The Missing Billionaires

🚀 The Book in 3 Sentences

This book is about personal finance and risk. It starts with an interesting thought experiment about 40/60 % heads or tails and how much of your stake you should bet each time. Then it goes into detail.

🎨 Impressions

The thought experiment about the bet was super interesting. I have thought a lot about this after reading it. People are like so predictable in their irrationality. This is how we are. Interestingly, this book is written by the guys behind LSTM Capital, which went bust. Speaks that they took a lot of learnings from this experience in this book.

Another interesting aspect is risk in relation to your happiness. If you are deeply worried about your finances then it is most likely not smart to invest too much.

✍️ My Top Quotes

Any fool can make a fortune; it takes a man of brains to hold onto it. —Cornelius “Commodore” Vanderbilt
Unfortunately, the short run always comes before the long run, and neither of us got to enjoy the rebound of these investments. The lesson: good investments plus bad sizing can result in cataclysmic losses.
The decision‐making problems we focus on have three common features: They require a decision to be made in the face of uncertain outcomes. Some of the outcomes will have a meaningful impact on your happiness or welfare. The impact on your welfare will not exactly mirror the monetary outcomes.
It's virtually a law of human nature that we experience a diminishing marginal benefit from further and further increases in spending (or wealth).
The utility‐based decision framework has at its core three main steps for any given financial decision. First, we need to assess possible monetary outcomes and estimate their associated probabilities. Then we need to map these monetary outcomes into utility outcomes. Finally, we need to search over the range of different possible decisions, to find the one which produces the highest Expected Utility.
An investment in knowledge pays the best interest. —Benjamin Franklin
“How did you go bankrupt?” “Gradually, and then suddenly.” —Ernest Hemingway, The Sun Also Rises
Only 5 of our 61 financially sophisticated students and young investment professionals reported they had ever heard of constant fractional betting or related strategies.
Victor's mom played the game just for fun and when asked why she bet on tails on a few occasions, she said, “I knew I shouldn't, but I just couldn't help myself. It just felt like tails was due to come up.” In the behavioral economics literature, this is referred to as the “gambler's fallacy” or the “illusion of control bias.”
It is widely believed that both Apple's iTunes and Spotify have made their algorithm for “shuffling” songs from a playlist somewhat nonrandom because in early versions when it was truly randomly generated, they got so many complaints from users that the play order just didn't seem random to them.
In this spirit, we conducted a survey in 2017,2 asking respondents to guess how many flips they'd want to see in order to discern, with 95% confidence, a fair coin from a coin biased 60% to land on heads. About 30% of the people thought 10 or fewer flips would do the trick, and roughly half thought that fewer than 30 flips would be enough. Most people, your authors included, are surprised at first that the correct answer is 143 flips, which we think is another indication of just how hard‐wired humans are to draw conclusions from sample sizes that are too small, a behavioral bias termed the “law of small numbers bias.”
If you gave an investor the next day's news 24 hours in advance, he would go bust in less than a year. —Nassim Nicholas Taleb
The optimal bet size, expressed as a fraction of wealth, is directly proportional to the gamble's expected return, and inversely proportional to its variance and to your personal degree of risk‐aversion.
Kelly was thinking about the optimal amount of wealth to bet on a binary gamble and concluded, as we did at the beginning of this chapter, that optimizing expected wealth makes no sense. Instead, he proposed optimizing the rate of growth of wealth. He wrote a mathematical expression for the wealth growth rate as a function of the terms of the bet and from that derived a formula for the optimal bet size that maximizes it, which has since become known as the Kelly criterion: where “edge” is the ratio of expected gain to potential loss, and “odds” is the ratio of potential gain to potential loss.g For example, risking $10 to make $30 represents “odds” of 3.
Standard deviation captures risk relative to an expected return, not risk of loss, which some believe is the main type of risk investors should care about.
Standard deviation does not directly measure the degree to which return distributions are asymmetric or fat‐tailed.
Bet size is a function of individual risk attitudes (, but should be made consistently across bets with differing attractiveness. Bet size should be proportional to expected gain ( Bet size should be inversely proportional to the square of risk (: if risk halves, bet size should quadruple. We saw how these three characteristics come together to give us an optimal betting rule, the Merton share:
The determination of the value of an item must not be based on the price, but rather on the Utility it yields. —Daniel Bernoulli, Swiss mathematician and gambler (1738)
If people do not believe that mathematics is simple, it is only because they do not realize how complicated life is. —John von Neumann
I've been rich and I've been poor. Believe me, rich is better. —Mae West
In Stumbling on Happiness, the Harvard psychologist Daniel Gilbert explains that the most effective way to predict your experience in a different circumstance is not to imagine how you'll feel, but rather to find out how others that are actually experiencing it feel. In general, we are not as individually different as we like to think we are.
When an economist calls you irrational, it almost always means that if you follow through on your stated preferences, a sufficiently clever opponent can take all your money, leaving you smiling along the way. It's worth being alert to such things.