A recent, two-part article in Barron’s summarizes an interview with mathematician Ed Thorp, who gained celebrity after figuring out how to use his skills to “beat the casino at roulette,” then applied his techniques to the stock market and wrote best-selling books about them.
Here are some highlights:
Thorp explained, “In high school, it occurred to me that the roulette ball moves in a stately orbit like a planet…and I was convinced I could predict from the motion of the ball and the spinning rotor roughly where the ball would fall, and if I did so I would have a huge advantage. That’s what got me interested in gambling.”
He likens the stock market to a casino in that the investor sees a “long-term drift” in their favor—using the example of an index fund that fluctuates by about 1% on any given day: “If you had $1 million in your portfolio in such an index, Mr. Market will come to you each day and say, ‘Let’s flip a coin. If it’s 50/50, the you’ll win $10,000 or lose $10,000. But I’ll pay you $500 if you play that day.'” Those payments add up if you play for 10 or 20 years, says Thorp, adding that the process is similar to the compounding that Warren Buffett touts as so important in investing.
On stock picking, Thorp explains that investors interested in enjoying returns without spending lot of time do well with index investing.
Thorp’s only stock market investment is Berkshire Hathaway. “One good stroke of good fortune,” he recalls, “was meeting Warren Buffett in 1968.” He doesn’t spend time looking for investments these days, he says, because, “at 85, the marginal value of time is higher and the marginal value of money is lower. These are strong disincentives when I make a long-run 10% or so by doing nothing.”
Thorp believes that, although there are many quant funds competing in the market today, there are still inefficiencies to find. He says that “there’s a lot of information about companies that aren’t available in the data, including strategic thinking.”
On today’s market, Thorp says stocks are “on the high side and will be hurt as rates rise,” adding, “We’re due for a slowdown and maybe another severe correction. If you’re a long-term investor, though, equities are the way to go.”
Thorp says that the message of his new book A Man for All Markets, is, “the best thing you can do for yourself is to educate yourself and think clearly and rationally,” adding that it’s also good for investors to be “widely read and curious. If you are that way, you have so much more to use in terms of tools.”