When 'Too Good To Be True' IS Actually True (and other news)
In investing, and life, it can be very useful to be sceptical if something (or someone) seems too good to be true. Often we find the ‘perfect’ thing comes with a host of catches. Perhaps it’s a job that pays more for working less. Maybe it’s a luxurious looking holiday location going cheap. Or even a new friend in life that appears perfect.
In investing it’s normally a promise of above average returns with below average risk.
If it sounds too good to be true, it probably is.
But maybe it isn’t.
How can you know? In life, a rational assessment of the situation can often reveal the truth. But sometimes only time, experience and wisdom will tell you.
When it comes to your money, it can be difficult.
England in the sunshine - too good to be true?
Here’s a way to think about it.
Tim Ferriss recently interviewed a gentleman by the name Ed O. Thorp. I doubt you have heard of him. Ed is almost 90 years old (he looks about 60), and he was once one of the world’s best blackjack players. He wrote the book Beat the Dealer which transformed the game of blackjack by mathematically proving that the house advantage could be overcome by card counting, particularly near the end of a card deck that is not being reshuffled after every deal (casinos now shuffle a long way before the end of the deck is reached as a countermeasure to his methods).
Ed has a PhD in mathematics and taught maths at some of the best colleges in the US. He is, when you listen to him speak, clearly a genius.
After breaking the game of blackjack and writing about it, he had gambling winnings and book royalties. He realised he needed to invest his cash . After making what he calls ‘a lot of foolish beginner mistakes’ (which cost him), he decided he ought to really figure investing out.
So he started studying. He spent two summers reading every investing book and newspaper he could get his hands on.
He picked up a book about common stock purchase warrants – a type of security that formed the basis for what people call ‘options’ today.
He described how a ‘light came on’. He realized that he could mathematicise these things and value them in a way that no one else had yet done. He knew he could gain an edge over other investors.
He developed a mathematical model that enabled him to make a steady 25 percent a year with practically no risk. He launched a hedge fund which ran for about 20 years. He kept generating new mathematical finance ideas that enabled him to stay ahead of other investors and continue generating extraordinary returns. He describes his edge over other investors in the 1970s like having machine guns against bows and arrows.
In 20 years, he only had three down months and they were all down less than one percent.
If you showed me those returns today, I would say ‘impossible – too good to be true – it’s a ponzi scheme’. (Ed was actually one of the first people to identify that Madoff was a ponzi).
And it probably would be a ponzi scheme or fraud. To convince myself otherwise I would need to see an Ed O. Thorp managing the money. A true genius. A person who has figured out something that no one else yet has.
There aren’t many of those people around today. There were a few back in the early and middle part of last century but the professionalisation of the market today means it’s incredibly hard to know something that other investors don’t, and to keep it a secret. As soon as the secret is out, other investors start doing the same thing and bang, the edge has gone – arbitraged away.
If you get presented with something that looks too good to be true, ask that question. Is there a true genius behind it (not just a slick sales person)? Someone with a method that can be explained? If not, stay clear.
But it’s ok – you don’t need to be a genius to be a successful investor. Tim asked Ed what he would teach a group of students today about investing.
He answers, “Well, the first thing I would tell them is the answer is really easy for almost everybody, but you’re not going to believe me until you work through yourself and understand it. And I’ll tell you the answer to start with and then I’ll try to convince you that’s the right answer. The answer is, if you’re a long-term investor, you should just buy and hold equities.”
He goes on, “You can prove by logical mathematical arguments that if a person simply buys the index and holds it, he will outperform most or all the other players.”
This is what I want you to understand. Beating other investors is hard – really hard. Ed O Thorp did it. He achieved returns that were ‘too good to be true’. But the chances of you or I doing it are almost zero. We have worked through it ourselves and we understand it. That’s why we explain to our clients that we don’t think about how we can be smarter than others, we think about what we can do that others aren’t prepared to do.
And that comes back to behaviour. We can be more patient and more disciplined than everyone else around us. That’s our edge. It’s the only edge that exists today for most people, and it will never be arbitraged away (humans will never change).
If you are busy trading your account, trying to beat the market, take Ed’s advice if you won’t take mine. If you are a Liberty Wealth client with a beautifully diversified portfolio of index funds and ETFs, take comfort in the advice of one of the world’s smartest investors.
As he put it, “Pile it all in equities and let it rip.”
And on the topic of ‘too good to be true’, we are over the moon to welcome this dreamboat to the world – Rocco Ari Campbell – born on 17th August to Guy and his wife Allie. Their first child, my fourth nephew and my parents’ thirteenth grandchild. He is very loved. Guy is taking a few weeks off to spend special first days with his new family.
Georgie
georgie@libertywealth.ky