Psychology of Money PDF

For My parents, who teach me. Gretchen, who guides me. Miles and Reese, who inspire me. Introduction: The Greatest Show On Earth 1. No One’s Crazy 2. Luck & Risk 3. Never Enough 4. Confounding Compounding 5. Getting Wealthy vs. Staying Wealthy 6. Tails, You Win 7. Freedom 8. Man in the Car Paradox 9. Wealth is What You Don’t See 10. Save Money 11. Reasonable > Rational 12. Surprise! 13. Room for Error 14. You’ll Change 15. Nothing’s Free 16. You & Me 17. The Seduction of Pessimism 18. When You’ll Believe Anything 19. All Together Now 20. Confessions Postscript: A Brief History of Why the U.S. Consumer Thinks the Way They Do Endnotes Acknowledgements Publishing details “A genius is the man who can do the average thing when everyone else around him is losing his mind.” —Napoleon “The world is full of obvious things which nobody by any chance ever observes.” —Sherlock Holmes Ispent my college years working as a valet at a nice hotel in Los Angeles. One frequent guest was a technology executive. He was a genius, having designed and patented a key component in Wi-Fi routers in his 20s. He had started and sold several companies. He was wildly successful. He also had a relationship with money I’d describe as a mix of insecurity and childish stupidity. He carried a stack of hundred dollar bills several inches thick. He showed it to everyone who wanted to see it and many who didn’t. He bragged openly and loudly about his wealth, often while drunk and always apropos of nothing. One day he handed one of my colleagues several thousand dollars of cash and said, “Go to the jewelry store down the street and get me a few $1,000 gold coins.” An hour later, gold coins in hand, the tech executive and his buddies gathered around by a dock overlooking the Paciﬁc Ocean. They then proceeded to throw the coins into the sea, skipping them like rocks, cackling as they argued whose went furthest. Just for fun. Days later he shattered a lamp in the hotel’s restaurant. A manager told him it was a $500 lamp and he’d have to replace it. “You want ﬁve hundred dollars?” the executive asked incredulously, while pulling a brick of cash from his pocket and handing it to the manager. “Here’s ﬁve thousand dollars. Now get out of my face. And don’t ever insult me like that again.” You may wonder how long this behavior could last, and the answer was “not long.” I learned years later that he went broke. The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people. A genius who loses control of their emotions can be a ﬁnancial disaster. The opposite is also true. Ordinary folks with no ﬁnancial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence. My favorite Wikipedia entry begins: “Ronald James Read was an American philanthropist, investor, janitor, and gas station attendant.” Ronald Read was born in rural Vermont. He was the ﬁrst person in his family to graduate high school, made all the more impressive by the fact that he hitchhiked to campus each day. For those who knew Ronald Read, there wasn’t much else worth mentioning. His life was about as low key as they come. Read ﬁxed cars at a gas station for 25 years and swept ﬂoors at JCPenney for 17 years. He bought a two-bedroom house for $12,000 at age 38 and lived there for the rest of his life. He was widowed at age 50 and never remarried. A friend recalled that his main hobby was chopping ﬁrewood. Read died in 2014, age 92. Which is when the humble rural janitor made international headlines. 2,813,503 Americans died in 2014. Fewer than 4,000 of them had a net worth of over $8 million when they passed away. Ronald Read was one of them. In his will the former janitor left $2 million to his stepkids and more than $6 million to his local hospital and library. Those who knew Read were baﬄed. Where did he get all that money? It turned out there was no secret. There was no lottery win and no inheritance. Read saved what little he could and invested it in blue chip stocks. Then he waited, for decades on end, as tiny savings compounded into more than $8 million. That’s it. From janitor to philanthropist. A few months before Ronald Read died, another man named Richard was in the news. Richard Fuscone was everything Ronald Read was not. A Harvard-educated Merrill Lynch executive with an MBA, Fuscone had such a successful career in ﬁnance that he retired in his 40s to become a philanthropist. Former Merrill CEO David Komansky praised Fuscone’s “business savvy, leadership skills, sound judgment and personal integrity.”¹ Crain’s business magazine once included him in a “40 under 40” list of successful businesspeople.² But then—like the gold-coin-skipping tech executive—everything fell apart. In the mid-2000s Fuscone borrowed heavily to expand an 18,000-square foot home in Greenwich, Connecticut that had 11 bathrooms, two elevators, two pools, seven garages, and cost more than $90,000 a month to maintain. Then the 2008 ﬁnancial crisis hit. The crisis hurt virtually everyone’s ﬁnances. It apparently turned Fuscone’s into dust. High debt and illiquid assets left him bankrupt. “I currently have no income,” he allegedly told a bankruptcy judge in 2008. First his Palm Beach house was foreclosed. In 2014 it was the Greenwich mansion’s turn. Five months before Ronald Read left his fortune to charity, Richard Fuscone’s home—where guests recalled the “thrill of dining and dancing atop a see-through covering on the home’s indoor swimming pool”—was sold in a foreclosure auction for 75% less than an insurance company ﬁgured it was worth.³ Ronald Read was patient; Richard Fuscone was greedy. That’s all it took to eclipse the massive education and experience gap between the two. The lesson here is not to be more like Ronald and less like Richard—though that’s not bad advice. The fascinating thing about these stories is how unique they are to ﬁnance. In what other industry does someone with no college degree, no training, no background, no formal experience, and no connections massively outperform someone with the best education, the best training, and the best connections? I struggle to think of any. It is impossible to think of a story about Ronald Read performing a heart transplant better than a Harvard-trained surgeon. Or designing a skyscraper superior to the best-trained architects. There will never be a story of a janitor outperforming the world’s top nuclear engineers. But these stories do happen in investing. The fact that Ronald Read can coexist with Richard Fuscone has two explanations. One, ﬁnancial outcomes are driven by luck, independent of intelligence and eﬀort. That’s true to some extent, and this book will discuss it in further detail. Or, two (and I think more common), that ﬁnancial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know. I call this soft skill the psychology of money. The aim of this book is to use short stories to convince you that soft skills are more important than the technical side of money. I’ll do this in a way that will help everyone—from Read to Fuscone and everyone in between—make better ﬁnancial decisions. These soft skills are, I’ve come to realize, greatly underappreciated. Finance is overwhelmingly taught as a math-based ﬁeld, where you put data into a formula and the formula tells you what to do, and it’s assumed that you’ll just go do it. This is true in personal ﬁnance, where you’re told to have a six-month emergency fund and save 10% of your salary. It’s true in investing, where we know the exact historical correlations between interest rates and valuations. And it’s true in corporate ﬁnance, where CFOs can measure the precise cost of capital. It’s not that any of these things are bad or wrong. It’s that knowing what to do tells you nothing about what happens in your head when you try to do it. Two topics impact everyone, whether you are interested in them or not: health and money. The health care industry is a triumph of modern science, with rising life expectancy across the world. Scientiﬁc discoveries have replaced doctors’ old ideas about how the human body works, and virtually everyone is healthier because of it. The money industry—investing, personal ﬁnance, business planning—is another story. Finance has scooped up the smartest minds coming from top universities over the last two decades. Financial Engineering was the most popular major in Princeton’s School of Engineering a decade ago. Is there any evidence it has made us better investors? I have seen none. Through collective trial and error over the years we learned how to become better farmers, skilled plumbers, and advanced chemists. But has trial and error taught us to become better with our personal ﬁnances? Are we less likely to bury ourselves in debt? More likely to save for a rainy day? Prepare for retirement? Have realistic views about what money does, and doesn’t do, to our happiness? I’ve seen no compelling evidence. Most of the reason why, I believe, is that we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance). And that, to me, is as fascinating as it is important. Money is everywhere, it aﬀects all of us, and confuses most of us. Everyone thinks about it a little diﬀerently. It oﬀers lessons on things that apply to many areas of life, like risk, conﬁdence, and happiness. Few topics oﬀer a more powerful magnifying glass that helps explain why people behave the way they do than money. It is one of the greatest shows on Earth. My own appreciation for the psychology of money is shaped by more than a decade of writing on the topic. I began writing about ﬁnance in early 2008. It was the dawn of a ﬁnancial crisis and the worst recession in 80 years. To write about what was happening, I wanted to ﬁgure out what was happening. But the ﬁrst thing I learned after the ﬁnancial crisis was that no one could accurately explain what happened, or why it happened, let alone what should be done about it. For every good explanation there was an equally convincing rebuttal. Engineers can determine the cause of a bridge collapse because there’s agreement that if a certain amount of force is applied to a certain area, that area will break. Physics isn’t controversial. It’s guided by laws. Finance is diﬀerent. It’s guided by people’s behaviors. And how I behave might make sense to me but look crazy to you. The more I studied and wrote about the ﬁnancial crisis, the more I realized that you could understand it better through the lenses of psychology and history, not ﬁnance. To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism. To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperiling their future. I love Voltaire’s observation that “History never repeats itself; man always does.” It applies so well to how we behave with money. In 2018, I wrote a report outlining 20 of the most important ﬂaws, biases, and causes of bad behavior I’ve seen aﬀect people when dealing with money. It was called The Psychology of Money, and over one million people have read it. This book is a deeper dive into the topic. Some short passages from the report appear unaltered in this book. What you’re holding is 20 chapters, each describing what I consider to be the most important and often counterintuitive features of the psychology of money. The chapters revolve around a common theme, but exist on their own and can be read independently. It’s not a long book. You’re welcome. Most readers don’t ﬁnish the books they begin because most single topics don’t require 300 pages of explanation. I’d rather make 20 short points you ﬁnish than one long one you give up on. On we go. Let me tell you about a problem. It might make you feel better about what you do with your money, and less judgmental about what other people do with theirs. People do some crazy things with money. But no one is crazy. Here’s the thing: People from diﬀerent generations, raised by diﬀerent parents who earned diﬀerent incomes and held diﬀerent values, in diﬀerent parts of the world, born into diﬀerent economies, experiencing diﬀerent job markets with diﬀerent incentives and diﬀerent degrees of luck, learn very diﬀerent lessons. Everyone has their own unique experience with how the world works. And what you’ve experienced is more compelling than what you learn second-hand. So all of us—you, me, everyone— go through life anchored to a set of views about how money works that vary wildly from person to person. What seems crazy to you might make sense to me. The person who grew up in poverty thinks about risk and reward in ways the child of a wealthy banker cannot fathom if he tried. The person who grew up when inﬂation was high experienced something the person who grew up with stable prices never had to. The stock broker who lost everything during the Great Depression experienced something the tech worker basking in the glory of the late 1990s can’t imagine. The Australian who hasn’t seen a recession in 30 years has experienced something no American ever has. On and on. The list of experiences is endless. You know stuﬀ about money that I don’t, and vice versa. You go through life with diﬀerent beliefs, goals, and forecasts, than I do. That’s not because one of us is smarter than the other, or has better information. It’s because we’ve had diﬀerent lives shaped by diﬀerent and equally persuasive experiences. Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works. So equally smart people can disagree about how and why recessions happen, how you should invest your money, what you should prioritize, how much risk you should take, and so on. In his book on 1930s America, Frederick Lewis Allen wrote that the Great Depression “marked millions of Americans—inwardly —for the rest of their lives.” But there was a range of experiences. Twenty-ﬁve years later, as he was running for president, John F. Kennedy was asked by a reporter what he remembered from the Depression. He remarked: I have no ﬁrst-hand knowledge of the Depression. My family had one of the great fortunes of the world and it was worth more than ever then. We had bigger houses, more servants, we traveled more. About the only thing that I saw directly was when my father hired some extra gardeners just to give them a job so they could eat. I really did not learn about the Depression until I read about it at Harvard. This was a major point in the 1960 election. How, people thought, could someone with no understanding of the biggest economic story of the last generation be put in charge of the economy? It was, in many ways, overcome only by JFK’s experience in World War II. That was the other most widespread emotional experience of the previous generation, and something his primary opponent, Hubert Humphrey, didn’t have. The challenge for us is that no amount of studying or open- mindedness can genuinely recreate the power of fear and uncertainty. I can read about what it was like to lose everything during the Great Depression. But I don’t have the emotional scars of those who actually experienced it. And the person who lived through it can’t fathom why someone like me could come across as complacent about things like owning stocks. We see the world through a diﬀerent lens. Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior. We all think we know how the world works. But we’ve all only experienced a tiny sliver of it. As investor Michael Batnick says, “some lessons have to be experienced before they can be understood.” We are all victims, in diﬀerent ways, to that truth. In 2006 economists Ulrike Malmendier and Stefan Nagel from the National Bureau of Economic Research dug through 50 years of the Survey of Consumer Finances—a detailed look at what Americans do with their money.⁴ In theory people should make investment decisions based on their goals and the characteristics of the investment options available to them at the time. But that’s not what people do. The economists found that people’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation—especially experiences early in their adult life. If you grew up when inﬂation was high, you invested less of your money in bonds later in life compared to those who grew up when inﬂation was low. If you happened to grow up when the stock market was strong, you invested more of your money in stocks later in life compared to those who grew up when stocks were weak. The economists wrote: “Our ﬁndings suggest that individual investors’ willingness to bear risk depends on personal history.” Not intelligence, or education, or sophistication. Just the dumb luck of when and where you were born. The Financial Times interviewed Bill Gross, the famed bond manager, in 2019. “Gross admits that he would probably not be where he is today if he had been born a decade earlier or later,” the piece said. Gross’s career coincided almost perfectly with a generational collapse in interest rates that gave bond prices a tailwind. That kind of thing doesn’t just aﬀect the opportunities you come across; it aﬀects what you think about those opportunities when they’re presented to you. To Gross, bonds were wealth-generating machines. To his father’s generation, who grew up with and endured higher inﬂation, they might be seen as wealth incinerators. The diﬀerences in how people have experienced money are not small, even among those you might think are pretty similar. Take stocks. If you were born in 1970, the S&P 500 increased almost 10-fold, adjusted for inﬂation, during your teens and 20s. That’s an amazing return. If you were born in 1950, the market went literally nowhere in your teens and 20s adjusted for inﬂation. Two groups of people, separated by chance of their birth year, go through life with a completely diﬀerent view on how the stock market works: Or inﬂation. If you were born in 1960s America, inﬂation during your teens and 20s—your young, impressionable years when you’re developing a base of knowledge about how the economy works—sent prices up more than threefold. That’s a lot. You remember gas lines and getting paychecks that stretched noticeably less far than the ones before them. But if you were born in 1990, inﬂation has been so low for your whole life that it’s probably never crossed your mind. America’s nationwide unemployment in November 2009 was around 10%. But the unemployment rate for African American males age 16 to 19 without a high school diploma was 49%. For Caucasian females over age 45 with a college degree, it was 4%. Local stock markets in Germany and Japan were wiped out during World War II. Entire regions were bombed out. At the end of the war German farms only produced enough food to provide the country’s citizens with 1,000 calories a day. Compare that to the U.S., where the stock market more than doubled from 1941 through the end of 1945, and the economy was the strongest it had been in almost two decades. No one should expect members of these groups to go through the rest of their lives thinking the same thing about inﬂation. Or the stock market. Or unemployment. Or money in general. No one should expect them to respond to ﬁnancial information the same way. No one should assume they are inﬂuenced by the same incentives. No one should expect them to trust the same sources of advice. No one should expect them to agree on what matters, what’s worth it, what’s likely to happen next, and what the best path forward is. Their view of money was formed in diﬀerent worlds. And when that’s the case, a view about money that one group of people thinks is outrageous can make perfect sense to another. A few years ago, The New York Times did a story on the working conditions of Foxconn, the massive Taiwanese electronics manufacturer. The conditions are often atrocious. Readers were rightly upset. But a fascinating response to the story came from the nephew of a Chinese worker, who wrote in the comment section: My aunt worked several years in what Americans call “sweat shops.” It was hard work. Long hours, “small” wage, “poor” working conditions. Do you know what my aunt did before she worked in one of these factories? She was a prostitute. The idea of working in a “sweat shop” compared to that old lifestyle is an improvement, in my opinion. I know that my aunt would rather be “exploited” by an evil capitalist boss for a couple of dollars than have her body be exploited by several men for pennies. That is why I am upset by many Americans’ thinking. We do not have the same opportunities as the West. Our governmental infrastructure is diﬀerent. The country is diﬀerent. Yes, factory is hard labor. Could it be better? Yes, but only when you compare such to American jobs. I don’t know what to make of this. Part of me wants to argue, ﬁercely. Part of me wants to understand. But mostly it’s an example of how diﬀerent experiences can lead to vastly diﬀerent views within topics that one side intuitively thinks should be black and white. Every decision people make with money is justiﬁed by taking the information they have at the moment and plugging it into their unique mental model of how the world works. Those people can be misinformed. They can have incomplete information. They can be bad at math. They can be persuaded by rotten marketing. They can have no idea what they’re doing. They can misjudge the consequences of their actions. Oh, can they ever. But every ﬁnancial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences. Take a simple example: lottery tickets. Americans spend more on them than movies, video games, music, sporting events, and books combined. And who buys them? Mostly poor people. The lowest-income households in the U.S. on average spend $412 a year on lotto tickets, four times the amount of those in the highest income groups. Forty percent of Americans cannot come up with $400 in an emergency. Which is to say: Those buying $400 in lottery tickets are by and large the same people who say they couldn’t come up with $400 in an emergency. They are blowing their safety nets on something with a one-in- millions chance of hitting it big. That seems crazy to me. It probably seems crazy to you, too. But I’m not in the lowest income group. You’re likely not, either. So it’s hard for many of us to intuitively grasp the subconscious reasoning of low-income lottery ticket buyers. But strain a little, and you can imagine it going something like this: We live paycheck-to-paycheck and saving seems out of reach. Our prospects for much higher wages seem out of reach. We can’t aﬀord nice vacations, new cars, health insurance, or homes in safe neighborhoods. We can’t put our kids through college without crippling debt. Much of the stuﬀ you people who read ﬁnance books either have now, or have a good chance of getting, we don’t. Buying a lottery ticket is the only time in our lives we can hold a tangible dream of getting the good stuﬀ that you already have and take for granted. We are paying for a dream, and you may not understand that because you are already living a dream. That’s why we buy more tickets than you do. You don’t have to agree with this reasoning. Buying lotto tickets when you’re broke is still a bad idea. But I can kind of understand why lotto ticket sales persist. And that idea—“What you’re doing seems crazy but I kind of understand why you’re doing it.”—uncovers the root of many of our ﬁnancial decisions. Few people make ﬁnancial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you. Another important point that helps explain why money decisions are so diﬃcult, and why there is so much misbehavior, is to recognize how new this topic is. Money has been around a long time. King Alyattes of Lydia, now part of Turkey, is thought to have created the ﬁrst oﬃcial currency in 600 BC. But the modern foundation of money decisions—saving and investing—is based around concepts that are practically infants. Take retirement. At the end of 2018 there was $27 trillion in U.S. retirement accounts, making it the main driver of the common investor’s saving and investing decisions.⁵ But the entire concept of being entitled to retirement is, at most, two generations old. Before World War II most Americans worked until they died. That was the expectation and the reality. The labor force participation rate of men age 65 and over was above 50% until the 1940s: Social Security aimed to change this. But its initial beneﬁts were nothing close to a proper pension. When Ida May Fuller cashed the ﬁrst Social Security check in 1940, it was for $22.54, or $416 adjusted for inﬂation. It was not until the 1980s that the average Social Security check for retirees exceeded $1,000 a month adjusted for inﬂation. More than a quarter of Americans over age 65 were classiﬁed by the Census Bureau as living in poverty until the late 1960s. There is a widespread belief along the lines of, “everyone used to have a private pension.” But this is wildly exaggerated. The Employee Beneﬁt Research Institute explains: “Only a quarter of those age 65 or older had pension income in 1975.” Among that lucky minority, only 15% of household income came from a pension. The New York Times wrote in 1955 about the growing desire, but continued inability, to retire: “To rephrase an old saying: everyone talks about retirement, but apparently very few do anything about it.”⁶ It was not until the 1980s that the idea that everyone deserves, and should have, a digniﬁed retirement took hold. And the way to get that digniﬁed retirement ever since has been an expectation that everyone will save and invest their own money. Let me reiterate how new this idea is: The 401(k)—the backbone savings vehicle of American retirement—did not exist until 1978. The Roth IRA was not born until 1998. If it were a person it would be barely old enough to drink. It should surprise no one that many of us are bad at saving and investing for retirement. We’re not crazy. We’re all just newbies. Same goes for college. The share of Americans over age 25 with a bachelor’s degree has gone from less than 1 in 20 in 1940 to 1 in 4 by 2015.⁷ The average college tuition over that time rose more than fourfold adjusted for inﬂation.⁸ Something so big and so important hitting society so fast explains why, for example, so many people have made poor decisions with student loans over the last 20 years. There is not decades of accumulated experience to even attempt to learn from. We’re winging it. Same for index funds, which are less than 50 years old. And hedge funds, which didn’t take oﬀ until the last 25 years. Even widespread use of consumer debt—mortgages, credit cards, and car loans—did not take oﬀ until after World War II, when the GI Bill made it easier for millions of Americans to borrow. Dogs were domesticated 10,000 years ago and still retain some behaviors of their wild ancestors. Yet here we are, with between 20 and 50 years of experience in the modern ﬁnancial system, hoping to be perfectly acclimated. For a topic that is so inﬂuenced by emotion versus fact, this is a problem. And it helps explain why we don’t always do what we’re supposed to with money. We all do crazy stuﬀ with money, because we’re all relatively new to this game and what looks crazy to you might make sense to me. But no one is crazy—we all make decisions based on our own unique experiences that seem to make sense to us in a given moment. Now let me tell you a story about how Bill Gates got rich. Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual eﬀort. NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others’: “Nothing is as good or as bad as it seems.” Bill Gates went to one of the only high schools in the world that had a computer. The story of how Lakeside School, just outside Seattle, even got a computer is remarkable. Bill Dougall was a World War II navy pilot turned high school math and science teacher. “He believed that book study wasn’t enough without real-world experience. He also realized that we’d need to know something about computers when we got to college,” recalled late Microsoft co-founder Paul Allen. In 1968 Dougall petitioned the Lakeside School Mothers’ Club to use the proceeds from its annual rummage sale— about $3,000—to lease a Teletype Model 30 computer hooked up to the General Electric mainframe terminal for computer time-sharing. “The whole idea of time-sharing only got invented in 1965,” Gates later said. “Someone was pretty forwardlooking.” Most university graduate schools did not have a computer anywhere near as advanced as Bill Gates had access to in eighth grade. And he couldn’t get enough of it. Gates was 13 years old in 1968 when he met classmate Paul Allen. Allen was also obsessed with the school’s computer, and the two hit it oﬀ. Lakeside’s computer wasn’t part of its general curriculum. It was an independent study program. Bill and Paul could toy away with the thing at their leisure, letting their creativity run wild—after school, late into the night, on weekends. They quickly became computing experts. During one of their late-night sessions, Allen recalled Gates showing him a Fortune magazine and saying, “What do you think it’s like to run a Fortune 500 company?” Allen said he had no idea. “Maybe we’ll have our own computer company someday,” Gates said. Microsoft is now worth more than a trillion dollars. A little quick math. In 1968 there were roughly 303 million high-school-age people in the world, according to the UN. About 18 million of them lived in the United States. About 270,000 of them lived in Washington state. A little over 100,000 of them lived in the Seattle area. And only about 300 of them attended Lakeside School. Start with 303 million, end with 300. One in a million high-school-age students attended the high school that had the combination of cash and foresight to buy a computer. Bill Gates happened to be one of them. Gates is not shy about what this meant. “If there had been no Lakeside, there would have been no Microsoft,” he told the school’s graduating class in 2005. Gates is staggeringly smart, even more hardworking, and as a teenager had a vision for computers that even most seasoned computer executives couldn’t grasp. He also had a one in a million head start by going to school at Lakeside. Now let me tell you about Gates’ friend Kent Evans. He experienced an equally powerful dose of luck’s close sibling, risk. Bill Gates and Paul Allen became household names thanks to Microsoft’s success. But back at Lakeside there was a third member of this gang of high-school computer prodigies. Kent Evans and Bill Gates became best friends in eighth grade. Evans was, by Gates’ own account, the best student in the class. The two talked “on the phone ridiculous amounts,” Gates recalls in the documentary Inside Bill’s Brain. “I still know Kent’s phone number,” he says. “525-7851.” Evans was as skilled with computers as Gates and Allen. Lakeside once struggled to manually put together the school’s class schedule—a maze of complexity to get hundreds of students the classes they need at times that don’t conﬂict with other courses. The school tasked Bill and Kent—children, by any measure—to build a computer program to solve the problem. It worked. And unlike Paul Allen, Kent shared Bill’s business mind and endless ambition. “Kent always had the big briefcase, like a lawyer’s briefcase,” Gates recalls. “We were always scheming about what we’d be doing ﬁve or six years in the future. Should we go be CEOs? What kind of impact could you have? Should we go be generals? Should we go be ambassadors?” Whatever it was, Bill and Kent knew they’d do it together. After reminiscing on his friendship with Kent, Gates trails oﬀ. “We would have kept working together. I’m sure we would have gone to college together.” Kent could have been a founding partner of Microsoft with Gates and Allen. But it would never happen. Kent died in a mountaineering accident before he graduated high school. Every year there are around three dozen mountaineering deaths in the United States.⁹ The odds of being killed on a mountain in high school are roughly one in a million. Bill Gates experienced one in a million luck by ending up at Lakeside. Kent Evans experienced one in a million risk by never getting to ﬁnish what he and Gates set out to achieve. The same force, the same magnitude, working in opposite directions. Luck and risk are both the reality that every outcome in life is guided by forces other than individual eﬀort. They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes. They are driven by the same thing: You are one person in a game with seven billion other people and inﬁnite moving parts. The accidental impact of actions outside of your control can be more consequential than the ones you consciously take. But both are so hard to measure, and hard to accept, that they too often go overlooked. For every Bill Gates there is a Kent Evans who was just as skilled and driven but ended up on the other side of life roulette. If you give luck and risk their proper respect, you realize that when judging people’s ﬁnancial success—both your own and others’—it’s never as good or as bad as it seems. Years ago I asked economist Robert Shiller, who won the Nobel Prize in economics, “What do you want to know about investing that we can’t know?” “The exact role of luck in successful outcomes,” he answered. I love that response, because no one actually thinks luck doesn’t play a role in ﬁnancial success. But since it’s hard to quantify luck and rude to suggest people’s success is owed to it, the default stance is often to implicitly ignore luck as a factor of success. If I say, “There are a billion investors in the world. By sheer chance, would you expect 10 of them to become billionaires predominantly oﬀ luck?” You would reply, “Of course.” But then if I ask you to name those investors—to their face—you will likely back down. When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept. Economist Bhashkar Mazumder has shown that incomes among brothers are more correlated than height or weight. If you are rich and tall, your brother is more likely to also be rich than he is tall. I think most of us intuitively know this is true—the quality of your education and the doors that open for you are heavily linked to your parents’ socioeconomic status. But ﬁnd me two rich brothers and I’ll show you two men who do not think this study’s ﬁndings apply to them. Failure—which can be anything from bankruptcy to not meeting a personal goal—is equally abused. Did failed businesses not try hard enough? Were bad investments not thought through well enough? Are wayward careers due to laziness? Sometimes, yes. Of course. But how much? It’s so hard to know. Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation. Just as with luck, the story gets too hard, too messy, too complex if we try to pick apart how much of an outcome was a conscious decision versus a risk. Say I buy a stock, and ﬁve years later it’s gone nowhere. It’s possible that I made a bad decision by buying it in the ﬁrst place. It’s also possible that I made a good decision that had an 80% chance of making money, and I just happened to end up on the side of the unfortunate 20%. How do I know which is which? Did I make a mistake, or did I just experience the reality of risk? It’s possible to statistically measure whether some decisions were wise. But in the real world, day to day, we simply don’t. It’s too hard. We prefer simple stories, which are easy but often devilishly misleading. After spending years around investors and business leaders I’ve come to realize that someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk. When judging your failures I’m likely to prefer a clean and simple story of cause and eﬀect, because I don’t know what’s going on inside your head. “You had a bad outcome so it must have been caused by a bad decision” is the story that makes the most sense to me. But when judging myself I can make up a wild narrative justifying my past decisions and attributing bad outcomes to risk. The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both ﬂipped the same coin that happened to land on a diﬀerent side. The dangerous part of this is that we’re all trying to learn about what works and what doesn’t with money. What investing strategies work? Which ones don’t? What business strategies work? Which ones don’t? How do you get rich? How do you avoid being poor? We tend to seek out these lessons by observing successes and failures and saying, “Do what she did, avoid what he did.” If we had a magic wand we would ﬁnd out exactly what proportion of these outcomes were caused by actions that are repeatable, versus the role of random risk and luck that swayed those actions one way or the other. But we don’t have a magic wand. We have brains that prefer easy answers without much appetite for nuance. So identifying the traits we should emulate or avoid can be agonizingly hard. Let me tell you another story of someone who, like Bill Gates, was wildly successful, but whose success is hard to pin down as being caused by luck or skill. Cornelius Vanderbilt had just ﬁnished a series of business deals to expand his railroad empire. One of his business advisors leaned in to tell Vanderbilt that every transaction he agreed to broke the law. “My God, John,” said Vanderbilt, “You don’t suppose you can run a railroad in accordance with the statutes of the State of New York, do you?”¹⁰ My ﬁrst thought when reading this was: “That attitude is why he was so successful.” Laws didn’t accommodate railroads during Vanderbilt’s day. So he said “to hell with it” and went ahead anyway. Vanderbilt was wildly successful. So it’s tempting to view his law-ﬂaunting—which was notorious and vital to his success —as sage wisdom. That scrappy visionary let nothing get in his way! But how dangerous is that analysis? No sane person would recommend ﬂagrant crime as an entrepreneurial trait. You can easily imagine Vanderbilt’s story turning out much diﬀerent—an outlaw whose young company collapsed under court order. So we have a problem here. You can praise Vanderbilt for ﬂaunting the law with as much passion as you criticize Enron for doing the same. Perhaps one got lucky by avoiding the arm of the law while the other found itself on the side of risk. John D. Rockefeller is similar. His frequent circumventing of the law—a judge once called his company “no better than a common thief”—is often portrayed by historians as cunning business smarts. Maybe it was. But when does the narrative shift from, “You didn’t let outdated laws get in the way of innovation,” to “You committed a crime?” Or how little would the story have to shift for the narrative to have turned from “Rockefeller was a genius, try to learn from his successes,” to “Rockefeller was a criminal, try to learn from his business failures.” Very little. “What do I care about the law?” Vanderbilt once said. “Ain’t I got the power?” He did, and it worked. But it’s easy to imagine those being the last words of a story with a very diﬀerent outcome. The line between bold and reckless can be thin. When we don’t give risk and luck their proper billing it’s often invisible. Benjamin Graham is known as one of the greatest investors of all time, the father of value investing and the early mentor of Warren Buﬀett. But the majority of Benjamin Graham’s investing success was due to owning an enormous chunk of GEICO stock which, by his own admission, broke nearly every diversiﬁcation rule that Graham himself laid out in his famous texts. Where does the thin line between bold and reckless fall here? I don’t know. Graham wrote about his GEICO bonanza: “One lucky break, or one supremely shrewd decision—can we tell them apart?” Not easily. We similarly think Mark Zuckerberg is a genius for turning down Yahoo!’s 2006 $1 billion oﬀer to buy his company. He saw the future and stuck to his guns. But people criticize Yahoo! with as much passion for turning down its own big buyout oﬀer from Microsoft—those fools should have cashed out while they could! What is the lesson for entrepreneurs here? I have no idea, because risk and luck are so hard to pin down. There are so many examples of this. Countless fortunes (and failures) owe their outcome to leverage. The best (and worst) managers drive their employees as hard as they can. “The customer is always right” and “customers don’t know what they want” are both accepted business wisdom. The line between “inspiringly bold” and “foolishly reckless” can be a millimeter thick and only visible with hindsight. Risk and luck are doppelgangers. This is not an easy problem to solve. The diﬃculty in identifying what is luck, what is skill, and what is risk is one of the biggest problems we face when trying to learn about the best way to manage money. But two things can point you in a better direction. Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming. Or, just be careful when assuming that 100% of outcomes can be attributed to eﬀort and decisions. After my son was born, I wrote him a letter that said, in part: Some people are born into families that encourage education; others are against it. Some are born into ﬂourishing economies encouraging of entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself. Therefore, focus less on speciﬁc individuals and case studies and more on broad patterns. Studying a speciﬁc person can be dangerous because we tend to study extreme examples—the billionaires, the CEOs, or the massive failures that dominate the news—and extreme examples are often the least applicable to other situations, given their complexity. The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was inﬂuenced by extreme ends of luck or risk. You’ll get closer to actionable takeaways by looking for broad patterns of success and failure. The more common the pattern, the more applicable it might be to your life. Trying to emulate Warren Buﬀett’s investment success is hard, because his results are so extreme that the role of luck in his lifetime performance is very likely high, and luck isn’t something you can reliably emulate. But realizing, as we’ll see in chapter 7, that people who have control over their time tend to be happier in life is a broad and common enough observation that you can do something with it. My favorite historian, Frederick Lewis Allen, spent his career depicting the life of the average, median American—how they lived, how they changed, what they did for work, what they ate for dinner, etc. There are more relevant lessons to take away from this kind of broad observation than there are in studying the extreme characters that tend to dominate the news. Bill Gates once said, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” When things are going extremely well, realize it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly. But the same is true in the other direction. Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reﬂect the unforgiving realities of risk. The trick when dealing with failure is arranging your ﬁnancial life in a way that a bad investment here and a missed ﬁnancial goal there won’t wipe you out so you can keep playing until the odds fall in your favor. But more important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures. Nothing is as good or as bad as it seems. Now let’s look at the stories of two men who pushed their luck. John Bogle, the Vanguard founder who passed away in 2019, once told a story about money that highlights something we don’t think about enough: At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch- 22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.” Enough. I was stunned by the simple eloquence of that word —stunned for two reasons: ﬁrst, because I have been given so much in my own life and, second, because Joseph Heller couldn’t have been more accurate. For a critical element of our society, including many of the wealthiest and most powerful among us, there seems to be no limit today on what enough entails. It’s so smart, and so powerful. Let me oﬀer two examples of the dangers of not having enough, and what they can teach us. Rajat Gupta was born in Kolkata and orphaned as a teenager. People talk about the privileged few who begin life on third base. Gupta couldn’t even see the baseball stadium. What he went on to achieve from those beginnings was simply phenomenal. By his mid 40s Gupta was CEO of McKinsey, the world’s most prestigious consulting ﬁrm. He retired in 2007 to take on roles with the United Nations and the World Economic Forum. He partnered on philanthropic work with Bill Gates. He sat on the board of directors of ﬁve public companies. From the slums of Kolkata, Gupta had quite literally become one of the most successful businessmen alive. With his success came enormous wealth. By 2008 Gupta was reportedly worth $100 million.¹¹ It’s an unfathomable sum of money to most. A ﬁve percent annual return on that much money generates almost $600 an hour, 24 hours a day. He could have done anything he wanted in life. And what he wanted, by all accounts, wasn’t to be a mere centa-millionaire. Rajat Gupta wanted to be a billionaire. And he wanted it badly. Gupta sat on the board of directors of Goldman Sachs, which surrounded him with some of the wealthiest investors in the world. One investor, citing the paydays of private equity tycoons, described Gupta like this: “I think he wants to be in that circle. That’s a billionaire circle, right? Goldman is like the hundreds of millions circle, right?”¹² Right. So Gupta found a lucrative side hustle. In 2008, as Goldman Sachs stared at the wrath of the ﬁnancial crisis, Warren Buﬀett planned to invest $5 billion into the bank to help it survive. As a Goldman board member Gupta learned of this transaction before the public. It was valuable information. Goldman’s survival was in doubt and Buﬀett’s backing would surely send its stock soaring. Sixteen seconds after learning of the pending deal Gupta, who was dialed into the Goldman board meeting, hung up the phone and called a hedge fund manager named Raj Rajaratnam. The call wasn’t recorded, but Rajaratnam immediately bought 175,000 shares of Goldman Sachs, so you can guess what was discussed. The Buﬀett-Goldman deal was announced to the public hours later. Goldman stock surged. Rajaratnam made a quick $1 million. That was just one example of an alleged trend. The SEC claims Gupta’s insider tips led to $17 million in proﬁts. It was easy money. And, for prosecutors, it was an even easier case. Gupta and Rajaratnam both went to prison for insider trading, their careers and reputations irrevocably ruined. Now consider Bernie Madoﬀ. His crime is well known. Madoﬀ is the most notorious Ponzi schemer since Charles Ponzi himself. Madoﬀ swindled investors for two decades before his crime was revealed—ironically just weeks after Gupta’s endeavor. What’s overlooked is that Madoﬀ, like Gupta, was more than a fraudster. Before the Ponzi scheme that made Madoﬀ famous he was a wildly successful and legitimate businessman. Madoﬀ was a market maker, a job that matches buyers and sellers of stocks. He was very good at it. Here’s how The Wall Street Journal described Madoﬀ’s market-making ﬁrm in 1992: He has built a highly proﬁtable securities ﬁrm, Bernard L. Madoﬀ Investment Securities, which siphons a huge volume of stock trades away from the Big Board. The $740 million average daily volume of trades executed electronically by the Madoﬀ ﬁrm oﬀ the exchange equals 9% of the New York exchange’s. Mr. Madoﬀ’s ﬁrm can execute trades so quickly and cheaply that it actually pays other brokerage ﬁrms a penny a share to execute their customers’ orders, proﬁting from the spread between bid and ask prices that most stocks trade for. This is not a journalist inaccurately describing a fraud yet to be uncovered; Madoﬀ’s market-making business was legitimate. A former staﬀer said the market-making arm of Madoﬀ’s business made between $25 million and $50 million per year. Bernie Madoﬀ’s legitimate, non-fraudulent business was by any measure a huge success. It made him hugely—and legitimately—wealthy. And yet, the fraud. The question we should ask of both Gupta and Madoﬀ is why someone worth hundreds of millions of dollars would be so desperate for more money that they risked everything in pursuit of even more. Crime committed by those living on the edge of survival is one thing. A Nigerian scam artist once told The New York Times that he felt guilty for hurting others, but “poverty will not make you feel the pain.”¹³ What Gupta and Madoﬀ did is something diﬀerent. They already had everything: unimaginable wealth, prestige, power, freedom. And they threw it all away because they wanted more. They had no sense of enough. They are extreme examples. But there are non-criminal versions of this behavior. The hedge fund Long-Term Capital Management was staﬀed with traders personally worth tens and hundreds of millions of dollars each, with most of their wealth invested in their own funds. Then they took so much risk in the quest for more that they managed to lose everything—in 1998, in the middle of the greatest bull market and strongest economy in history. Warren Buﬀett later put it: To make money they didn’t have and didn’t need, they risked what they did have and did need. And that’s foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense. There is no reason to risk what you have and need for what you don’t have and don’t need. It’s one of those things that’s as obvious as it is overlooked. Few of us will ever have $100 million, as Gupta or Madoﬀ did. But a measurable percentage of those reading this book will, at some point in their life, earn a salary or have a sum of money suﬃcient to cover every reasonable thing they need and a lot of what they want. If you’re one of them, remember a few things. 1. The hardest ﬁnancial skill is getting the goalpost to stop moving. But it’s one of the most important. If expectations rise with results there is no logic in striving for more because you’ll feel the same after putting in extra eﬀort. It gets dangerous when the taste of having more—more money, more power, more prestige—increases ambition faster than satisfaction. In that case one step forward pushes the goalpost two steps ahead. You feel as if you’re falling behind, and the only way to catch up is to take greater and greater amounts of risk. Modern capitalism is a pro at two things: generating wealth and generating envy. Perhaps they go hand in hand; wanting to surpass your peers can be the fuel of hard work. But life isn’t any fun without a sense of enough. Happiness, as it’s said, is just results minus expectations. 2. Social comparison is the problem here. Consider a rookie baseball player who earns $500,000 a year. He is, by any deﬁnition, rich. But say he plays on the same team as Mike Trout, who has a 12-year, $430 million contract. By comparison, the rookie is broke. But then think about Mike Trout. Thirty-six million dollars per year is an insane amount of money. But to make it on the list of the top-ten highest-paid hedge fund managers in 2018 you needed to earn at least $340 million in one year.¹⁴ That’s who people like Trout might compare their incomes to. And the hedge fund manager who makes $340 million per year compares himself to the top ﬁve hedge fund managers, who earned at least $770 million in 2018. Those top managers can look ahead to people like Warren Buﬀett, whose personal fortune increased by $3.5 billion in 2018. And someone like Buﬀett could look ahead to Jeﬀ Bezos, whose net worth increased by $24 billion in 2018—a sum that equates to more per hour than the “rich” baseball player made in a full year. The point is that the ceiling of social comparison is so high that virtually no one will ever hit it. Which means it’s a battle that can never be won, or that the only way to win is to not ﬁght to begin with—to accept that you might have enough, even if it’s less than those around you. A friend of mine makes an annual pilgrimage to Las Vegas. One year he asked a dealer: What games do you play, and what casinos do you play in? The dealer, stone-cold serious, replied: “The only way to win in a Las Vegas casino is to exit as soon as you enter.” That’s exactly how the game of trying to keep up with other people’s wealth works, too. 3. “Enough” is not too little. The idea of having “enough” might look like conservatism, leaving opportunity and potential on the table. I don’t think that’s right. “Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret. The only way to know how much food you can eat is to eat until you’re sick. Few try this because vomiting hurts more than any meal is good. For some reason the same logic doesn’t translate to business and investing, and many will only stop reaching for more when they break and are forced to. This can be as innocent as burning out at work or a risky investment allocation you can’t maintain. On the other end there’s Rajat Guptas and Bernie Madoﬀs in the world, who resort to stealing because every dollar is worth reaching for regardless of consequence. Whatever it is, the inability to deny a potential dollar will eventually catch up to you. 4. There are many things never worth risking, no matter the potential gain. After he was released from prison Rajat Gupta told The New York Times he had learned a lesson: Don’t get too attached to anything—your reputation, your accomplishments or any of it. I think about it now, what does it matter? O.K., this thing unjustly destroyed my reputation. That’s only troubling if I am so attached to my reputation. This seems like the worst possible takeaway from his experience, and what I imagine is the comforting self- justiﬁcations of a man who desperately wants his reputation back but knows it’s gone. Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable. Being loved by those who you want to love you is invaluable. Happiness is invaluable. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough. The good news is that the most powerful tool for building enough is remarkably simple, and doesn’t require taking risks that could damage any of these things. That’s the next chapter. Lessons from one ﬁeld can often teach us something important about unrelated ﬁelds. Take the billion-year history of ice ages, and what they teach us about growing your money. Our scientiﬁc knowledge of Earth is younger than you might think. Understanding how the world works often involves drilling deep below its surface, something we haven’t been able to do until fairly recently. Isaac Newton calculated the movement of the stars hundreds of years before we understood some of the basics of our planet. It was not until the 19th century that scientists agreed that Earth had, on multiple occasions, been covered in ice.¹⁵ There was too much evidence to argue otherwise. All over the world sat ﬁngerprints of a previously frozen world: huge boulders strewn in random locations; rock beds scraped down to thin layers. Evidence became clear that there had not been one ice age, but ﬁve distinct ones we could measure. The amount of energy needed to freeze the planet, melt it anew, and freeze it over yet again is staggering. What on Earth (literally) could be causing these cycles? It must be the most powerful force on our planet. And it was. Just not in the way anyone expected. There were plenty of theories about why ice ages occurred. To account for their enormous geological inﬂuence the theories were equally grand. The uplifting of mountain ranges, it was thought, may have shifted the Earth’s winds enough to alter the climate. Others favored the idea that ice was the natural state, interrupted by massive volcanic eruptions that warmed us up. But none of these theories could account for the cycle of ice ages. The growth of mountain ranges or some massive volcano may explain one ice age. It could not explain the cyclical repetition of ﬁve. In the early 1900s a Serbian scientist named Milutin Milanković studied the Earth’s position relative to other planets and came up with the theory of ice ages that we now know is accurate: The gravitational pull of the sun and moon gently aﬀect the Earth’s motion and tilt toward the sun. During parts of this cycle—which can last tens of thousands of years—each of the Earth’s hemispheres gets a little more, or a little less, solar radiation than they’re used to. And that is where the fun begins. Milanković’s theory initially assumed that a tilt of the Earth’s hemispheres caused ravenous winters cold enough to turn the planet into ice. But a Russian meteorologist named Wladimir Köppen dug deeper into Milanković’s work and discovered a fascinating nuance. Moderately cool summers, not cold winters, were the icy culprit. It begins when a summer never gets warm enough to melt the previous winter’s snow. The leftover ice base makes it easier for snow to accumulate the following winter, which increases the odds of snow sticking around in the following summer, which attracts even more accumulation the following winter. Perpetual snow reﬂects more of the sun’s rays, which exacerbates cooling, which brings more snowfall, and on and on. Within a few hundred years a seasonal snowpack grows into a continental ice sheet, and you’re oﬀ to the races. The same thing happens in reverse. An orbital tilt letting more sunlight in melts more of the winter snowpack, which reﬂects less light the following years, which increases temperatures, which prevents more snow the next year, and so on. That’s the cycle. The amazing thing here is how big something can grow from a relatively small change in conditions. You start with a thin layer of snow left over from a cool summer that no one would think anything of and then, in a geological blink of an eye, the entire Earth is covered in miles-thick ice. As glaciologist Gwen Schultz put it: “It is not necessarily the amount of snow that causes ice sheets but the fact that snow, however little, lasts.” The big takeaway from ice ages is that you don’t need tremendous force to create tremendous results. If something compounds—if a little growth serves as the fuel for future growth—a small starting base can lead to results so extraordinary they seem to defy logic. It can be so logic- defying that you underestimate what’s possible, where growth comes from, and what it can lead to. And so it is with money. More than 2,000 books are dedicated to how Warren Buﬀett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buﬀett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child. As I write this Warren Buﬀett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualiﬁed for Social Security, in his mid-60s. Warren Buﬀett is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buﬀett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inﬂation.¹⁶ What if he was a more normal person, spending his teens and 20s exploring the world and ﬁnding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $84.5 billion. $11.9 million. 99.9% less than his actual net worth. Eﬀectively all of Warren Buﬀett’s ﬁnancial success can be tied to the ﬁnancial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works. Think of this another way. Buﬀett is the richest investor of all time. But he’s not actually the greatest—at least not when measured by average annual returns. Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. As we just saw, Buﬀett has compounded at roughly 22% annually, a third as much. Simons’ net worth, as I write, is $21 billion. He is—and I know how ridiculous this sounds given the numbers we’re dealing with—75% less rich than Buﬀett. Why the diﬀerence, if Simons is such a better investor? Because Simons did not ﬁnd his investment stride until he was 50 years old. He’s had less than half as many years to compound as Buﬀett. If James Simons had earned his 66% annual returns for the 70-year span Buﬀett has built his wealth he would be worth—please hold your breath—sixty- three quintillion nine hundred quadrillion seven hundred eighty-one trillion seven hundred eighty billion seven hundred forty-eight million one hundred sixty thousand dollars. These are ridiculous, impractical numbers. The point is that what seem like small changes in growth assumptions can lead to ridiculous, impractical numbers. And so when we are studying why something got to become as powerful as it has —why an ice age formed, or why Warren Buﬀett is so rich— we often overlook the key drivers of success. I have heard many people say the ﬁrst time they saw a compound interest table—or one of those stories about how much more you’d have for retirement if you began saving in your 20s versus your 30s—changed their life. But it probably didn’t. What it likely did was surprise them, because the results intuitively didn’t seem right. Linear thinking is so much more intuitive than exponential thinking. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8×8×8×8×8×8×8×8×8, your head will explode (it’s 134,217,728). IBM made a 3.5 megabyte hard drive in the 1950s. By the 1960s things were moving into a few dozen megabytes. By the 1970s, IBM’s Winchester drive held 70 megabytes. Then drives got exponentially smaller in size with more storage. A typical PC in the early 1990s held 200–500 megabytes. And then … wham. Things exploded. 1999—Apple’s iMac comes with a 6 gigabyte hard drive. 2003—120 gigs on the Power Mac. 2006—250 gigs on the new iMac. 2011—ﬁrst 4 terabyte hard drive. 2017—60 terabyte hard drives. 2019—100 terabyte hard drives. Put that all together: From 1950 to 1990 we gained 296 megabytes. From 1990 through today we gained 100 million megabytes. If you were a technology optimist in the 1950s you may have predicted that practical storage would become 1,000 times larger. Maybe 10,000 times larger, if you were swinging for the fences. Few would have said “30 million times larger within my lifetime.” But that’s what happened. The counterintuitive nature of compounding leads even the smartest of us to overlook its power. In 2004 Bill Gates criticized the new Gmail, wondering why anyone would need a gigabyte of storage. Author Steven Levy wrote, “Despite his currency with cutting-edge technologies, his mentality was anchored in the old paradigm of storage being a commodity that must be conserved.” You never get accustomed to how quickly things can grow. The danger here is that when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider compounding potential. None of the 2,000 books picking apart Buﬀett’s success are titled This Guy Has Been Investing Consistently for Three- Quarters of a Century. But we know that’s the key to the majority of his success. It’s just hard to wrap your head around that math because it’s not intuitive. There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called Shut Up And Wait. It’s just one page with a long-term chart of economic growth. The practical takeaway is that the counterintuitiveness of compounding may be responsible for the majority of disappointing trades, bad strategies, and successful investing attempts. You can’t blame people for devoting all their eﬀort—eﬀort in what they learn and what they do—to trying to earn the highest investment returns. It intuitively seems like the best way to get rich. But good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one- oﬀ hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild. The opposite of this—earning huge returns that can’t be held onto—leads to some tragic stories. We’ll need the next chapter to tell them. There are a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia. And that’s a topic we don’t discuss enough. Let’s begin with a quick story about two investors, neither of whom knew the other, but whose paths crossed in an interesting way almost a century ago. Jesse Livermore was the greatest stock market trader of his day. Born in 1877, he became a professional trader before most people knew you could do such a thing. By age 30 he was worth the inﬂation-adjusted equivalent of $100 million. By 1929 Jesse Livermore was already one of the most well- known investors in the world. The stock market crash that year that ushered in the Great Depression cemented his legacy in history. More than a third of the stock market’s value was wiped out in an October 1929 week whose days were later named Black Monday, Black Tuesday, and Black Thursday. Livermore’s wife Dorothy feared the worst when her husband returned home on October 29th. Reports of Wall Street speculators committing suicide were spreading across New York. She and her children greeted Jesse at the door in tears, while her mother was so distraught she hid in another room, screaming. Jesse, according to biographer Tom Rubython, stood confused for a few moments before realizing what was happening. He then broke the news to his family: In a stroke of genius and luck, he had been short the market, betting stocks would decline. “You mean we are not ruined?” Dorothy asked. “No darling, I have just had my best ever trading day—we are fabulously rich and can do whatever we like,” Jesse said. Dorothy ran to her mother and told her to be quiet. In one day Jesse Livermore made the equivalent of more than $3 billion. During one of the worst months in the history of the stock market he became one of the richest men in the world. As Livermore’s family celebrated their unfathomable success, another man wandered the streets of New York in desperation. Abraham Germansky was a multimillionaire real estate developer who made a fortune during the roaring 1920s. As the economy boomed, he did what virtually every other successful New Yorker did in the late 1920s: bet heavily on the surging stock market. On October 26th, 1929, The New York Times published an article that in two paragraphs portrays a tragic ending: Bernard H. Sandler, attorney of 225 Broadway, was asked yesterday morning by Mrs. Abraham Germansky of Mount Vernon to help ﬁnd her husband, missing since Thursday Morning. Germansky, who is 50 years old and an east side real estate operator, was said by Sandler to have invested heavily in stocks. Sandler said he was told by Mrs. Germansky that a friend saw her husband late Thursday on Wall Street near the stock exchange. According to her informant, her husband was tearing a strip of ticker tape into bits and scattering it on the sidewalk as he walked toward Broadway. And that, as far as we know, was the end of Abraham Germansky. Here we have a contrast. The October 1929 crash made Jesse Livermore one of the richest men in the world. It ruined Abraham Germansky, perhaps taking his life. But fast-forward four years and the stories cross paths again. After his 1929 blowout Livermore, overﬂowing with conﬁdence, made larger and larger bets. He wound up far over his head, in increasing amounts of debt, and eventually lost everything in the stock market. Broke and ashamed, he disappeared for two days in 1933. His wife set out to ﬁnd him. “Jesse L. Livermore, the stock market operator, of 1100 Park Avenue missing and has not been seen since 3pm yesterday,” The New York Times wrote in 1933. He returned, but his path was set. Livermore eventually took his own life. The timing was diﬀerent, but Germansky and Livermore shared a character trait: They were both very good at getting wealthy, and equally bad at staying wealthy. Even if “wealthy” is not a word you’d apply to yourself, the lessons from that observation apply to everyone, at all income levels. Getting money is one thing. Keeping it is another. If I had to summarize money success in a single word it would be “survival.” As we’ll see in chapter 6, 40% of companies successful enough to become publicly traded lost eﬀectively all of their value over time. The Forbes 400 list of richest Americans has, on average, roughly 20% turnover per decade for causes that don’t have to do with death or transferring money to another family member.¹⁷ Capitalism is hard. But part of the reason this happens is because getting money and keeping money are two diﬀerent skills. Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risk. It requires humility, and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indeﬁnitely. Michael Moritz, the billionaire head of Sequoia Capital, was asked by Charlie Rose why Sequoia was so successful. Moritz mentioned longevity, noting that some VC ﬁrms succeed for ﬁve or ten years, but Sequoia has prospered for four decades. Rose asked why that was: Moritz: I think we’ve always been afraid of going out of business. Rose: Really? So it’s fear? Only the paranoid survive? Moritz: There’s a lot of truth to that … We assume that tomorrow won’t be like yesterday. We can’t aﬀord to rest on our laurels. We can’t be complacent. We can’t assume that yesterday’s success translates into tomorrow’s good fortune. Here again, survival. Not “growth” or “brains” or “insight.” The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest diﬀerence. This should be the cornerstone of your strategy, whether it’s in investing or your career or a business you own. There are two reasons why a survival mentality is so key with money. One is the obvious: few gains are so great that they’re worth wiping yourself out over. The other, as we saw in chapter 4, is the counterintuitive math of compounding. Compounding only works if you can give an asset years and years to grow. It’s like planting oak trees: A year of growth will never show much progress, 10 years can make a meaningful diﬀerence, and 50 years can create something absolutely extraordinary. But getting and keeping that extraordinary growth requires surviving all the unpredictable ups and downs that everyone inevitably experiences over time. We can spend years trying to ﬁgure out how Buﬀett achieved his investment returns: how he found the best companies, the cheapest stocks, the best managers. That’s hard. Less hard but equally important is pointing out what he didn’t do. He didn’t get carried away with debt. He didn’t panic and sell during the 14 recessions he’s lived through. He didn’t sully his business reputation. He didn’t attach himself to one strategy, one world view, or one passing trend. He didn’t rely on others’ money (managing investments through a public company meant investors couldn’t withdraw their capital). He didn’t burn himself out and quit or retire. He survived. Survival gave him longevity. And longevity— investing consistently from age 10 to at least age 89—is what made compounding work wonders. That single point is what matters most when describing his success. To show you what I mean, you have to hear the story of Rick Guerin. You’ve likely heard of the investing duo of Warren Buﬀett and Charlie Munger. But 40 years ago there was a third member of the group, Rick Guerin. Warren, Charlie, and Rick made investments together and interviewed business managers together. Then Rick kind of disappeared, at least relative to Buﬀett and Munger’s success. Investor Mohnish Pabrai once asked Buﬀett what happened to Rick. Mohnish recalled: [Warren said] “Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry.” What happened was that in the 1973–1974 downturn, Rick was levered with margin loans. And the stock market went down almost 70% in those two years, so he got margin calls. He sold his Berkshire stock to Warren—Warren actually said “I bought Rick’s Berkshire stock”—at under $40 a piece. Rick was forced to sell because he was levered.¹⁸ Charlie, Warren, and Rick were equally skilled at getting wealthy. But Warren and Charlie had the added skill of staying wealthy. Which, over time, is the skill that matters most. Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two diﬀerent things: the ﬁrst requires the second. You need to avoid ruin. At all costs.” Applying the survival mindset to the real world comes down to appreciating three things. 1. More than I want big returns, I want to be ﬁnancially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders. No one wants to hold cash during a bull market. They want to own assets that go up a lot. You look and feel conservative holding cash during a bull market, because you become acutely aware of how much return you’re giving up by not owning the good stuﬀ. Say cash earns 1% and stocks return 10% a year. That 9% gap will gnaw at you every day. But if that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year—it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners. Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win. 2. Planning is important, but the most important part of every plan is to plan on the plan not going according to plan. What’s the saying? You plan, God laughs. Financial and investment planning are critical, because they let you know whether your current actions are within the realm of reasonable. But few plans of any kind survive their ﬁrst encounter with the real world. If you’re projecting your income, savings rate, and market returns over the next 20 years, think about all the big stuﬀ that’s happened in the last 20 years that no one could have foreseen: September 11th, a housing boom and bust that caused nearly 10 million Americans to lose their homes, a ﬁnancial crisis that caused almost nine million to lose their jobs, a record-breaking stock- market rally that ensued, and a coronavirus that shakes the world as I write this. A plan is only useful if it can survive reality. And a future ﬁlled with unknowns is everyone’s reality. A good plan doesn’t pretend this weren’t true; it embraces it and emphasizes room for error. The more you need speciﬁc elements of a plan to be true, the more fragile your ﬁnancial life becomes. If there’s enough room for error in your savings rate that you can say, “It’d be great if the market returns 8% a year over the next 30 years, but if it only does 4% a year I’ll still be OK,” the more valuable your plan becomes. Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right. Room for error—often called margin of safety —is one of the most underappreciated forces in ﬁnance. It comes in many forms: A frugal budget, ﬂexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes. It’s diﬀerent from being conservative. Conservative is avoiding a certain level of risk. Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome. 3. A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital. Optimism is usually deﬁned as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is ﬁlled with misery. And in fact you know it will be ﬁlled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is ﬁlled with landmines, and always will be. Those two things are not mutually exclusive. The idea that something can gain over the long run while being a basketcase in the short run is not intuitive, but it’s how a lot of things work in life. By age 20 the average person can lose roughly half the synaptic connections they had in their brain at age two, as ineﬃcient and redundant neural pathways are cleared out. But the average 20-year-old is much smarter than the average two-year-old. Destruction in the face of progress is not only possible, but an eﬃcient way to get rid of excess. Imagine if you were a parent and could see inside your child’s brain. Every morning you notice fewer synaptic connections in your kid’s head. You would panic! You would say, “This can’t be right, there’s loss and destruction here. We need an intervention. We need to see a doctor!” But you don’t. What you are witnessing is the normal path of progress. Economies, markets, and careers often follow a similar path— growth amid loss. Here’s how the U.S. economy performed over the last 170 years: But do you know what happened during this period? Where do we begin... 1.3 million Americans died while ﬁghting nine major wars. Roughly 99.9% of all companies that were created went out of business. Four U.S. presidents were assassinated. 675,000 Americans died in a single year from a ﬂu pandemic. 30 separate natural disasters killed at least 400 Americans each. 33 recessions lasted a cumulative 48 years. The number of forecasters who predicted any of those recessions rounds to zero. The stock market fell more than 10% from a recent high at least 102 times. Stocks lost a third of their value at least 12 times. Annual inﬂation exceeded 7% in 20 separate years. The words “economic pessimism” appeared in newspapers at least 29,000 times, according to Google. Our standard of living increased 20-fold in these 170 years, but barely a day went by that lacked tangible reasons for pessimism. A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less eﬀort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism. Jesse Livermore ﬁgured this out the hard way. He associated good times with the end of bad times. Getting wealthy made him feel like staying wealthy was inevitable, and that he was invincible. After losing nearly everything he reﬂected: I sometimes think that no price is too high for a speculator to pay to learn that which will keep him from getting the swelled head. A great many smashes by brilliant men can be traced directly to the swelled head. “It’s an expensive disease,” he said, “everywhere to everybody.” Next, we’ll look at another way growth in the face of adversity can be so hard to wrap your head around. “I’ve been banging away at this thing for 30 years. I think the simple math is, some projects work and some don’t. There’s no reason to belabor either one. Just get on to the next.” —Brad Pitt accepting a Screen Actors Guild Award Heinz Berggruen ﬂed Nazi Germany in 1936. He settled in America, where he studied literature at U.C. Berkeley. By most accounts he did not show particular promise in his youth. But by the 1990s Berggruen was, by any measure, one of the most successful art dealers of all time. In 2000 Berggruen sold part of his massive collection of Picassos, Braques, Klees, and Matisses to the German government for more than 100 million euros. It was such a bargain that the Germans eﬀectively considered it a donation. The private market value of the collection was well over a $1 billion. That one person can collect huge quantities of masterpieces is astounding. Art is as subjective as it gets. How could anyone have foreseen, early in life, what were to become the most sought-after works of the century? You could say “skill.” You could say “luck.” The investment ﬁrm Horizon Research has a third explanation. And it’s very relevant to investors. “The great investors bought vast quantities of art,” the ﬁrm writes.¹⁹ “A subset of the collections turned out to be great investments, and they were held for a suﬃciently long period of time to allow the portfolio return to converge upon the return of the best elements in the portfolio. That’s all that happens.” The great art dealers operated like index funds. They bought everything they could. And they bought it in portfolios, not individual pieces they happened to like. Then they sat and waited for a few winners to emerge. That’s all that happens. Perhaps 99% of the works someone like Berggruen acquired in his life turned out to be of little value. But that doesn’t particularly matter if the other 1% turn out to be the work of someone like Picasso. Berggruen could be wrong most of the time and still end up stupendously right. A lot of things in business and investing work this way. Long tails—the farthest ends of a distribution of outcomes—have tremendous inﬂuence in ﬁnance, where a small number of events can account for the majority of outcomes. That can be hard to deal with, even if you understand the math. It is not intuitive that an investor can be wrong half the time and still make a fortune. It means we underestimate how normal it is for a lot of things to fail. Which causes us to overreact when they do. Steamboat Willie put Walt Disney on the map as an animator. Business success was another story. Disney’s ﬁrst studio went bankrupt. His ﬁlms were monstrously expensive to produce, and ﬁnanced at outrageous terms. By the mid-1930s Disney had produced more than 400 cartoons. Most of them were short, most of them were beloved by viewers, and most of them lost a fortune. Snow White and the Seven Dwarfs changed everything. The $8 million it earned in the ﬁrst six months of 1938 was an order of magnitude higher than anything the company earned previously. It transformed Disney Studios. All company debts were paid oﬀ. Key employees got retention bonuses. The company purchased a new state-of-the-art studio in Burbank, where it remains today. An Oscar turned Walt from famous to full-blown celebrity. By 1938 he had produced several hundred hours of ﬁlm. But in business terms, the 83 minutes of Snow White were all that mattered. Anything that is huge, proﬁtable, famous, or inﬂuential is the result of a tail event—an outlying one-in-thousands or millions event. And most of our attention goes to things that are huge, proﬁtable, famous, or inﬂuential. When most of what we pay attention to is the result of a tail, it’s easy to underestimate how rare and powerful they are. Some tail-driven industries are obvious. Take venture capital. If a VC makes 50 investments they likely expect half of them to fail, 10 to do pretty well, and one or two to be bonanzas that drive 100% of the fund’s returns. Investment ﬁrm Correlation Ventures once crunched the numbers.²⁰ Out of more than 21,000 venture ﬁnancings from 2004 to 2014: 65% lost money. Two and a half percent of investments made 10x–20x. One percent made more than a 20x return. Half a percent—about 100 companies out of 21,000—earned 50x or more. That’s where the majority of the industry’s returns come from. This, you might think, is what makes venture capital so risky. And everyone investing in VC knows it’s risky. Most startups fail and the world is only kind enough to allow a few mega successes. If you want safer, predictable, and more stable returns, you invest in large public companies. Or so you might think. Remember, tails drive everything. The distribution of success among large public stocks over time is not much diﬀerent than it is in venture capital. Most public companies are duds, a few do well, and a handful become extraordinary winners that account for the majority of the stock market’s returns. J.P. Morgan Asset Management once published the distribution of returns for the Russell 3000 Index—a big, broad, collection of public companies—since 1980.²¹ Forty percent of all Russell 3000 stock components lost at least 70% of their value and never recovered over this period. Eﬀectively all of the index’s overall returns came from 7% of component companies that outperformed by at least two standard deviations. That’s the kind of thing you’d expect from venture capital. But it’s what happened inside a boring, diversiﬁed index. This thumping of most public companies spares no industry. More than half of all public technology and telecom companies lose most of their value and never recover. Even among public utilities the failure rate is more than 1 in 10: The interesting thing here is that you have to have achieved a certain level of success to become a public company and a member of the Russell 3000. These are established corporations, not ﬂy-by-night startups. Even still, most have lifespans measured in years, not generations. Take an example one of these companies: Carolco, a former member of the Russell 3000 Index. It produced some of the biggest ﬁlms of the 1980s and 1990s, including the ﬁrst three Rambo ﬁlms, Terminator 2, Basic Instinct, and Total Recall. Carolco went public in 1987. It was a huge success, churning out hit after hit. It did half a billion dollars in revenue in 1991, commanding a market cap of $400 million—big money back then, especially for a ﬁlm studio. And then it failed. The blockbusters stopped, a few big-budget projects ﬂopped, and by the mid-1990s Carolco was history. It went bankrupt in 1996. Stock goes to zero, have a nice day. A catastrophic loss. And one that 4 in 10 public companies experience over time. Carolco’s story is not worth telling because it’s unique, but because it’s common. Here’s the most important part of this story: The Russell 3000 has increased more than 73-fold since 1980. That is a spectacular return. That is success. Forty percent of the companies in the index were eﬀectively failures. But the 7% of components that performed extremely well were more than enough to oﬀset the duds. Just like Heinz Berggruen, but with Microsoft and Walmart instead of Picasso and Matisse. Not only do a few companies account for most of the market’s return, but within those companies are even more tail events. In 2018, Amazon drove 6% of the S&P 500’s returns. And Amazon’s growth is almost entirely due to Prime and Amazon Web Services, which itself are tail events in a company that has experimented with hundreds of products, from the Fire Phone to travel agencies. Apple was responsible for almost 7% of the index’s returns in 2018. And it is driven overwhelmingly by the iPhone, which in the world of tech products is as tail-y as tails get. And who’s working at these companies? Google’s hiring acceptance rate is 0.2%.²² Facebook’s is 0.1%.²³ Apple’s is about 2%.²⁴ So the people working on these tail projects that drive tail returns have tail careers. The idea that a few things account for most results is not just true for companies in your investment portfolio. It’s also an important part of your own behavior as an investor. Napoleon’s deﬁnition of a military genius was, “The man who can do the average thing when all those around him are going crazy.” It’s the same in investing. Most ﬁnancial advice is about today. What should you do right now, and what stocks look like good buys today? But most of the time today is not that important. Over the course of your lifetime as an investor the decisions that you make today or tomorrow or next week will not matter nearly as much as what you do during the small number of days—likely 1% of the time or less—when everyone else around you is going crazy. Consider what would happen if you saved $1 every month from 1900 to 2019. You could invest that $1 into the U.S. stock market every month, rain or shine. It doesn’t matter if economists are screaming about a looming recession or new bear market. You just keep investing. Let’s call an investor who does this Sue. But maybe investing during a recession is too scary. So perhaps you invest your $1 in the stock market when the economy is not in a recession, sell everything when it’s in a recession and save your monthly dollar in cash, and invest everything back into the stock market when the recession ends. We’ll call this investor Jim. Or perhaps it takes a few months for a recession to scare you out, and then it takes a while to regain conﬁdence before you get back in the market. You invest $1 in stocks when there’s no recession, sell six months after a recession begins, and invest back in six months after a recession ends. We’ll call you Tom. How much money would these three investors end up with over time? Sue ends up with $435,551. Jim has $257,386. Tom $234,476. Sue wins by a mile. There were 1,428 months between 1900 and 2019. Just over 300 of them were during a recession. So by keeping her cool during just the 22% of the time the economy was in or near a recession, Sue ends up with almost three-quarters more money than Jim or Tom. To give a more recent example: How you behaved as an investor during a few months in late 2008 and early 2009 will likely have more impact on your lifetime returns than everything you did from 2000 to 2008. There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing. Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control. A good deﬁnition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy. Tails drive everything. When you accept that tails drive everything in business, investing, and ﬁnance you realize that it’s normal for lots of things to go wrong, break, fail, and fall. If you’re a good stock picker you’ll be right maybe half the time. If you’re a good business leader maybe half of your product and strategy ideas will work. If you’re a good investor most years will be just OK, and plenty will be bad. If you’re a good worker you’ll ﬁnd the right company in the right ﬁeld after several attempts and trials. And that’s if you’re good. Peter Lynch is one of the best investors of our time. “If you’re terriﬁc in this business, you’re right six times out of 10,” he once said. There are ﬁelds where you must be perfect every time. Flying a plane, for example. Then there are ﬁelds where you want to be at least pretty good nearly all the time. A restaurant chef, let’s say. Investing, business, and ﬁnance are just not like these ﬁelds. Something I’ve learned from both investors and entrepreneurs is that no one makes good decisions all the time. The most impressive people are packed full of horrendous ideas that are often acted upon. Take Amazon. It’s not intuitive to think a failed product launch at a major company would be normal and ﬁne. Intuitively, you’d think the CEO should apologize to shareholders. But CEO Jeﬀ Bezos said shortly after the disastrous launch of the company’s Fire Phone: If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip. It’s OK for Amazon to lose a lot of money on the Fire Phone because it will be oﬀset by something like Amazon Web Services that earns tens of billions of dollars. Tails to the rescue. Netﬂix CEO Reed Hastings once announced his company was canceling several big-budget productions. He responded: Our hit ratio is way too high right now. I’m always pushing the content team. We have to take more risk. You have to try more crazy things, because we should have a higher cancel rate overall. These are not delusions or failures of responsibility. They are a smart acknowledgement of how tails drive success. For every Amazon Prime or Orange is The New Black you know, w

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