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The investing book that started it all: how $25 changed my life

warren buffett the making of an american capitalist finance books best money books money book

I moved to Sydney at the start of 1996 and that December I was shopping for a book to read on the six-hour train trip back to the country for Christmas.

I was in the Dymocks store in George Street and clearly remember the moment I picked up Buffett: The Making of an American Capitalist by Roger Lowenstein.

That book set off a chain of events that led to me achieving many of my financial goals ahead of schedule.

Crucially, it inspired my original three-step game plan for accumulating wealth in the sharemarket:
1. Learn accounting, the language of business;
2. Learn how to value companies;
3. Buy shares in companies for less than your valuation.

I love that such powerful insights and, eventually, favourable outcomes can be reaped from an object costing just $24.95 and requiring only 10 or 12 hours to read.

Since then I’ve read more than 100 investing books, many of them mediocre.

But this year, 21 years after first reading about Buffett, another book gave me the same frisson of excitement.

It was an autobiography called A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market.

And I couldn’t help but compare the protagonist to my long-time hero.

Thorp v Buffett

Edward Thorp was born in August 1932, two years after Buffett. He was raised in a dirt-poor family, while Buffett grew up middle class, the son of a stockbroker and, later, congressman.

While Buffett began delivering newspapers out of self-motivation and love of the money he had begun accumulating at a young age, Thorp ended up in the same occupation because “there was no spare money” and his parents encouraged him to earn something so he might one day go to college.

Thorp became a voracious reader (as did Buffett) and developed a keen interest in and aptitude for mathematics and science. He won a prestigious physics competition, beating out kids from privileged backgrounds and earning himself a scholarship to university.

But that was followed by a crushing blow.

“Shortly before leaving for college, I learned that my mother had cashed in the war bonds I had paid for with my paper route and spent the money. Her unexpected betrayal was an emotional blow that estranged us for years, and whether I could support myself at the university was now in doubt.”

edward thorp

Thorp survived on grit and his intellect flourished. First he succeeded in academia. Then he pioneered card counting, making significant amounts of money at blackjack and baccarat. In 1962 he literally wrote the book on card counting (Beat the Dealer).

In 1961 he developed the world’s first wearable computer with “the father of information theory”, Claude Shannon. This device gave Thorp and Shannon an astounding 44% edge over the casino when betting on roulette.

From here he moved into the world of investing, achieving impressive returns with tiny amounts of risk.

The type of instruments in which he invested are ones I usually avoid: options, futures, warrants and many other complex financial derivatives. But his methodology was so sound that even Buffett apparently endorsed Thorp.

When Buffett closed down his original investing partnerships in the late 1960s, one of his clients asked him to check out Thorp as an alternative.

The client ended up transferring their money to Thorp’s fund, so Thorp assumes that he received Buffett’s approval. He went on to produce a 19.1% average annual return over the next two decades, with very little risk.

Time to change course?

I’m not about to throw in the value investing towel and become a “quantitative trader” (as those who practise Thorp-like strategies are known). For one, I don’t have the mathematical aptitude for it. And I have an approach with which I’m comfortable and that continues to be effective for me. But I have taken away bucketloads of insight and inspiration from Thorp’s story. Here are some of my favourite quotes.

In describing key pillars of his thinking, “First, rather than subscribing to widely accepted views – such as you can’t beat the casinos – I checked for myself. Second, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought – such as a formula for valuing warrants – and using it profitably. Third, when I set a worthwhile goal for myself, I made a realistic plan and persisted until I succeeded. Fourth, I strove to be consistently rational, not just in a specialised area of science, but in dealing with all aspects of the world. I also learned the value of withholding judgment until I could make a decision based on evidence.”

This is great advice to those cultivating an independent mind and I’ll be incorporating it into my annual letter to my son this year.

Another key insight originally came from the casino tables but extended to his investment activities: “This plan, of betting only at a level at which I was emotionally comfortable and not advancing until I was ready, enabled me to play my system with a calm and disciplined accuracy. This lesson from the blackjack tables would prove invaluable throughout my investment lifetime as the stakes grew ever larger.”

Emotion is not often discussed in the investment literature.

But Thorp acknowledges it and I think more of us should. Imagine two beginner investors, both earning $50,000 a year. One has just managed to scrape together $5000, at the same time the other has inherited $120,000.

On paper, the process of investing these amounts might be the same but the emotional stakes and pressure are far higher in the second case. That could lead to bad outcomes – for instance, a higher possibility of panic selling if a stock were to fall in the short term.

I’ll explore some of the investment themes Thorp raises more deeply in next month’s column. But I’d like to conclude here with a few thoughts on self-education.

Seeking knowledge

The fact that you’re reading Money means you have an appetite for increasing your knowledge. Perhaps your interest is casual, or maybe you’re in a more intense phase of learning.

It’s a wonderful feeling to dive into a subject that you’re fascinated with.

And Thorp’s description reminded me of that joy: “Relishing the intellectual challenge and the fun of exploring the markets, I spent the summer of 1964 educating myself about them … I read stockmarket classics … and scores of other books and periodicals ranging from fundamental to technical, theoretical to practical, and simple to abstruse. Much of what I read was dross but, like a baleen whale filtering the tiny nutritious krill from huge volumes of sea water, I came away with a foundation of knowledge.”

I love this description. While the Buffett biography set me on the right path, the answers to the many questions I had lay elsewhere.

I devoured everything from accounting textbooks to tomes on behavioural psychology and stories about both great and failed businesses and investors.

As no single book contains all of the answers, ingesting as much as you can is crucial. And if you’re educating yourself about the sharemarket, I reckon purchasing these two books will be among the best investments you ever make.

Written by Greg Hoffman

Greg Hoffman

Greg Hoffman is a non-executive chairman of Forager Funds Management and is an independent financial educator, commentator and investor.

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