[Book Summary] Outliers

April 7th, 2010

What Is the Secret of Success?

People who succeed must work hard, but lots of people work hard and don’t succeed. So stars must have some distinct talent or gift, right? They must be special somehow. That’s the common explanation of why some people do well and others don’t – and it is wrong or, at least, it tells only part of the story. In leaving out the other elements of success, this old model dangerously distorts reality. It personalizes a process that, while personal, is also social and cultural. It thus leaves people looking for talent in the wrong places.

Take the Canadian Hockey League. Its late-teenage athletes are superb players. They’re fit and talented, and many turn professional. However, though they all pour out endless energy to reach the top, that’s only half the story. The other half is found in what biologists call the “ecology” of a specific living thing. A tall oak tree standing in the forest didn’t just come from a good acorn; that acorn also landed in the right place, on good soil with no other trees blocking the sun, and so on. Likewise, these athletes are superior, in part, because of their work and gifts, and, in part, because of the intersection of random chance and an arbitrary social choice.

The date that demarcates athletes in the top Canadian hockey leagues is January 1. An overwhelming percentage of champions are born in the first few months of the year. Scant months make a big difference in a child’s development, so when kids with birthdays early in the year begin to compete, they are already larger, more coordinated and more promising than those born later the same year. Thus, they get singled out early as having more potential. They receive more coaching and more time on the ice. As a result, they become better hockey players than slightly younger kids. Adults focus resources on them early in their development, but it isn’t their talent that gets rewarded; it is their birth dates.

This early selection process matters greatly because of a second factor that determines superior performance – amount of practice time. If you track a group of potential professionals in an area such as music from childhood through adulthood, a marked pattern emerges: Their final status depends on how much they practice. Strong amateurs accumulate about 2,000 hours of practice by adulthood. Future music teachers build up about 4,000 hours. Really good students amass about 8,000 hours and “elite performers” invest about 10,000 hours of practice. This 10,000-hour marker carries over to other fields, such as sports, the arts and even technical training, like computer programming. People who have dominated the computer world, such as Bill Joy, who rewrote UNIX and Java, put in parallel practice time. That’s what carried Joy to stunning computer feats. But it wasn’t dedication alone that let him succeed; it was also the right situation. In the 1970s, Joy attended the University of Michigan – one of the few places in the U.S. at the time with the resources to let many people practice programming at once. Joy didn’t go to Michigan to study computers; he stumbled across the computer center by accident. But, once he did, he could program round the clock, due to access and to a glitch in the system that let students get more than their allotted computer time. Bill Gates had similar luck; he was bright and talented with computers, but he also attended a Seattle private school that had a computer club in the 1960s, and he could “steal” time on the computers of a nearby university.

For such an incredible tally of time, effort and proximity to pay off, the larger context still has to work. The 75 richest people who ever lived include individuals from across history’s span, but nearly 20% of them come from “a single generation in a single country”: the mid-19th century in the U.S. John D. Rockefeller, Andrew Carnegie, Jay Gould and more became so rich because they were born at just the right time to take advantage of the American economic explosion. You’ll find a similar age grouping for Gates, Joy and other major tech players: Gates was born in 1955, Joy in 1954, Paul Allen in 1953, Steve Ballmer in 1956 and Steve Jobs in 1955. They shaped their field because they entered it at the right time: early enough to have a major impact, but late enough to get practice time on computers after the early days of punch cards.

This historical positioning is rarely conscious and it doesn’t necessarily seem like a good thing at the time. It can happen accidentally, even via negative social forces, and still produce striking success. Take Harvard Law graduate Joseph Flom (last living “named” partner of the law firm Skadden, Arps, Slate, Meagher & Flom). When he started, he was one of the few grads who could not get hired. He was “ungainly, awkward, a fat kid” and Jewish, at a time when the New York legal establishment was made up of socially graceful WASPs (White Anglo-Saxon Protestant) who all knew one another. Excluded from white glove firms, Flom and two partners started their own firm and handled whatever cases came to them. One kind of case got referred to them specifically because Flom was Jewish and, thus, at the time, an outsider to his profession. Established firms didn’t want to touch the harsher edges of corporate law, like takeovers involving ugly proxy battles, so they shunted such cases to Flom. When the business climate shifted and takeovers became common, Flom was already an expert, with far more experience in the field than his competitors, and far less emotional investment in maintaining good personal relations with other lawyers (who had already excluded him). Demand for his legal services boomed and he prospered.

Genius Is Not Enough

When Christopher Langan won on a quiz show called 1 VS. 100, he became famous for his staggering IQ, said to be “too high to be accurately measured.” Langan’s childhood intellectual accomplishments were stunning. He talked at six months old, taught himself to read by age three, read Principia Mathematica at 16 and “got a perfect score on his SAT, even though he fell asleep” during the exam. Nevertheless, he achieved little success until he won the quiz show – because pure intellectual genius alone is not enough. It must be paired with “practical intelligence,” which Langan’s life had systematically omitted. His mother was isolated from her family and had four sons, each by a different man. Langan’s father was an abusive alcoholic. Langan lost his first college scholarship because he was a social misfit, and car trouble kept him from his classes at Montana State. He raked clams, worked in factories and took jobs as a bouncer at bars. He never really used his intelligence professionally.

Robert Oppenheimer (scientific director of the Manhattan Project) provides a vivid counterexample of what happens when practical intelligence and genius are combined. Like Langan, he demonstrated his intelligence at an early age, conducting science experiments by third grade, and speaking Latin and Greek by age nine. He, too, ran into self-created trouble at college: gripped by serious depression, he planned to kill his adviser! Langan dropped out of college due to a dead car and social differences, but Oppenheimer was merely put on probation for planning a homicide. The difference was Oppenheimer’s practical intelligence. At ease with social norms, he could talk his way into opportunities, in large part, due to his background. His family placed him in special schools that gave him extra attention when he showed his potential. They praised his interests and gave him the sense that he would rise to the top, which he did as a physicist. These men illustrate what formal long-term studies of high IQ individuals have shown: Family background markedly influences success, even for a genius. To succeed, brilliant people need praise for their intellectual gains, guidance through human society’s complexities and practicality.

The Social Roots of Conflict and Math Ability

For years, deadly family feuds disrupted life in Harlan County, Kentucky. Sons and cousins killed cousins and sons, as their fathers had killed other fathers. Facing violence bravely and accepting feuds as part of life became integral to Appalachian culture – but why there to such an intense degree? The answer resides in the origins of the British immigrants who came to Harlan County in 1819. They brought a “culture of honor” that required a man to respond violently to threats, insults and economic pressure.

Such cultures turn out to be common in rocky areas where herding is pivotal. The shepherd lives at risk, and must act quickly and in isolation to protect his livelihood. This is unlike farming, which depends on community involvement. In herding cultures, a single insult might define a man’s character, so he must respond to it. Such characteristics carry over into regional cultures, long after their roots are forgotten. Men from America’s South, where the heritage includes a culture of honor, are more likely to be gracious on first meeting – but also likelier to respond to an insult with violent anger – than U.S. northerners, even if both have long lived far from their home regions.

In another example, Asian superiority in math has clear cultural roots. Asians have linguistic advantages. The Chinese words for numbers are shorter than the English words, thus easier to process quickly. Japan, Korea and China’s counting system is more logical, too; rather than using new words for numbers greater than ten, it makes combinations: “Eleven is ten-one. Twelve is ten-two.” Thus, adding and subtracting are almost automatic: Say the words and you add them.

Some Asian mathematical superiority comes, surprisingly, from historical contrasts between Asian agriculture, especially rice growing, and European farming. In 18thcentury Europe, peasants worked hard in the spring to plant their fields, worked somewhat hard in the summer to weed them and labored hard again to harvest in the fall. They were sometimes idle in the winter and had many days off because of how the plants grew. By contrast, rice farming took regular, extremely hard work. Asian peasants had to prepare rice paddies with an established, constantly monitored water flow. Rice crops were timed for two annual yields from the same fields. Farmers could choose among a much larger array of seeds, switching strains of rice from one planting to another. This produced a deeply ingrained cultural predisposition toward working very long hours while maintaining focused attention on multiple factors: exactly what you need to master math.

In the Air

Social influences affect individual actions even in the specific field of commercial plane crashes. Commercial airliners are mature machines with highly dependable technology, so accidents don’t happen because a plane suddenly bursts into flames. Instead, they happen because pilots encounter complications, like bad weather, in situations where one mistake happens, then another, then another. In fact, “the typical accident involves seven consecutive human errors,” stemming not from lack of flying skill, but from stress, poor communication and the crew’s social morés.

National cultures differ in several relevant traits, for example, the “Power Distance Index.” The more a “culture values and respects authority,” the less likely its members are to challenge their superiors or to tell them unpleasant information (e.g., that a crash is impending). Cultures also differ in how independent they expect their members to be. Some cultures expect people to align with the group; others expect members to be “highly individualistic.” In certain contexts, like a stress-filled, error-ridden plane cabin, members of individualistic cultures function better at focusing attention on missed information. As a result, crews from hierarchical, group-focused nations (e.g., Korea) are more likely to crash planes than those from other nations, unless specialized training counters these cultural influences. Thus, once businesses recognize that many of the factors determining performance are cultural, they can develop training programs to reshape cultural habits and generate greater success. Korean Air did so when it asked consultant David Greenberg to retrain its crews. He taught the crew members English to help lighten “the heavy weight of their country’s cultural legacy.” He also taught them new attitudes about hierarchy, and showed that it was possible for them to be “re-normed.”

The Knowledge Is Power Program (KIPP) in New York is attempting a similar revision of cultural norms. To improve low-income students’ education, KIPP teaches some of the cultural practices that help middle-class students succeed academically. One “protocol,” called “SSLANT,” stands for “smile, sit up, listen, ask questions, nod when being spoken to and track with your eyes.” KIPP also extends the school day, week and year. These actions address a socioeconomic reality: Outside school, middle- and upper-class kids are more intellectually active. Various activities stimulate their minds over vacations and on weekends, when lower class kids lose ground. KIPP asks a lot of its students and challenges long-standing educational models, but it also produces superior results, giving students who were performing badly a much better chance at academic success.

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[Book Summary] Fooled by Randomness

February 12th, 2009

The past decade has witnessed the release of many books about risk management, but none have managed to illustrate the role that random events play in life and markets as well as Fooled by Randomness. Writing in a leisurely and personal style that makes this complex subject utterly accessible, the author, Nassim Taleb, instructs us on how to account for randomness in our decision making, and illustrates the many ways in which we confuse luck with skill.

“It is foolish to think that an irrational market cannot become even more irrational.”

This confusion, when applied to the market, often results in lucky fools - people who have succeeded due to essentially random events beyond their control, but deem themselves skilled investors. Such perceptions cause people to overlook real volatility and focus only on returns.

The potential for randomness can be a disruptive force in whatever you are doing. People can be lucky fools without ever even being aware that they are successful by virtue of luck. Such good fortune will be reflected in the way they act and think, since an increase in personal performance for whatever reason causes a rise in serotonin, enhancing leadership abilities.

“Evolutionary psychology claims that such physical manifestations of one’s performance in life, just like an animal’s dominant condition, can be used for signaling: it makes the winners seem easily visible, which is efficient in mate selection.”

Successful people appear more powerful and dominant, just as an animal’s behavior signals other animals about his dominance. But with a single shift of fortune, that could all be taken away.

“Never ask a trader if he is profitable; you can easily see it in his gesture and gait.”

Unfortunately, most people don’t pay enough attention to randomness. They underestimate the effects of randomness and have little understanding of how probability affects events.

The Real Reality –> What People Think
Luck –> Skills
Randomness –> Determinism
Probability –> Certainty
Belief, conjecture –> Knowledge, certitude
Theory –> Reality
Anecdote, coincidence –> Causality, law
Forecast –> Prophecy

Some successful traders are like Russian roulette players. They have the external signs of wealth, but the probability over the long haul is that they will lose and lose big. In fact, reality is even more vicious than Russian roulette, since it only infrequently delivers the fatal bullet, so you can easily forget that this bullet is there. Therefore, you can be lulled into a false sense of security, forgetting that reality is like a revolver with hundreds or thousands of chambers. In reality, risks are hidden away, whereas Russian roulette is a well-defined game. As a result, you may not be aware that you are playing the game while you are generating your wealth, so you lose sight of your risks. You keep playing, not realizing the potential for very high losses.

You can understand a sequence of random historical events with the Monte Carlo metaphor. Imagine a perfect roulette wheel that simulates random events. You have a certain probability of achieving enrichment and a certain probability of achieving annihilation. Using the Monte Carlo method, you can explore alternate paths of history and see what is most likely under different conditions. By using the model to simulate how the bulls, bears and cautious traders fare under different boom and bust scenarios you can better understand prospects for success. Using this model, you’ll see that the bull traders who get rich from a rally buy more assets and drive prices higher until they ultimately fail, while bearish traders rarely made it to the boom to participate in the bust. Options traders fare best because they buy insurance against a random blow-up.

“One cannot judge a performance in any given field (war, politics, medicine, investments) by the results, but by the costs of the alternative (i.e. if history played out in a different way.)”

Traders get fooled by randomness when they overestimate the accuracy of their beliefs in an economic or statistical measure; they don’t consider that their trading worked in the past because it was merely coincidental or that their economic analysis masked the random element in past events.

People often confuse probability with expectation, which is the probability times the payoff. People intuitively apply lessons learned from symmetric environments - like a coin toss - in which minor differences don’t matter. But in the market slight difference can be decisive when you factor in the potential payoff or loss. This is why words like “bullish” and “bearish” can be misleading, since they imply a high probability that the market can go up or down, without indicating exactly what that probability is. The idea of asymmetry doesn’t matter in most disciplines, but it is critical in finance, where an event, even if rare, cannot be ignored if it brings large consequences. Statistics often fail to detect rare events because statistical formulas become complex and easily fail when dealing with distributions that are not symmetric.

So you must either find more accurate predictive measures or limit your assessments to situations in which you can make a judgment independent of how frequently such rare events occur. Inference and induction also are complicated by randomness, but even so, they are extremely useful tools in making aggressive bets in the hopes of winning big. But don’t try to use inference or induction in managing risks and exposure, since a single, random event could spell your ruin.

Once you’ve recognized the important role that randomness plays in our lives and in our markets, follow this simple advice to improve your performance:

  • Don’t use highly visible examples of success to prove a point, since there may be many examples of failure that you don’t see
  • Don’t let survivorship bias - seeing success in survivors - fool you into giving a survivor too much credit. The fact that a person made money in the past isn’t meaningful or relevant unless you know the size of the population from which that person came - how many other managers tried and failed - so you can properly assess the winner’s track record. If the success comes from a very large population, ignore the result
  • Remember that it isn’t the estimate or forecast that matters as much as the level of confidence in that opinion. Likewise, guide your activity in the market less on where you think the market is going than on the degree of error you are willing to allow

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[Book Summary] The Cult of the Luxury Brand: Inside Asia’s Love Affair With Luxury

February 8th, 2009

Asia has fallen madly, deeply, hopelessly in love, and the objects of its affection are Louis Vuitton bags, Ferragamo shoes and Burberry trench coats with their instantly recognizable plaid lining. Why? Find out from this witty, insightful and fun-to-read book.

“Why are millions of Asians, not all of them rich, rushing to buy outrageously expensive designer-label bags, shoes, clothes, watches, jewelry, and accessories? Why do they queue for hours outside stores in Paris, often putting up with degrading treatment, all for the sake of a logo-splashed bag? Why is it “normal” for Hong Kong people, whether wealthy tycoons or your average Joe, to own several expensive Swiss watches? Why do South Korean office ladies purchase Ferragamo shoes on installment plans? Why do junior executives in Shanghai happily shell out their entire month’s salary for a Gucci purse? Why do some Japanese teenagers even sleep with middle-aged salarymen just to get money together for that all-essential luxe bag?”

This socio-cultural phenomenon of “luxeplosion” is reverberating throughout Asia. New money is upsetting old ways, allowing people to purchase their way up the status ladder. The practice of “gifting” and a cultural emphasis on conformity contribute to the craze.

“Many Asians of moderate means are simply spending their way up the social hierarchy, often in amounts totally out of whack with their real income.”

“In today’s Asia you are what you wear,” so Asia’s fashionistas are carrying Louis Vuitton and Hermès bags, wearing Gucci and Ferragamo shoes, buying Zegna suits, and telling time with Cartier, Rolex and Piaget watches. Products from these high-priced, luxury brands are flying off the shelves in Japan, Hong Kong, South Korea, China, India, Singapore and other Asian countries. And this trend is expected to keep growing. What explains the relatively new phenomenon of Asia’s love affair with luxury? The region is undergoing a massive transformation “politically, socially and economically.” Asians are redefining the rigid social orders of the past. Now the class you are born into no longer dictates your status for the rest of your life. Instead, money defines the new social order. What better way to display wealth than to wear the easily identifiable logos of the rich and famous.

“Luxury brands are a modern set of symbols that Asians are wearing to redefine their identity and social position.”

Asia is responsible for some 37% of the $80 billion global luxury industry. The U.S. buys 24%, Europe takes 35% and other nations only 4%. Of Asia’s 37%, Japan accounts for a whopping 62%, followed by Hong Kong (12%), South Korea and China (8% each, but China’s share is growing faster); Taiwan, Singapore and Southeast Asia (3% each), and India (1%). The top 10 brands Asians love most, in descending order are: Louis Vuitton, Rolex, Cartier, Gucci, Burberry, Hermès, Chanel, Prada, Tiffany and Armani.

The spread of luxury mania in Asian countries typically follows a five-stage process:

  1. “Subjugation” - Under authoritarian rule, most people live in poverty.
  2. “Start of money” - Economic growth reaches the masses; elites begin buying luxury.
  3. “Show off” - People purchase deluxe brands to display their growing wealth.
  4. “Fit in” - Everyone wants a little luxury in order to conform.
  5. “Way of life” - Luxury brands become a necessity rather than a lavish expenditure.

Luxury shoppers can be “luxury gourmands,” “luxury regulars” or “luxury nibblers.” The gourmands are rich people who spend millions on designer labels. The regulars are not quite as wealthy, but their affluence lets them purchase luxury goods regularly. The nibblers are young people or up-and-comers who sacrifice in other areas to buy a bit of luxury each season.

Japan
The Japanese have had an insatiable appetite for luxury since the mid-70s. Today, luxury is a way of life. Three Japanese social forces drive this passion: the need to conform, a lack of other ways to display a high standard of living and women’s societal status.

“In Japan, even the fishmongers tuck away their cash receipts in Louis Vuitton bags - every section of society, every country in Asia, is falling under the spell of Western luxury brands.”

Japanese society views conformity as the path to harmony, so when a trend takes root, everyone wants to join. Rebels face ostracism and even ridicule from their peers. Thus, fashion magazines wield a lot of power. People want an authority to provide expertise and guidance. Japan’s economy provides many citizens with substantial wealth, but people have few ways to display it except on their bodies. Homes are small by necessity, space is limited and parking is scarce. Male domination of society has given rise to a generation of “parasite singles”: women in their 20s and 30s who choose to remain single and live with their parents. They are Japan’s largest luxury consumer segment.

Hong Kong
“Shopping is a way of life” in Hong Kong, where the culture encourages over-the-top consumption and fosters a multibillion dollar luxury market. The retail scene is a shopper’s delight. High-end shops are interlaced throughout residential and commercial areas, making the city “one big shopping mall.” Malls are embedded into multi-use complexes, so you pass luxury window displays on your way to work, on your way home, when you go out to eat or even when you catch the train.

Tourists love to shop in Hong Kong. It is duty-free and there’s no sales tax. More than 23 million tourists visit Hong Kong each year, spending more than $12 billion. The locals, who pay very low income taxes, also love luxury. The members of one group of luxury gourmands are known as “tai-tais.” Each of these high-society wives of billionaires and tycoons spend as much as $1 million a year on luxury goods. Hong Kong has 50 to 100 such women, and some 300 more who spend $500,000 to $1 million annually. It also has a substantial group of working women with money who might indulge in $15,000 to $50,000 in deluxe goods each year. Lastly, the office ladies and up-and-comers dabble in luxury on a budget, buying well-chosen items now and then.

China
Why discuss luxury brands in a country where most people are poor? China is undergoing a reawakening, its economy is accelerating and its potential is boundless. The luxury market is already growing 25% per year. China’s 400 wealthiest people have a combined worth of $75 billion. More than 300,000 Chinese millionaires make up the next level, and the rich spend heavily. The practice of “gifting,” bestowing presents when you do business, also boosts the luxury market. Deluxe goods have replaced cash in greasing the wheels of government and commerce. Something small and pricey makes the perfect gift, to the benefit of such brands as Hugo Boss, Dunhill and Rolex. Several other factors pave the way for these goods. The explosive growth of the economy has lured expatriate Chinese back home, bringing their knowledge of western brands back with them. The Chinese are also traveling and shopping abroad for the first time in decades, and tourists are flowing into China, ready to shop. China’s emerging modern cities, such as Shanghai and Beijing, host world-class restaurants, hotels and nightclubs. As the new metropolises boom, the retail trade keeps pace. Hot brands, like Vuitton and Armani, are already expanding in China.

South Korea
South Korea suffers most from a “clash of values.” The country is obsessed with beauty, so luxury brands are a natural magnet. But, unlike in Hong Kong, where conspicuous consumption is encouraged, the South Korean culture considers unnecessary excess downright sinful. Yet, the desire for luxury brands runs rampant. Women are fixated on perfection. Cosmetic surgery is the norm. Estimates say that more than half of South Korean women in their 20s have indulged in a little help from the scalpel. Dermatology clinics, hair salons and spas cater to this obsession. With your perfect face and body, you need the perfect designer handbag. Recent access to easy credit also fuels this craze. Bustling local markets, like Dongdaemun, display Ferragomo shoes, Hermès bags, and other popular luxury items, both originals and counterfeits, in great abundance.

India
The masses are beginning to make money. The economy is booming, the IT industry is making an impact on the world market and the stock market is rising, but name brands have not yet made a significant impact. In fact, the luxury market is only some $100 million. But India is where China was a decade ago, in the “start of money” stage of the luxury model, poised to grow very rapidly.

Luxury marketers can target four major groups in India: First, “the old-money industrial dynasties” have been shopping globally for years. These sophisticated consumers are comfortable with luxury brands. Second, “new-money entrepreneurs” show a propensity for “bling” and designer wear, although they need more education to join the sophisticated elite. Third, the “gold collars of the corporate world” are earning large salaries and upping their lifestyles. However, they want long-term value rather than just a short-term boost. Fourth, India’s youth are earning precedent-setting IT salaries. They yearn for the latest high-tech gadgets, stylish clothes and other emblems of the good life. And, they’re willing to spend their newly earned money to get them.

Two other factors might drive designer brand growth in India. First, people already spend substantial amounts on elaborate four- or five-day weddings. This show of opulence paves the way for luxury, from the trousseau, to luggage, suits and gifts. The second factor is the celebrity sway of Bollywood, which produces more than 1,000 popular movies every year. A celebrity endorsement or product placement can set off a national trend.

Fakes
The quality of counterfeit luxury items has given birth to the oxymoron, a “genuine fake.” These copies bring in more than $27 billion annually, equivalent to a quarter of the legitimate luxury trade. More Asians buy copies than the real thing. Culturally, this indulgence is not viewed as breaking any laws. Westerners might be aware that they are doing something illegal, but they do it anyway. Fake markets abound, with South Korea and China leading the way. Who are the counterfeiters? Many producers originally were trained by and worked for a luxury brand company. Their expertise proves more valuable on the black market, where counterfeiting brings in $10 for every dollar invested - on par with the drug trade! Of course, Asian countries have laws against counterfeiting, but they are not well-enforced. Luxury brands are trying to fight back by lobbying local governments and bringing in lawsuits, but it’s an uphill battle. After all, everyone is doing it.

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[Book Summary] The Snowball

February 7th, 2009

If you love money, admire Warren Buffet, or simply just want to read a well-written book, The Snowball, one of the best business biographies available, is for you.

“The very mention that Buffett had bought a stock could, all by itself, move its price and revalue a company by hundreds of millions of dollars.”

This summary is by no means comprehensive given the sheer density of the book (976 pages). Please do go and purchase a copy; it’s well worth your shelve space.

Warren Buffett amassed his vast fortune all by himself. Instead of living amid Wall Street’s hustle and bustle, Buffett lives and works in the bucolic city of Omaha. To build his enormous wealth, Buffett zealously studied everything he could find about business and investing, including decades-old magazines and newspapers. “He never hosted backyard barbecues, lazed around a swimming pool, stargazed or simply went for a walk in the woods. A stargazing Warren would have looked at the Big Dipper and seen a dollar sign.” This hard-earned knowledge has been his guiding light and his path to becoming the richest man in the world (in 2008, Forbes magazine ranked him as the world’s richest man, with a net worth of approximately US$62.3 billion).

Buffett’s investment philosophy is remarkably simple, “Look for companies whose stock values are priced less than the organization’s intrinsic value and invest accordingly.” Through this straightforward process, he made his fortune. His story is the classic tale of hard work that pays off beyond all expectations. How the kid who wanted to make a million actually did that, and much more, is a truly amazing story!

“Warren Buffett was a man who loved money, a man for whom the game of collecting it ran in his veins as his lifeblood.”

As a kid, Warren loved numbers: his hobbies included counting and measuring. Warren was a bona fide businessman. His first products were packs of gum, which he sold to his neighbors. Later he sold golf balls that he retrieved from the lake at Omaha’s Elmwood Park golf course. Warren also sold popcorn and peanuts at local football games. He saved every penny that he made.

“Since Warren looked at every dollar as $10 someday, he wasn’t going to hand over a dollar more than he needed to spend.”

In 1944, Warren submitted his first income tax return. By age 14, he had saved US$1,000. Through hard work, he doubled it and purchased a 40-acre tenant farm in Nebraska. As a teenager, Warren also went into the pinball business, buying and installing the machines in local barbershops. Moreover, he became a horse-race handicapper, selling a tip-sheet he called Stable-Boy Selections. Warren was shocked when Harvard turned him down; he got admitted to Columbia University instead, where he soon became the star pupil of Benjamin Graham (the famous author of The Intelligent Investor).

After graduation, Warren returned to Omaha, where he sold stocks for his father’s firm and taught investing at the University of Omaha. He also married a sensitive and empathetic girl named Susan (”Susie”) Thompson. They lived inexpensively because Warren was quite cheap. For example, he would wash his car only when it rained, so he could save on water. In 1953, their first child, Susan Alice (”Little Susie”), was born. They later had two sons, Howard and Peter.

In 1965, Buffett and his young family moved to New York, where he went to work at Benjamin Graham’s investment firm, the Graham-Newman Corporation. Warren focused on companies’ net worth and purchasing stocks that Wall Street undervalued. Graham called such companies “cigar butts.” Buffett’s prodigious ability to absorb numbers and to analyze them soon made him a sensation, often recommending great buys. It is during this time that Buffett learned about “capital allocation,” which is “placing money where it would earn the highest return.” This became one of his bedrock investment principles. When Graham retired, he offered Buffett a partnership to keep him at the firm, but Buffett had only come to New York to be close to Graham. With him gone, Buffett saw no reason to stay and moved his family back to Omaha.

By 1956, Buffett had US$174,000. Although only 26, he planned to retire and live off the investment income that he could make from his nest egg. He invited some friends and relatives to benefit from his investment expertise. Buffett later setup numerous additional partnerships with other investors, including attorney Charlie Munger, who also operated his own investment firm. He eventually became Buffett’s primary partner. Buffett’s “snowball” was starting to grow substantially.

Buffett was managing more than a million dollars a year by 1958. In 1962, Buffett merged his partnerships into Buffett Partnership Ltd. (BPL), with assets of US$7.2 million. Buffett was now a millionaire. While Buffett made himself and his partners wildly rich, his wife Susie made a separate life for herself though deeply supportive of her husband. By 1966, Buffett’s wealth totaled nearly US$10 million, but Berkshire Hathaway, a New England textile firm, was now “on life support.” Eventually Buffett closed the plants and Berkshire Hathaway became Buffett’s holding company. By 1977, his wealth surpassed US$70 million and he was only 47. But Susie wanted something else. By this time, she had already moved to San Francisco, where she now lived alone. She loved her husband very much but wanted a life outside Omaha. The couple remained devoted and talked daily on the phone. In 1978, at Susie’s urging, Astrid Menks (age 32) began to take care of Buffett, eventually moving in with him. The arrangement was an unusual triangle, but Buffett never felt the need to explain it to anyone. It worked well for all the parties concerned.

Buffett’s wealth continued to expand. By 1980, Berkshire Hathaway was listed for US$375 a share and by 1985, Buffet was a billionaire (age 55). In 1987, Berkshire Hathaway traded at almost US$3,000 per share and Buffett was worth US$2.1 billion. Buffett’s initial partners each had made US$3 million for every $1,000 they originally invested with him. Year after year, Buffett’s “snowball” grew exponentially. By 2008, he was the richest man in the world. Throughout his climb, Buffett never allowed the fickle stock market to dictate to him; he dictated to the market.

Even though Buffett loved money, he loved his reputation for honesty even more. In 1991, Salomon Brothers - a Wall Street investment bank that Buffett had a US$700 million investment - tested his reputation. A Salomon executive, Paul Mozer, had engaged in a series of rule-breaking bids in his dealings with the U.S. Treasury. It turned out that other Salomon executives, including CEO John Gutfreund, had known of Mozer’s misdeeds. Gutfreund, who should have fired Mozer and didn’t had to resign. Salomon’s stock nosedived.

“Buffett would undertake almost anything from his short list of most-loathed tasks - get into an angry, critical confrontation; fire someone; cut off a long friendship carefully cultivated; eat Japanese food…almost anything - than make a withdrawal from the Bank of Reputation.”

During this rough period, Buffett put his reputation on the line by assuming the post of Salomon’s interim chairman. He was known worldwide for his integrity; therefore, his willingness to rescue Salomon saved it from declaring bankruptcy. During Buffett’s testimony before the U.S. Congress about this affair, he said he had told Salomon’s executives, “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”

In 2004, Buffett’s beloved wife Susie died of a cerebral hemorrhage. Two years later, he married Astrid Menks, his longtime live-in companion. Also in 2006, Buffett announced that he planned to give away his Berkshire Hathaway stock, valued at US$37 billion, “for the betterment of the world.” Buffett did not ask anyone to memorialize him. He only requested that his donations be spent quickly to help people in distress.

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[Book Summary] Trading in the Zone

November 3rd, 2008

Buy this book: Trading in the Zone: Master the Market with Confidence, Discipline and a Winning Attitude

  • Trading skills can be learned or acquired
  • That so few traders are consistently successful is attributable to their mistaken perceptions of what it means to be a trader
  • The market operates in ways that are counter-intuitive to most of us
  • The market is neither good nor bad, neither right nor wrong — it just is
  • If we see trading as a personal challenge and success as personal validation, we are doomed to inconsistency
  • Taking responsibility is the common, core attitude of all successful traders
  • Successful traders embrace the uncertainty of the market. They have faith in trends
  • Successful traders think in terms of probabilities, not results
  • The best traders are not afraid or reckless. They have confi dence in their system
  • The more a trader thinks he knows, the less successful he will be

Chapter 4 - State of Mind

  • State of mind is like software code. Could have several thousand lines of perfectly written code, with only one flawed line, and in that one flawed line there might be only one character out of place. Solution is simple, fix the misplaced character (p. 65)

Chapter 5 - The Dynamics of Perception

  • The first dog a child encounters attacks him; subsequently he associates negative feelings with dogs, even if he meets the friendliest in the world the next time (p. 77)
  • The power of association (p. 80)

Chapter 6 - the Market’s Perspective

  • Anything can happen. “…chairman looked over to the analyst and said, ‘This is where the market is supposed to stop and go higher, right?’ The analyst responded, ‘Absolutely! This is the low of the day.’ ‘That’s bullshit!’ the chairman retorted. ‘Watch this.’ He picked up the phone, called one of the clerks handling orders for the soybean pit, and said, ‘Sell two million beans (bushels) at the market.’” (p. 97)

Chapter 7 - The Trader’s Edge

  • Here’s an interesting paradox. Casinos make consistent profits day after day and year after year, facilitating an event that has a purely random outcome. At the same time, most traders believe that the outcome of the market’s behavior is not random, yet can’t seem to produce consistent profits (p. 102)
  • Does not truly accept that “anything can happen” as the thought of being wrong is associated with all the wrongs in life. Example of a trader who put on a stop when entering a trade but does not really believe that he’ll be stopped out (p. 109). A wrong call in a coin flip would not tap into the accumulated pain because we believe the outcome is random

Chapter 8 - Working with Your Beliefs

  • Fundamental truths: 1. Anything can happen, 2. You don’t need to know what’s going to happen next to make money, 3. There’s a random distribution between wins & losses for any given set of variables that define an edge, 4. An edge is nothing more than an indication of a higher probability of one thing happening over another, 5. Every moment in the market is unique (p. 133)

Chapter 9 - The Nature of Beliefs

  • Gotcha Chicago sent a man to give out free money; nobody took it (thought he was crazy/dangerous) & only the person needing the bus fare asked for a quarter. If we stepped outside our comfort zone & ask & received, we feel elated and want to share with others. But when others tell us that we could’ve asked for more, we all of a sudden feel down because we have missed out. So many different types of reactions to the exact same situation (a guy handing out free money) (p. 147)

Chapter 11 - Thinking like a Trader

  • Set a goal (5-mile) for jogging but always had mental conflicts. As one gets closer to fulfilling the 5-mile objective, little by little, the conflicting thoughts began to dissipate (p. 182)
  • I’m a consistent winner because: 1. I objectively identify my edges, 2. I predefine the risk of every trade, 3. I completely accept the risk or I am willing to let go of the trade, 4. I act on my edges without reservation or hesitation, 5. I pay myself as the market makes money available to me, 6. I continually monitor my susceptibility for making errors, 7. I understand the absolute necessity of these principles of consistent success and I NEVER violate them (p. 185)
  • Learning to trade an edge like casino (p. 189)
  1. Pick a market (liquid enough for 300 shares / 3 futures contracts per trade)
  2. Choose a system that defines an edge. Entry & stop-loss exit has to be absolutely exact, requiring no subjective decision making
  3. Time frame (can be any) - “trend is your friend.” Objective is to determine, in a down-trending market (i.e. day chart), how far it can rally on an intraday basis (i.e. 30-min chart) and BUY, and vice versa
  4. Taking profits - On average, only one out of every ten trades was an immediate loser. So take 1/3 position off when market makes the money available to you
  5. Trading in sample sizes (20 trades) - has to be large enough to give your system an adequate test but small enough so that if its effectiveness diminishes, you can detect it before losing an inordinate amount of money
  6. Accepting the risks (calculate dollar amount for worst case scenario, losing all 20 trades)
  • You’ll know that thinking in probability is a functioning part of your identity when you’re able to go through one sample size (20 trades) without difficulty, resistance, or conflicting thoughts distracting you from the mechanical system. Only then will you be read to move to intuitive stages of trading. If you wanted to be a pro golfer, it wouldn’t be unusual to hitting 10,000 balls until the precise combination of movements in your swing were so ingrained in the muscle memory that you no longer need to think about it consciously (p. 201)

Categories: Book Summaries, Investing / Economy | Tags: , , , , | 1 Comment

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