now, this is the sixth part of a series that I'm doing that started back on Founder's Number 88, which is when... It's a podcast I did that when I read every single shareholder letter Warren Buffett has ever written. And in the past few weeks, I've read books about people Warren Buffett mentioned and admired. And I do this to try to deepen my understanding of how Buffett thinks and the kind of ideas and people that he favors. And Ed Thorp is one of those people. Okay, so I want to go right into Ed's early life and he quickly starts out with what I call Thorpe's Four Rules.

• 8:38David Senra?

  And so first, let's talk a little bit about like when he was born and how that may have influenced like the ideas and the way he ran his business and his life later. So he says, "I began life in the Great Depression of the 1930s. Along with millions of others, my family was struggling to get by from one day to the next. Though we didn't have helpful connections and I went to public schools, I found a resource that made all the difference. I learned how to think. Because of circumstances, I was largely self-taught and that led me to think differently." So he jumps into his Four Rules for Learning. First, rather than subscribing to widely accepted views, such as you can't beat the casinos, I checked for myself.

• 9:23David Senra?

  So it's important to note, he uses this trait over and over again in life. Example, when everybody knew that you couldn't beat any of the games in Las Vegas, not only roulette, they told him you couldn't, and then blackjack. And then also, everybody knew, and "knew" is in quotes, that the market was efficient and it's impossible for you to find any kind of edge, so why would you bother trying? Ed didn't believe either of those and he wound up finding a lot of opportunities because he didn't accept like conventional wisdom. Rule number two, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought, such as a formula for valuing warrants and using it profitably. So he'll talk about warrants a few times. It's one of his most, actually first very successful financial idea in finance.

• 10:08David Senra?

  And he says the best way to think about it is very similar to an option, it's just the difference is it's issued by the company. Rule number three, when I set a worthwhile goal for myself, I made a realistic plan and persisted until I succeeded. And number four... I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I learned the value of withholding judgment until I could make a decision based on evidence. Okay, so he mentioned a little bit about his early life. There's another important part. So not only were they extremely poor, but both of his parents had to work. They weren't making a lot of money. And so, as a large part, he grew up rather unsupervised. And so, one of the most important things that happened to him at a very young age is

• 10:53David Senra?

  he developed a love of reading. And so, he talks a little bit about that here. He says, "My parents were usually gone or sleeping, seldom seeing us or each other. That left my brother and me to raise ourselves. I responded by exploring endless worlds, both real and imagined, that I found in the books that my father gave me. I learned about heroes and villains, romance, justice, and retribution. I admired the heroes who, through extraordinary abilities and resourcefulness, achieved great things." And that sentence right there is a good description of Ed's life. He, through extraordinary abilities and resourcefulness, he achieved great things. "I was inspired to mirror this in my future by using my mind to overcome obstacles.

• 11:37David Senra?

  Though we were poor, my parents valued books and managed to buy me one occasionally." Now, he talks a lot about how early, and this is universal human trade, like we're foreign, but there's things that happen to us early in our lives that stick with us for the rest of our lives. And there's a heavy influence on how we think, how we organize relationships, how we organize our work. And the Great Depression, as we've seen many times on the podcast with other founders, anybody that grew up during the Great Depression, they kept that with them for their whole life. And Ed was no different. And he says, "As we were bear," this is the long-term effects of the Great Depression on Ed, "As we were barely managing on my father's depression-era wages, an academically advanced private school was never an option.

• 12:21David Senra?

  The depression permeated every facet of our lives. We lived on my father's $25 a week salary. As such, we never wasted food, and we wore our clothes until they fell apart. For the rest of my life, I would meet depression-era survivors who retained a compulsive, often irrational frugality and an economically efficient tendency to hoard."

• 12:45David Senra?

  And you'll see kind of an echo of this conservatism in Ed a little later on, although he was certainly would seize opportunities when it presented itself and bet heavily. But he was running a very successful hedge fund, and he did so for like 20 something years. And I think something like the first 10 or 12 years, he refused to quit his day job. So he was doing both, and he was running, he was working at the University of California, Irvine. Alright, so going back to his early age, this is some early lessons in entrepreneurship, and something he retains with him for the rest of his life. He says, "When my father gave me a nickel to shovel the snow from our sidewalk, I hit a bonanza. I offered the same deal to our neighbors, and after an exhausting day of snow removal, I returned

• 13:29David Senra?

  home soaked in sweat and bearing the huge sum of a couple of dollars, almost half of what my father was paid per day. Soon, lots of other kids were out following my lead, and the bonanza ended. This was an early lesson in how competition can drive down profits, and why you need to find your edge." So, one of the most shocking things I found in the book was, he has, a large part of his family was in the Philippines, and during World War II, they were prisoners of war when the Japanese invaded Philippines. So his family suffered greatly as a result of this. And this is some lessons and some motivation they took away from this. He says after

• 14:12David Senra?

  the war, "Meanwhile, American troops had liberated the survivors of my mother's family from a Japanese prison camp in the Philippines. Multiple families came over from the Philippines to live with us." So at the time, even though they didn't have a lot of money and a lot of space, they wound up, there's 10 plus people, multiple families, living with him at this point. "They told us stories such as my aunt and her husband, who had been beheaded in front of their children by the Japanese, and that my grandfather had died painfully of prostate cancer in the camp just a week before liberation. Seeing what World War II had done to my relatives, and how World War I, plus the Great Depression, had limited my father's future, I determined to do better for myself and the children that I had hoped to have."

• 14:55David Senra?

  So I'm gonna skip forward in the timeline, I'm gonna get to when he gets to college. Now, before college, he's like, you know, even at the time, I think he said, college was something like $70 a semester at this time. And he, he still didn't know if he could afford that. And so he had this idea a few years in advance to buy these war bonds. And the maturity, at the time they were mature, would be just about the time he was going to college. And so he's like, okay, I'm going to use this, like, as a, you know, basically like a college savings account. And so this section I'm gonna read to you is how he supported himself in college. And he didn't come from a, like, a well-functioning family. His parents wind up cheating on each other, they get divorced, he then went from living with his dad to seeing his dad like, once a week.

• 15:39David Senra?

  And then, he's betrayed by his mom here. His mom takes, so he says, "Whether I could support myself at the university was now in doubt." What does that mean? "His mother took his bonds, cashed them out, and spent the money." So he says, "I survived with scholarships, part-time jobs, and $40 a month for my, for the first year for my father. I got by on less than $100 a month, including everything: books, tuition, food, shelter, and clothes. On Sundays, when my boarding house did not provide meals, I visited church open houses, where I consumed large quantities of free hot chocolate and donuts." When I read that part, that was a very similar, it reminded me of a very similar situation that Steve Jobs was in before he started Apple, where he wasn't eating a lot, and the

• 16:21David Senra?

  one good meal they would have is every, I think, Sunday, they'd walk over to the, I think it was like, Hare Krishna or something like that, to get one good meal. So Ed's kinda, we're seeing similarities in Ed's early life. So Wise in college, he picks up a habit that he maintains for the rest of his life, and that benefits him for the rest of his life. And that's a focus on health and fitness. So, the main point I took away from this book and what I learned, really, it's a book, it is a book about entrepreneurship, and risk-taking, and working hard, and educating yourself, but really, at its core, it's a book about how to live well. And he, one way Ed did that is, he didn't over-optimize just for money. And we've seen that on, in past podcasts. So there's a lot of autobiographies, you know, the entrepreneur waits close to the end of

• 17:06David Senra?

  his life, starts writing entrepreneur, writing his autobiography, and there's a lot of regret. So, the two that come to mind right now are Sam Walton, the founder of Walmart, and Phil Knight, the founder of Nike. Both of their autobiographies, they talk about, you know, spending so much time on their business that if they could do it over again, they would have spent more time with their family. Ed doesn't make that mistake. So he, he makes a lot of money, but he also spends a lot of time with his family and loved ones. He also takes care of his health. And in addition to reading this book, I also took notes, um, cause on, I would say, I think there's two or three different, um, talks I found of his. And one of them, I've showed the video to several people. And I was like, tell me how old do you think that guy in the video is? And they hear him talk, they look at him, they're like, I don't know, 60, 65?

• 17:50David Senra?

  He's 85 years old in the videos. And today he's 87 and he's still fit and healthy. So one of the things that he, he's gonna stumble upon now in college is he starts to develop simple systems, just like he developed simple systems for everything in his life, to maintain a healthy lifestyle, cause he understood, uh, how that affects every other aspect of your life. So he says, "One evening, I heard the sound of iron clanking. Curious, I ventured inside and found three muscular residents hoisting barbells. When I suggested that this seemed like a lot of work for who knew how much gain, they bet me a milkshake that if I would work out with them for one hour, three times a week for a year, I would double my strength. I accepted their challenge.

• 18:32David Senra?

  When the year ended, I had more than double what I could lift and gladly paid off the bet. This was the beginning of a lifelong interest in fitness and health." Okay, so now I'm fast forwarding, he's in grad school, uh, studying physics, uh, physics. And, uh, there's like, he's at this gathering and there's a group of, uh, physics students that are saying, I said, "Someone who had been to Las Vegas was explaining that no one could beat the casinos. Uh, this was the consensus view of the group. It was also the view of the world in general, backed up by the painful experience of generations of gamblers." So this goes back to his trait, what he recommended earlier, we investigate things for ourselves, right? And so this is also when he starts taking the idea to beat roulette seriously. So he says, "I argued with others at the table that you could beat roulette.

• 19:16David Senra?

  Using what I learned from physics, I explained that friction would gradually slow the orbiting ball on the circular track until finally, gravity would be enough to cause it to spiral down and in towards the center. I argued that an equation could forecast the ball's position during this process. Limiting the predictive power of my equations were random irregularities that can't be forecast. This is what mathematicians and physicists call noise. Conventional wisdom said that noise was enough to ruin the prediction. I didn't think so and I decided to find out." So this is what I was, what Taleb was referencing in the foreword of the book, where he, him and Claude Shannon actually build one of the first wearable computers.

• 19:55David Senra?

  And they take what winds up being a negative, what, 5% edge or whatever it was, to a positive edge of 40%. So he's actually winds up being correct. And this is a weird, and I mean that in a like a positive way, because I love weirdos and misfits. I mean, this is what this entire podcast is about, right? You're not going to write a biography on your life if you just toe the line and just accepted conventional wisdom and never deviated from that, right? So he meets Richard Feynman, right? And he's encouraged, he asks, let me just read this to you and then I guess, so I don't trip over my own point. So he winds up stumbling at this party, stumbling into this party, and Richard Feynman's in the corner playing bongos. And so he walks up to him, he says, "If anyone knew whether physical prediction of roulette

• 20:40David Senra?

  was possible, it should be Richard Feynman. I asked him, 'Is there any way to beat the game of roulette? When he said there wasn't, this is the weird part, which I admire, 'I was relieved and encouraged.'" Okay. "This suggested that no one had yet worked out what I believed was possible. With this incentive, I began a series of experiments."

• 21:01David Senra?

  So then this next paragraph, before I read, or as I was reading the book, I also read like blog posts and anything I could to try to study to understand Ed Thorp a little bit more. And so there's a blog post called "A Dozen Lessons From Ed Thorp," if you Google that, you can see it. And there's a quote there. He says, "Try to figure out what your skillset is and apply that to markets." Thorp likes to stay within his circle of competence. This is going to echo Warren Buffett, right? "This is a hallmark of people who are rational. In that sense, Thorp reminds me of Warren Buffett." Not only does he remind me of Warren Buffett, but it's exactly what David Ogilvy told us a few weeks ago. He's like, "Listen, I'm an idiot on everything except advertising. On advertising, I got my stuff together." But so David, what David's saying there is like, "I know what my circle competence is. I'm going to stay within the circle competence based on my research of consumer behavior

• 21:44David Senra?

  and the applications of that research to advertising." And so Thorp is echoing that later. He says, "I also believe then, as I do now, more than 50, as more than 50 years as a money manager, that the surest way to get rich is to play only those gambling games or make those investments where I have an edge." Now, while he's doing, let me go back to the book. Now, while he's doing this research on roulette, he also comes across, there's some academic papers at this point. Now, keep in mind, Ed Thorp was, he thought he was going to be an academic his whole life. Him and his wife, when they got married, decided, "Okay, we're not going to make a lot of money, but we'll be around other smart, interesting people, and we'll just do the best we can." He did not expect to become fabulously wealthy. And while he's doing this, he's reading all

• 22:28David Senra?

  these papers on blackjack, and other people are computing, you know, it's been like 150 years at this point of people trying to compute different odds on casino games, games that are common for people to gamble on. And so that's when he comes, he's like, starts studying blackjack. He says, "Well, maybe, like roulette, I have to build," he wants to have him to build a computer, "but he is like, "Maybe I can come up with a formula or a system where I don't need any hardware," right? So he's doing this as he's thinking about roulette, but before he starts working with Claude Shannon. And what I took from this is like, being driven and curious, it can lead you anywhere. He does the same thing when studying blackjack that he does when he starts his business. He sits in a room and thinks about how to win. And then he goes out and tests the results of that computation.

• 23:12David Senra?

  So he says, "It wasn't the money that drew me to blackjack. What intrigued me was the possibility that merely by sitting in a room and thinking, I could figure out how to win. I was also curious to explore the world of gambling, about which I knew nothing." That's another thing. I think I cover it later on. He wants to becoming a millionaire, I think at age 43. And he did that direct result from finance. He never even thought about finance till he's 32 years old. So this trait about being interested in things that he knew nothing about, he didn't think of that as a barrier. He just thought about that as an opportunity. I think that's good for all of us. So he writes, he has this theory. He wants to, this is where he's, you might have heard card counting. Ed Thorp is credited with the invention of card counting.

• 23:56David Senra?

  He actually wrote a book called Beat the Dealer that winds up selling over a million copies. It was published in like 1967 or something like that. This is before the book and before he becomes infamous for that or famous for that. And he has this theory, but again, he's still an academic. So what happens is he wants to publish his theory on blackjack because he feels it's a problem of mathematics in a journal. So he can get credit for coming up with that idea because in the past, he had previous work stolen by other academics. He'd send a paper off to somebody for review and say, "Hey, what do you think of this?" And then he'd never hear back from them. Like a year later, that guy's giving presentations on Thorp's idea and passing it off as his own. So as a result of wanting to publish this, he's at MIT right now, working at MIT.

• 24:42David Senra?

  He meets Claude Shannon. Okay. And so he says, "To protect myself from this happening with my work on blackjack, I settled on the National Academy of Sciences." This is where he wants to publish his work on blackjack. "This required a member of the academy to approve and forward my work. So I sought out the only mathematics member of the academy at MIT, Claude Shannon. Claude was famous for the creation of information theory, which is crucial for modern computing, communications and much more. Essentially, we wouldn't have the entire technology, like internet economy we have now without Claude Shannon." I'm not going to cover too much of that. I'm going to read his biography. It'll be coming in the next few weeks. But I also talked about the impact of Claude Shannon last week on the founders episode I did for on Fortune's formula.

• 25:24David Senra?

  So if you want to learn more, I don't want to repeat that if I've already covered in a previous podcast. But I do want to talk a little bit about their work together. And I just find the mind of Ed Thorp and Claude Shannon fascinating. So Claude agrees to meet with him. Claude says, "Okay, I like your idea. Yes, I'll forward this to the National Academy of Sciences." They also asked, he also asked him, "Hey, do you have any other ideas?" And that's when he brings up this idea for the roulette computer. Claude Chan's one of his most famous passions was building gadgets. He had this thing in his house called the toy room, which had over $100,000 in 1960s money of like gadgets, like early predecessors' computers, some things that were completely mechanical. He just loved building weird things.

• 26:07David Senra?

  He'd build like a slackline in his house and he'd get on the slackline and juggle. He was just a very interesting person. So, as a result of the publication of his work, he then is invited to give a bunch of talks. And hundreds of people show up. And normally these talks at the time, there'd be like 50 people, you know, 50 academics. But the great, it started being covered in the press. And then, you know, you have mobsters, you have all kinds of crazy people that want to find a way to, you know, get rich quick essentially. And so, the press is largely cynical of him. But what I found interesting was, these are his thoughts right after he's done talking. So he gave his talk, he thought about all these bizarre twists in his life that just happened.

• 26:52David Senra?

  And he says, "During the long ride back, I wondered how my research into the mathematical theory of a game might change my life. In the abstract, life is a mixture of chance and choice. Chance can be thought of as the cards you are 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." And so that's a really important part, that the future and the world that we live in is way too complex to predict. All you can do is hope that you're exposing yourself to enough experiences that open up opportunities later in your life. In his case, you know, he still thinks he's an academic. "I'm going to study blackjack." Maybe I can figure something out, maybe I can't. Winds up making money at Blackjack, winds up making money selling a book at Blackjack,

• 27:36David Senra?

  then realizes, which I'll cover in a little bit, hey, I can apply these ideas to the stock market, which just seems like a large, you know, mathematical problem, just like a large casino. And then that forever changes the path of his life. So I like that idea about chances, the cards you're dealt, and choices, how you play them. Now, this is one of the things I admire most about Ed and what I'm learning from him, and I'll talk more about this in a little bit, but this is really Ed's philosophy on life, and I just want you to remember this part for when I get to the end. Claude, Claude, he's working about 20 hours a week in addition to all his other duties with Claude Shannon at Claude Shannon's house. He's building the roulette computer. Claude asked me at dinner if I ever thought anything would ever top this in my life.

• 28:18David Senra?

  My thoughts then were much like I had expected his to have been, that acknowledgement, applause, and honor are welcome and add zest to life, but these are not ends to be pursued. I felt then, as I do now, keep in mind he's 80, around 85 when he's writing these words, I felt then, as I do now, that what matters is what you do and how you do it, the quality of time you spend and the people you share it with. So now he's talking about taking on the casinos and realizing that they think everybody else is a fool, right? That they have the edge, that's why, you know, casinos can build hotels and shows, and where'd that money come from? It came from the people that went in there and gambled away their money. So the next pair of them I'm going to read you is, he's describing the casino here,

• 29:03David Senra?

  but what he's really saying is that he's operating with an edge, and it's also why we're able to start new companies that can, you know, everybody thinks that if the official market theory was correct, like, then no one would be, there would be no such thing as the reason to start new businesses, because the existing businesses would have already seized all the opportunity. We know that is fundamentally untrue. And so, he's talking about a casino here, why don't you think about, okay, one, he's talking about you need an edge, and then, second, take that thought... That you need an edge and think about that you can apply that edge to an unlimited number of opportunities in business because again, I love going back to that. The best basic way to think about for people that haven't started a business yet is like, I don't know what to do.

• 29:46David Senra?

  Just think about what Richard Branson said, a business or a product is just something that somebody that makes somebody's life better. If you apply that thought to the world, you'll see that there's unlimited opportunities for that. And so I also want you to think about how he is describing the Goliath as, you know, the existing companies that may or that may be missing opportunities or maybe too arrogant to think that other people can can capture opportunities from them. So he says, even though the Goliath I was challenging had always won, I knew something no one else did. That's his edge, right? He, meaning the Goliath, was nearsighted, clumsy, slow and stupid. And we were going to fight on my terms, not his.

• 30:29David Senra?

  So part of the benefit in counting cards is you know, when the when you have the edge to make a larger bet and when you and when the casino has the edge, so as a byproduct of that, you reduce your risk, right? And your bet. Now, this is a lesson he learned from blackjack that he later applies to his hedge fund. It's literally when you read the book, you're like, wow, this guy just took the basic idea and applied it to different domains. This is really genius. He says, this this plan of betting only at a level at which I was emotionally comfortable with and not advancing until I was ready, enabled me to play my system with a calm and disciplined accuracy. This is the same thing. That could be said by Buffett, by Munger, by any of the people that we've been studying. The lesson from the blackjack tables would prove invaluable throughout my investment

• 31:14David Senra?

  lifetime as the stakes grew even larger. Now, there's something really interesting that that that he discovers as a life lesson, you know, because. He was kind of bullied when he was younger and realized, hey, I may think differently. I'm kind of different than other people, than than than normal people, so to speak. But being living in academia, he got exposed to, you know, some kind of pettiness and stuff like that. But what he's gonna, he's getting a life lesson in human nature here. And what he discovers, right? First, he discovers it when he's trying to beat the casinos and later he applies this to the investment world at large. He actually, interesting enough, part of his, I mean, this guy's had an amazing life.

• 31:58David Senra?

  He winds up discovering the Ponzi scheme of Bernie Madoff like 18 or 19 years before Madoff gets caught. But anyways, what he's learning here is that cheating is rampant in gambling, investing, entrepreneurship, anything that business, just anything that has to do with humans being able to gain by cheating, right? And so he says, cheating was so relentless during those days in Las Vegas that I spent as much time learning about the many, many ways it was being done as it did playing. Everywhere we went, we reached a point where we were cheated, barred from play, or the dealer reshuffled the cards after every hand. So if they reshuffling the cards are taking away his ability to to to continue counting, because the longer he can count, the more precise the odds get and therefore his bets

• 32:43David Senra?

  are gonna be better. So, when I was taking notes on one of the talks he gave while promoting this book, he said something that I that I wrote down and put in my note, in my notebook, and it was interesting. And he says, um, that that business and investing is very much like making a good Super Bowl team. And I was like, what do you mean by that? So he says, if you want a good Super Bowl team, you need a good offense and a good defense. So your offense is your edge, right? What does your, what does he mean by good defense? A good defense keeps other people from taking your money. So you can apply that what he's discovering, that almost every single system is rigged. And therefore, if you're naive to that, you have a bad defense and therefore other people are gonna take their edge, which is gonna take your money.

• 33:26David Senra?

  So you need your edge for your offense, but also you need a good defense to protect you from other people's edges. And this is a crazy story. He's, he's doing all this research, right? He's really not trying to get rich on blackjack still at this point. And he figures, okay, well, I'm discovering all different ways that that casinos are cheating. So of course, the Nevada Gaming Control Board, who is the regulator of the casinos, wanna know, right? So he goes to them with another trusted person that has a relationship with them. And he says, hey, my friend Ed's finding all these things out. We want to tell you so you can, you know, stop casinos from cheating regular consumers, right? And he's going to discover that the Nevada Gaming Control Board is not, the regulator has been captured by the casino.

• 34:10David Senra?

  Okay, so they suggest to Ed, hey, when you go gamble at these casinos, take one of our agents with you so he can protect you from their cheating, right? And this is what happens. So what they'll do is if you're winning, they'll bring in a new dealer right in the middle of like your win streak. And that person is very skilled at being able to show, to look at the top card, the card they're taking. And if it's not good, they can immediately with a really fast sleight of hand, take the second card, right? So it's a way for them to, it's called second card in the sense that they're getting the second card. They're getting, they're getting to choose between two cards instead of one. So it's flat out casinos cheating consumers, right? And this is happening while the agent's right next to him.

• 34:53David Senra?

  And he calls him his protector because that's what he was supposed to be, but that's really false. He says, as my protector followed me outside, I said, did you ever see a second card like that before? Because it wound up getting stuck and it wasn't like a good sleight of hand. It was very, very obvious. And the guy said, the guy replies, second? What second? This agent had been sitting three feet from the dealer. He saw everything and pretended to see nothing. Realizing that he was there to finger me for the casinos, I used the restroom to excuse myself and lose him and went to play at another casino. So going, there's something else he said that was interesting. This reminded me of what he said about Bernie Madoff. Because, you know, he was hired by somebody who had an investment in, it was a large institutional

• 35:37David Senra?

  investment of Madoff's in like the early 90s. And so he goes and investigates the trades. What he learns is that Madoff is basically making up the trades because you can go and check the trades. Well, he said on this day, he traded for this amount. Well, that volume's not there. Okay, that trade never happened. And so he winds up dedicating several weeks to this and he comes out, he's like, this guy's, he's a fraud. He's not trading what he's telling you. And so he's asked a question in one of these interviews, like, did you ever think that you should have gone to the authorities with this? And his response was really interesting. It kind of echoes the experience that he had younger, realizing the Nevada Gaming Control Board was corrupt. He says Bernie Madoff had been the chairman of the NASDAQ. He was the third biggest market trader in the United States. He was on all types of committees.

• 36:22David Senra?

  He was the establishment. The SEC checked him and gave him a rubber stamp of authenticity. And that happened year after year after year. And so what does that mean? If you hear him say that and then you read his description of the Nevada Gaming Control Board in his book, if you read between the lines, Thorpe is telling us that most systems are rigged. So this is an example that he's going to talk more about frauds and twiddles. That history doesn't repeat, human nature does. Alright, so he says, "The frauds, twiddles, and hoaxes, a flood reported almost daily in the financial press, have continued unabated during the more than 50 years of my investment career. But then hoaxes, scams, and large-scale financial irrationalities have been with us from the beginning of the markets in the 17th century."

• 37:07David Senra?

  So he's just telling us, listen, yeah, it's happening today, but it happened 300 years ago. And if something's happening today and happened 300 years ago, good chance that that's just going to be around for a long time. Alright, this is the lesson he learned from his time sitting blackjack in Las Vegas. "From a mathematical idea in my head, I forged a system for beating the game." He winds up being extremely successful then. I talked a little bit about that last week, too. "Then I was ridiculed by the casino, which said that it sent cabs for fools like me. Thinking they played fair..." Remember, I was talking about what his... The impression that he thought about the industry before he started interacting with it is vastly different than the one he actually experiences, right? "Thinking they played fair and I was taking my secret weapon, a brain, to a sporting event, I found myself barred, cheated,

• 37:52David Senra?

  betrayed by a representative of the Gaming Control Board, and generally persona non grata at the tables. I felt satisfaction and vindication when the great beast panicked." What he's talking about there is when he publishes his book. They start changing the rules in blackjack. And so that's what he means. He's like, "Oh, okay, so you said you sent cabs, so I'm an idiot. It's impossible. But then I proved that I was correct, and then you changed the rules to the game. It felt good to know that just by sitting in a room and using pure math, I could change the world around me." So you might be asking, like, he's got the system, he can travel all over the world, make money doing this. Why did he stop? He started being drugged by the casinos. They poisoned the drinks they gave him.

• 38:33David Senra?

  And then they're leaving the casinos, and somebody tampered the brakes on his car, and they almost stopped him, almost caused him to die. So after being drugged and the brakes on his car tampered with, he decides to focus his talents on the stock market.

• 38:47David Senra?

  So he says, "I invested money from book royalties and gambling winnings in stocks, but I was ignorant of the market as well as unlucky. The results were poor, and I wanted to do better. Investments presented a new type of uncertainty, but the theory of probability might help me make good choices. Things came together when I realized that there was a far greater casino than all of Nevada.

• 39:09David Senra?

  Could my methods for beating games of chance give me an edge in the great-- there's that word again-- in the great gambling-- in the greatest gambling arena on earth? Wall Street? Ever curious, I decided to find out. I began to teach myself about the financial markets and lighting my way with an unusual lamp, the knowledge that I had gained from gambling gains." So this is how he starts studying financial markets. "Relishing the intellectual challenge and the fun of exploring the markets, I spent the summer of 1964 educating myself about them. I read stock market classics like Graham and Dodd's Security Analysis, Edward and McGee's work on technical analysis, and scores of other books and periodicals ranging from the fundamental to technical, theoretical to practical, and simple to abstruse.

• 39:55David Senra?

  I came away with a foundation of knowledge. Once again, just as with casino games, I was surprised and encouraged by how little was known by so many. And just as in blackjack, my first investment was a loss that contributed to my education." So I'm gonna get into that here. But I need to tell you what's going on. There's a lot going on at this point. One, he's paying for his education in financial markets. He buys a stock after a positive news story, it promptly drops by half. That leads him to the lesson that you are unlikely to have an edge from anything you hear in the news, right? Two, he buys silver using leverage. The price goes up, everybody else is using leverage too. When the price starts dropping, the investors are forced to sell because their leverage is now too high.

• 40:39David Senra?

  Those sales causes this downward cycle that causes the price to drop even more. Three, he suspects the efficient market theory, which is all the rage in academia, which we know because Buffett talked about it a lot in his shareholder letters, is correct and almost gives up. Four, his natural inclination to not accept things at face value and verify the accuracy for him kicks in. So let me read this paragraph to you. He says, "I learned from this that even though I was right in my economic analysis, I hadn't properly evaluated the risk of too much leverage. For a few thousand dollars, I'd learned from this to make proper risk management a major theme of my life for more than 50 years thereafter." That's the Kelly criterion that we keep talking about, that we talked about last week.

• 41:23David Senra?

  I don't talk about too much in this podcast, but it's essential. He says, "In 2008, almost the entire world financial establishment didn't understand this lesson and had it over-leverage itself. I also learned from losing my silver investment that when the interests of the salesmen and promoters differ from that of the client, that the client had better look out for himself. After these lessons from Mr. Market, I was tempted to believe that the academics were right in claiming that any edge in the market is limited, small, temporary, and quickly captured. Once again, I was invited to accept a consensus opinion at face value, and once again, I decided to see for myself." Okay, so this is his first successful idea in finance.

• 42:07David Senra?

  And this is the only one I'm going to talk about because I think like they're all of them are in the book. Some of them still could apply today, but I don't think like a listening in a podcast is going to make sense. You have to kind of look at it and understand. But I do want you to understand this because it's he starts out just he eventually is going to work out to a very successful hedge fund, which I already told you, right? But right now he's just investing his own money. So to ever have the idea that you should have a hedge fund, you have to have a good idea first, right? And then the other point I want to make to you is that he didn't jump from, oh, I'm investing for myself to now I'm running a bunch of money for other people. He did it in steps and part of that steps is going to have him cross paths and have dinner with Warren Buffett. All right, so this is his first successful idea in finance. I think it's understandable, but it's the least understandable part about this whole podcast. He says, "I formed a rough idea of the rules relating to the warrant price to the stock

• 42:51David Senra?

  price. Since the prices of two..." Remember, the warrant is just like an option issued from the company, right? So what he's doing, why he calls it a hedge, remember the hedge funds, they're really popular now. Back in the 60s, they definitely weren't and they all existed to hedge. Now it's just more of like, hey, I'm a smart guy, I'm going to run some money and I'm going to, you know, call it a hedge fund or whatever. It's a little, it's different and he talks about that in the book too, but I exclude that from the podcast. Okay. "I formed a rough idea..." I already read the part. "Since the pieces of two, the price of two securities tended to move together." So what he means is he's buying, his first idea is, "Why don't I buy different securities for the same company?" Okay? That's how he's going to make his hedge. "Since the prices of the two securities tended to move together, the important idea of hedging

• 43:35David Senra?

  occurred to me, in which I could use this relationship to exploit any mispricing of the warrant and simultaneously reduce the risk of doing so." So how does he form his hedge? "Take two securities whose prices tend to move together, such as a warrant and a common stock that it can be used to purchase." So he buy, he'll either buy the stock and short the warrant or buy the warrant and short the stock. It's the same company though, okay? That's where he's getting his hedge. So he says, "Take two securities whose prices tend to move together, such as the warrant and the common stock, it can be used to purchase, but which are comparatively mispriced," which meaning he's, that's what he's determining his edge, the fact that the market is mispricing this. Buy the relatively underpriced security and sell short the relatively overpriced security. So that's his first insight that, hey, this is weird that you have different securities

• 44:20David Senra?

  that are from the same company or about the same company, and yet their pricing doesn't, it doesn't, they're not, they're not acting in relation. It doesn't make sense. He calls them mispricings. If the proportions in the position are chosen well, then even though prices fluctuate, the gains and losses on the two sides will approximately offset or hedge each other. And so that's this basic idea, which he applies to a bunch of different domains, is why he calls, he has a market neutral hedge fund. And he'll compare and contrast that with, with the ideas of Warren Buffett later. Now, he gets to his hedge fund in steps. First, he invests his own capital. The next step is this, he's doing well. The fact that, the fact that the available investment opportunities were much larger than I could exploit with my modest capital led to the next step.

• 45:05David Senra?

  I began to manage hedged portfolios for friends and acquaintances. At this point, he's at the University of California Irvine. A lot of other people understand the work he's doing, and so they say, hey, will you do this for me? So he starts these little, a bunch of separate little partnerships, and sometimes like $20,000 of their money, you know, small, but a bunch of them. Now, as a result of this, one of the deans at UC Irvine was in, I think you know this already, but in case you don't, before Buffett started Berkshire, took over Berkshire Hathaway, he had the Buffett Partnership Limited, which is just an investment fund. And he was winding it down at this point. So one of the people at UC Irvine, this guy named Gerard, who plays an important role in Thorpe's life, winds up, Buffett's liquidating his partnership, right? This is where Thorpe means Buffett, and I need to tell you one thing.

• 45:50David Senra?

  Warren is 38 years old here, at this point in the story. And his investment partnership is worth about $100 million. He's winding that down and giving the proceeds back to investors, or they can, they can invest in Berkshire Hathaway. Of that 100 million, about $25 million of that is Warren's, okay? So this is Thorpe on Buffett. Warren was a, so anyway, I don't know if I... Actually said that Gerard Gerard wants Warren to vet Thorpe as a potential replacement. So saying, hey, I'm going to take some of the money out of the Buffett partnership and put it with this guy. So they have dinner. So Warren was a high speed talker with a Nebraska twang and a stream of jokes, anecdotes, and clever sayings. He loved to play bridge and had a natural liking for the logical, the quantitative, and the mathematical. I learned

• 46:35David Senra?

  that he focused on finding and buying into undervalued companies. Warren was asked how he found so many millionaires for his partnership. Laughing, he said to me, I told them I grew my own. As Warren and I talked, the similarities and differences in our approaches to investing became clear 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. Same same thing that Thorpe does. Same thing that Shannon does. Same thing that Munger, obviously Munger and Buffett work together. You can see that over and over again. That's what Tillett said at the beginning, that any successful trader entrepreneur has a margin of safety. And how do you know they have a margin of

• 47:17David Senra?

  safety? Because they survive. And the people that don't, they will eventually blow up. That's part of the Kelly criteria. His objective was to outperform the market in the long run, and so he judged himself largely in his 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, that's what I was saying earlier, from which I can construct a hedge position, long to relatively undervalued, short to relatively overvalued, from which I could extract a positive return despite stark market start stock market ups and downs. Warren's goal was to accumulate the most money. I enjoyed using mathematics to solve certain interesting puzzles, which I found first in the world of gambling and then in the world of investing. Making money confirmed

• 48:01David Senra?

  my theories by showing that they worked in the real world. Now, as of right now, what are we doing? We're literally learning from the life experiences of Thorpe, which he spends 60 years accumulating and then writing it down so we could benefit. Well, just as we're learning from Thorpe, Thorpe learned from Buffett. So this is a guy named Gerard. Ralph Gerard gave me copies of Buffett's letters to his partners and his partnership document, a simple two-page affair. It was clear from this that the ideal plan would be to pool my investing for myself and others in a single limited partnership, just as Warren had eventually done. So at the time, he was just doing all these separate agreements. Well, this is stupid. Why don't I just put in one like Warren did?

• 48:41David Senra?

  This is the part of the unpredictability of life. We don't know how other, how individuals can, are gonna have lasting impact in our life. And just his decision to take this job at UC Irvine winds up leading him to reach, to, to meet Gerard, who in turn leads him to meet Buffett. Ralph Gerard had a profound effect on the outcome of Ed Thorp's life. So he says, "The time I spent with him," meaning Gerard, "had two major effects on my life. It helped me move me along, it helped move me along to a path to my own hedge fund." This is what, this is the vehicle that was gonna make Thorp have more money than he can ever spend. "And it later led me to make a very profitable investment in Berkshire Hathaway." So what does that mean?

• 49:23David Senra?

  Ed starts, because he met Buffett and knows of Buffett from Gerard, he starts buying Berkshire Hathaway stock at $900. Today, that single share is $300,000 per share. He's bought them at $900. It's bananas. Alright, I'm, I'm gonna run rapidly through his timeline here. Ed starts a hedge fund, right? So first, invests his own money, then he does these partnerships, and he's like, "I think I have the hand, hang, handle of this." This, this takes about, remember, he said in the summer of 64 is when he first starts thinking about finance and studying it. And I think it's 1969 is when he starts his first hedge fund. And he starts a hedge fund, he finds a partner that, that will do the things he doesn't like to do. I talked a little bit about that last week, so I'm not gonna cover it here.

• 50:07David Senra?

  But what I really want, what, what stuck out to me is that he has very modest goals. Okay, so he says, "Discussing how much capital we need to start with, we set $5 million as our target. If we made 20% net of expenses and charged 20% of that as a performance-based fee each year, we'd share 4% of $5 million. That's $200,000, and that was more than I was making as a professor." Okay, so first of all, they can't raise 5 million because it's a bad economic environment. They raised 1.4 million. But this $200,000 number a year he hopes to make, by the time the hedge fund shuts down, is 16 million a year, not including the compounding of his own personal investments. So he's printing money. All right.

• 50:49David Senra?

  Going back to something I want to keep reinforcing in your mind is the similarities of his blackjack strategy and his hedge fund strategy. He talks about that explicitly in the book. Betting on a hedge, I had researched, was like betting on a blackjack hand where I had the advantage. As in blackjack, I could estimate my expected return, estimate my risk, and choose how much of my bankroll to bet. Instead of a $10,000 bankroll, I now had 1.4 million. And instead of a $500 maximum bet, the Wall Street Casino had no limit. Influenced by having been born during the Great Depression and by my early investment experiences, I made reducing risk a central feature of my investing approach. So as he starts to expand his hedge fund, becomes more successful, now he runs into another problem he doesn't know how to deal with.

• 51:33David Senra?

  Didn't know anything about gambling games, study that. Didn't know anything about investing, study that. Now he's got to study management. He's got to manage people. He's running a business here. Says, "I had to learn to choose and manage employees. Figuring this out for myself, I evolved into the style later dubbed 'management by walking rounds.' Instead of the endless schedule of formal meetings I abhorred in academia, 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 that I wanted 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 since our

• 52:17David Senra?

  investment approach was new, I had to teach a unique set of skills. I chose smart, young people, just out of university, because they were not set in their ways from previous jobs. Better to teach a young athlete who comes fresh to his sport than to retrain one who has learned bad form." So, I already mentioned this one, I mentioned again, he never even thought about finance until he was 32. By 43, he's a millionaire. And this is when a millionaire, and I think that that would be the equivalent of like $8 or $10 million in today's money. When we started back in 1969, I forecast how quickly my wealth and Reagan's, that's his partner, would grow. With plausible assumptions about our company's rate of return, the rate of growth of our partnership's net worth, and taxes, I predicted that by 1975, we would be millionaires.

• 53:02David Senra?

  Sure enough, in 1975, we were both indeed millionaires.

• 53:07David Senra?

  His hedge funds called Princeton Newport Partners. It goes from 1.4 million to 273 million. PNP rose from 1.4 million partnership to being perhaps the most mathematical analytical and computer oriented firm on Wall Street. The partnership capital earned an annual rate of return of 22.8% before fees. Limited partners saw their wealth grow at 18% per year. We added extraordinary investment products that could have expanded our capital base to billions. But this was destined to come to an end. Remember in the in the prologue at the foreword of the book, talks about this fund closes, most people just get back into complexity. Thorpe chooses not to, and he still winds up being fabulously wealthy.

• 53:51David Senra?

  And so you might be asking, well, you're, you know, making almost 23% a year, why are you stopping? His East Coast office, he's based out in California, that's why the Newport in Princeton, Newport. The East Coast is the ones interacting more closely with Wall Street. The East Coast offices, his hedge fund is raided. And this is why. This is part of a campaign by Rudolph Giuliani, US Attorney at the time, to prosecute real and alleged Wall Street criminals. Giuliani's real objective in attacking individuals in our Princeton office was to get information to further his case against Michael Miliken. They were doing business with Michael Miliken, or Milken. He's famous for inventing junk bonds, he went to jail. But I think he also holds like, I think he made the most money ever in four years on

• 54:36David Senra?

  income taxes, it was like 250 million a year, each year for four years, something like that. So anyways, Giuliani is after this guy, Michael Milken, and this other guy named Robert Freeman at Goldman Sachs. Now, why is Ed getting, Ed's East Coast office getting raided? Because his partner, Jay Regan, knew them both well and spoke to them often, they worked together. Freeman had been a roommate of Regan's at Dartmouth. Giuliani believed that Reagan could help bring him down. So he's trying to, again, nonetheless of human nature, he's squeezing him, saying, I'm gonna mess up your life until you give me what you want. Reagan refused to cooperate. Well, that's a problem. Now- Something I want you to know is Ed was clean. He knew nothing was going on. Essentially, he said to do with this illegal tax avoidance scheme that the East Coast office was doing.

• 55:21David Senra?

  It's called stock parking, essentially faking like you're transferring assets from one firm to another. So you can benefit on stocks. So a few traders in his office are doing that. Says neither I nor the 40 or so other partners and employees in Newport Beach office had any knowledge of the alleged act in Princeton office. We were never implicated in any wrongdoing in this or any other matter. Limited partners were alarmed by the threat that RICO, Giuliani is using the RICO Act, which is normally reserved for like mafia and organized crime, could be extended to their partnership assets and by the doubts the investigation raised about some of our leadership in the Princeton office. As 1988 drew to a close, I saw no good way forward for PNP. I said I was leaving and limited partners followed and their partnership then wound down.

• 56:03David Senra?

  The US Department of Justice, and this is a few months after this, the US Department of Justice took steps to rein in the tactics in the racketeering prosecutions that sparked controversy during the Wall Street corruption cases brought by Rudolph Giuliani. The PNP defendants appealed and they wound up getting convicted, but then they get overturned on appeal. And all they, it says they threw out the convictions for racketeering and tax fraud. The prosecutors dropped the remaining charges against four of the five PNP defendants. So unbelievable destruction of wealth and they get one conviction. I think it was like, I think the guy had to do like three months or something like that and pay a little, and pay a fine.

• 56:42David Senra?

  So Ed, now this is why I'm only telling you the backstory because this what, what's so remarkable and what makes Ed Dorp's life worthy of study is in part is what he chooses to do next. So this is where in the book where Ed is reflecting on what his next move should be. And this is the He had this quote that I cannot stop thinking about when I took notes on it, uh, probably a week or two ago. And he says, he just says this random comment, "Life is really about spending time well." And so this is where Ed actually lives by this. Um, he reflects on what his next

• 57:23David Senra?

  move should be, and he decides to focus on time well spent. Okay, so he says, "What could have PMP have 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." This is the Citadel Investment Group. Citadel was started in 1990. I met with Frank and Ken, these are the founders of Citadel, outlining the workings and profit centers of PMP, as well as turning over cartons of documents outlining in detail the terms and conditions of older outstanding warrants and convertible bonds. So he's giving them his blueprint. Uh, Citadel grew from a humble start in 1990, when Ed became its first limited partner.

• 58:05David Senra?

  So again, not only did Ed make money for himself, he winds up having a hedge fund of hedge funds and like doing these smaller businesses that are not as complicated and much more automated. Um, but he also like made a ton of money on Berkshire stock. He winds up being the first LP in Citadel. So what could that possibly mean? Well, Citadel from 1990 grew from a few million dollars and one employee to a collection of businesses managing $20 billion in capital and having more than 1,000 employees 25 years. Uh, they experienced an annualized rate of return at 20% per year. Uh, Ken, one of the co-founders, uh, net worth in 2015 was estimated at 5.6 billion. So not saying that that could have happened, that Thorpe was guaranteed the same results, but he's, you know, it could

• 58:46David Senra?

  have. Uh, at Princeton Newport Partners, "As Princeton Newport Partners closed, I reflected on the proposition that what matters in life is how you spend your time." Now he's gonna pull from history. This is, I love this guy. I absolutely, I'm biased. If you came here for, I can't be, I, it's impossible. I love this book. I've texted it to so many people this week saying, "You need to buy this book." I've talked about it nonstop. I just, I'm so happy that I randomly discovered, uh, through, you know, the work of other people, Ed Thorpe. Like my life will be different. I really appreciate this guy. So he's gonna go through history and talk about like,

• 59:23David Senra?

  Am I trying to just to be the richest person in the cemetery? Like, what am I doing here? Like, I'm trying to live a good life. So it says, "When J. Paul Getty was the richest man in the world and manifestly not fulfilled, he had said the happiest time of his life was when he was 16, riding waves off the beach in Malibu." I read a magazine profile of multi-billionaire Henry T. Nichols III. Here's what the profile said. "It's 1:30 a.m. He sits at his desk in a dimly-lit office. He hasn't seen his wife and children for several days." Now, this is a quote from Nichols. "The last time we talked, Stacy, my wife, told me that she missed the old days when we lived in a condo. She told me she wants to go back to that life. But they can't go back because he can't give up. He can't let up.

• 1:00:08David Senra?

  They wind up later divorcing." And I also looked up this guy. Not only later divorcing, this guy winds up in rehab in 2008, and he just gets busted in 2018. He's a billionaire, multi-billionaire. So you think, "Oh, I'm gonna get rich and be happy," right? Gets busted in Las Vegas with some stripper, who's almost ODing in his room. They find him with heroin, ecstasy, cocaine, all this other stuff. Let me tell you something, because my cousin died from a heroin overdose when she was 27 years old. If there is no such thing as a happy person that's on heroin. Think about this. This guy could have three, or five, or four billion dollars, and he's doing heroin. Okay. Back to Ed.

• 1:00:52David Senra?

  "I initially thought that I might want to continue on my own, with a P&P-style partnership. But if I did that, then in addition to the fun parts, I would be responsible for things I didn't enjoy. I gradually wound down our P&P office in Newport Beach, finding good jobs in the security industry for some of our key people, at places like the giant hedge fund D.E. Shaw." D.E. Shaw, interestingly enough, was where Jeff Bezos worked. That was his last job he had before starting Amazon. Now, he's gonna go back to history to influence his decision. "Joseph Heller and Kurt Vonnegut were at a party given by a billionaire. When Vonnegut asked Heller how it felt to know that their host might have made more

• 1:01:34David Senra?

  money in one day than Heller's book Catch 22 had made since it was written, Heller said he had something the rich men could never have. When a puzzled Vonnegut asked what that could be, Heller answered, 'The knowledge that I have enough.'"

• 1:01:50David Senra?

  When Princeton Newport Partners closed, Vivian, that's his wife, and I had enough money for the rest of our lives. Though the ending of PNP was traumatic for us all, and the future wealth destroyed was in the billions, it freed us to do more of what we enjoyed most: spend time with each other, and family, and friends, and the friends we loved, travel, and pursue our interests. Taking to heart the lyrics of the song "Enjoy Yourself, It's Later Than You Think", Vivian and I would make the most of the one thing we could never have enough of: time together. Success on Wall Street was getting the most money. Success for us was having the best life.

• 1:02:34David Senra?

  So from that, he has this idea he wants to tell us about, which is the difference between satisfiers, I think is how you pronounce it, and maximizers. You can obviously... I'm gonna read the paragraph to you, and then I'm gonna leave it to you. You can figure out which one Ed Thorp is. "There's a distinction between two extremes on a continuum of types: satisfiers and maximizers. When a maximizer goes shopping, he searches for the best possible deal. Time and effort don't matter much. Missing the very best deal leads to regret and stress. On the other hand, the satisfier, so-called because he is satisfied with a result that is close to the best, factors in the cost of searching and decision-making, as well as the risk of losing a near-optimal opportunity,

• 1:03:20David Senra?

  and perhaps never finding anything as good again." Alright, now this is Ed on learning. So he writes the quote, that's rather famous. "Those who cannot remember the past are condemned to repeat it. Though the institutions of society have difficulty learning from history, individuals can do so. Next, I'll share some of what I learned. Education has made all the difference for me. Mathematics taught me to reason logically and to understand numbers, tables, charts, and calculations as second nature. Physics, chemistry, astronomy, and biology revealed the wonders of the world, and it showed me how to build models and theories to describe and to predict. This paid off for me both in gambling and investing.

• 1:04:05David Senra?

  Education builds software for your brain."

• 1:04:09David Senra?

  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, to mastering calculus. You will use these programs to make your way in the world. 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. And now I've finally got to what I feel is the main lesson from this book, and the life of Ed Thorp. Freud once said that "Once we have the basic necessities of food, clothing, shelter, and

• 1:04:54David Senra?

  health, then what we seek is wealth, power, honor, and the love of men and women." For financial titans who aggressively continue to seek tens of millions, hundreds of millions, and sometimes billions, you can ask, "Is the winner really the one who dies with the most toys? How much is enough? When will you be done?" Often, the answer is never. "To preserve the quality of my life and to spend more of it in the company of the people I value and the exploration of ideas I enjoy, I chose not to follow up on a number of business ventures, although I believed that they were nearly certain to become extremely profitable. Once I worked out the major concepts in a subject and proved them in action, I liked

• 1:05:39David Senra?

  new mental challenges, moving on from gambling games to the investment world with warrants, options, convertible bonds, other derivatives, and then statistical arbitrage. Starting as a university professor, I expected to spend my life teaching, doing research, and talking to smart, like-minded people. But from childhood, I was intrigued by the power of abstract thinking to understand and direct the natural world. When I later saw how physics could predict roulette outcomes through the fog of chance, and mathematics could tip the odds in blackjack, I was drawn into a lifetime of adventure."

• 1:06:19David Senra?

  It was my good fortune to share most of this journey with a remarkable companion, my wife, Vivian. She loved books and was a voracious reader. She passed on her love of books and her extraordinary facility with the English language to our children and grandchildren. She mastered bridge, studied art and art history, learned to prepare quality, healthy meals, completed a master's degree in library science, inspired her family to focus on personal fitness and health, and supported causes and charities. After she died from cancer in 2011, we celebrated her life with a memorial service.

• 1:07:00David Senra?

  When I think of our lives together, I remember what her brother said then: "Nobody can take away the dance you have danced." Life is like reading a novel or running a marathon. It is not so much about reaching a goal, but rather about the journey itself and the experiences along the way. As Benjamin Franklin said, "Time is the stuff life is made of, and how you spend it makes all the difference." Best of all is the time I've spent with the people in my life that I care about: my wife, my family, my friends, and my associates. Whatever you do, enjoy your life and the people who share it with you, and leave something

• 1:07:44David Senra?

  good of yourself for the generations to follow.