Hard-Won Investing Lessons From A Survivor Of Long Term Capital Management | Victor Haghani

Victor Haghani 0:00
Compound return is what matters to us. And that’s what we eat, you know, we don’t eat this arithmetic average return, we eat the compound return. So even investors who are not taking any leverage in their portfolio at all, if they just have too much risk in there that they’re not getting compensated for. It really eats into their compound return. And then they can really make that whole situation much much worse by by adopting a spending policy that’s kind of built over that expected returns.

Adam Taggart 0:37
Welcome to Wealthion. I’m Wealthion founder Adam Taggart. As regular viewers know, this channels mission is focused on wealth building, how to help its viewers fund their life goals, and risk management is a big part of successfully building wealth. But many people, even sometimes the smartest guys on Wall Street failed to adequately protect themselves from downside risk. Perhaps the best known example of this is the surprise implosion of the hedge fund the long term capital management. Back in the late 1990s. The firm was held by some of Wall Street’s most revered talent as well as several recipients of the Nobel Prize in economics. And yet it failed spectacularly. What lessons can we learn from this? And What chance does the regular investor have in making good financial decisions over time, when even the cream of the crop can get things so wrong? For answers, we’re fortunate to hear from Victor Haghani, one of the co-founding partners of long term capital management, and co author of the brand new book, The Missing billionaires – A guide to better financial decisions. Victor, thanks so much for joining us today.

Victor Haghani 1:46
Thank you very much great to be on the show.

Adam Taggart 1:48
Oh, it’s a privilege to have you here. I’m really looking forward to today’s discussion that kind of gave a little preview of the Wealthion viewers that you’re going to be coming on, folks, we’re very excited. So let’s dive right into it. But if we can, let me just start with a question I like to begin all these interviews with what’s your current assessment of the global economy and financial markets?

Victor Haghani 2:07
Well, you know, the way that the way that I like to look and the way my firm elm wealth likes to look at investing is very simply to think about, we have more or less two major choices, in terms of where we put our money, we can put them into safe assets. And you know, your choice of safe asset is an important one, you know, it might be something like, you know, cash in the bank, or Treasury bills, or it might be, you know, a longer term inflation protected investment, but you’ve got your safe asset, and then you’ve got your risky assets, you know, that are there to hopefully give you a higher return in, in, you know, as a compensation for bearing the risk of them. And so really, we just look at equities and say, fixed income as the two major asset classes to think about. And so, when we look at equities right now, the, you know, the expected return of global equities isn’t terrible, you know, we think that equities are priced to give, you know, something like a four or 5% long term, real return, but we’ve had a very big change in interest rates, and now you can earn, you know, two and a half percent on a pretty safe long term, inflation protected investment. And so the difference between those two, between those two expected returns, you know, it’s pretty narrow. And so we think that, that equities are not offering a very good extra return for the risk that’s involved in holding them and the risks abound, I mean, there’s always a lot of risk that’s either apparent or just under the surface, you know, right now, I would say the risks are a little bit more apparent, and the market is a little bit more volatile now than than it typically is. So between risk being a bit elevated, and the expected extra return from owning equities being a bit narrow, you know, we think that it’s a time that people should own less equities than they normally would, or then or that they would, you know, in, you know, in other sorts of environments. So, you know, we, so we kind of are a bit more cautious in terms of an investment stance. Now, I haven’t really answered your question about the economy. You know, that’s a really, you know, that’s the, you know, I think that the economy and investing are somewhat separate from each other. You know, like, if you get if you had a crystal ball and could tell me, you know, what the next year’s GDP would be, you know, that might not really help me too much to have a good return on my investments. So, but anyway, that’s, that’s how I look, that’s how we we’re looking at the overall investing landscape right now.

Adam Taggart 5:05
Okay, good. And just to make sure the audience followed along two things, one, you’re saying from a risk return standpoint, equities, on historical basis don’t look so attractive right now, when you talked about the ability to get a two and a half percent return, you know, pretty safe return in fixed income, I’m assuming you mean a real return because our audience knows we’ve talked a lot about, you know, where yields have been right now, they know that short term T bills are over 5%, you’re talking about a real return where you take that 5%, and you subtract, you know, or five and a half, quarter, five and a half, and then you subtract the three something inflation number, right?

Victor Haghani 5:44
That’s right. I mean, in fact, I’m really talking about the yield that’s offered by investing in treasury inflation protected securities tips, you know, so so we don’t even need to estimate inflation, we can just look at buying a 10 year Inflation Protected bond issued by the US government, and that’s yielding two and a half percent. So it’s also consistent with what you said. But you know, we can even just observe directly, what is the real yield offered unsafe government, government guaranteed investments right now? So that’s the two and a half percent indeed, is a real yield, not a nominal yield.

Adam Taggart 6:21
Okay, great. All right. Okay, so thanks for setting your general perspective on how you see the markets. Now, as I said in the introduction, this conversation is going to have to do a lot with financial decision making and risk management. You were part of the team there at Long Term Capital Management, I gave a little bit of a description of what it was in the introduction. But if you can, can you just sort of set the stage for us and explain how it was conceived? The firm was conceived? Do you know what it was what it was hoping to do? I mentioned it recruited some of the best talent around yourself included, I’m guessing you must have been about 12 years old when you joined? Because you certainly don’t, you know, looking at what your age must be, you must have been a very young man, during your time there. And, you know, once we kind of know the story about why it was created, what it was hoping to do, then if you can kind of paint the picture for us of how sort of it all went wrong.

Victor Haghani 7:21
Sure. So so long term capital management, was a hedge fund manager LTCM for short, and, and, and it came out of it kind of spun out of the Salomon Brothers of the, you know, of the 70s 80s and early 90s. So

Adam Taggart 7:44
we’re starting to wrap it. I mean, that was just a huge powerhouse on Wall Street at the time.

Victor Haghani 7:49
That’s right. I mean, Solomon was, you know, was was one of the premier trading houses, you know, particularly in the world of bonds and fixed income. You know, as the preeminent trading firm, underwriter and innovator, I mean that a lot of financial market innovation came out of Salomon Brothers, a lot of developments in the mortgage backed market that that made mortgages more, or the made house buying more affordable by having lower mortgage rates and a more efficient mortgage market. You know, many of those innovations came out of the mortgage department at Salomon Brothers also, you know, Solomon was a leader in interest rate swaps and interest rate options and all kinds of different financial innovations that were going on at the time, not the only place where innovation was happening, but you know, one of the, you know, one of the leaders, you know, of, of the firms that were doing that. So, within Salomon Brothers, there was a group of, of people led by John Merriweather, who had been there since the 1970s. And, and Solomon and Solomon liked and found it very rewarding to have some of its capital, you know, managed in a proprietary way, you know, put at risk in different transactions in the marketplace. I mean, really, everybody was doing that, at the time. And Solomon, you know, was was doing that quite aggressively and had a very good track record and return for the capital that had dedicated to proprietary trading. Now, these days, banks are not allowed to do that. That was an outgrowth of the financial market crisis in oh eight, where rules were put in place to really not allow banks to, to do this sort of proprietary trading after it went spectacularly wrong in the global financial crisis of oh eight. But back then, you know, it was just a very typical thing you know, particularly in investment banks and banking Then there was a real dichotomy between investment banks and commercial banks. Solomon was a was an investment bank, you know, after again after the, or during the global financial crisis to try to shore up the financial system, investment banks kind of went away and really got merged with commercial banks. And of course, you know, there was the repeal of Glass Steagall that that happened earlier than that. So investment and commercial banks were converging before that, too. But anyway, so. So Salomon had this, this, this history and tradition of proprietary trading. And then in in 1992, I think there was a treasury auction scandal involving Salomon Brothers, where were the head of the government desk. Or the government bond trading desk, which was, you know, one of the leading profitable and respected desks within the firm, got in trouble for trying to buy too much of the US Treasury issuance and a few cases and a few auctions. And there was a whole shake up at the firm and my boss, John Merriweather wound up leaving Salomon. And once he was outside of Salomon, a lot of people came to him and said, hey, you know, why do you want to go back to Salomon? Why don’t you start a hedge fund, and do what you were doing at Salomon, but do it outside, and we’d like to, you know, we’d like to give you some of the capital to do that. And we’ll pay you a higher fraction of the profits, let’s say, than what was happening at Salomon Brothers, and you’ll have a much nicer life, you know, you’ll just be, you know, out on your own doing this. And anyway, you know, you know, John decided to give this a try. And then

Adam Taggart 11:50
they made him an offer, he couldn’t refuse. And then a bunch

Victor Haghani 11:53
of us left Salomon to join him. And we set up LTCM, which was really trying to do what we were doing within Salomon, but now doing it, you know, in a, you know, in a specialized pool of capital. And trying to do it outside of Solomon. So that was the genesis of it. You know, it, you know, it turned out that that wasn’t such a great business idea, in the end, that it probably made a lot more sense to do this activity that we were doing within a large financial institution, you know, as opposed to being a mono line to be, you know, to be part of this big financial institution was was, you know, I think, in retrospect, was a much better way to, to do this business. Although, you know, today, 25 years later, there’s lots of places that are doing the same sorts of things that we were doing at LTCM. I mean, you know, 25 years later, you know, there are still places that do that, because it’s, you know, it, you know, at least on the surface, it looks like a very attractive, you know, proposition to, you know, to do that sort of trading. So let’s Okay, stop there. You know, okay, so

Adam Taggart 13:04
you’ve set the stage for us, I think you also recruited? Gosh, well, because you’re the developers of the Black Scholes,

Victor Haghani 13:18
Myron Scholes and Bob Merton. But we didn’t, you know, I would say that we didn’t really recruit them, you know, in the sense that Bob and Myron and all of us were like, working together still at Salomon Brothers. So, you know, yes, you could say it was recruited, but in a sense, you know, we had been all together at Salomon Brothers. And then, you know, a lot of us went on, and moved to LTCM. So the group kind of stayed intact. So Bob, and Myron, were already involved at Salomon Brothers, you know, you know, maybe less involved, you know, they became, like, these full time partners that LTCM and when they were both working in consulting at Salomon Brothers, you know, it was much more part time, but these really, you know, but we didn’t like start LTCM and then say, oh, let’s go recruit those guys. You know, they were really part of it. And Bob, Bob was really there. Bob, Bob was, you know, at sort of that the very founding of LTCM. Right at the very, very beginning. You know,

Adam Taggart 14:20
okay, so So I think the the narrative that was out there was, you know, they recruited a dream team, to come run LTCM, but it sounds like what you’re saying is, the dream team was actually already together beforehand. They just tumbled over together, which really

Victor Haghani 14:38
was a spin out rather than sort of some whole new construction. Yes.

Adam Taggart 14:42
Okay. Okay. But But I mean, correct me if I’m wrong, but still LTCM in its founding was touting, hey, we have all this talent on this team, right. We’ve got John Merriweather.

Victor Haghani 14:52
He didn’t say yeah, I wouldn’t say there was any touting going on. I mean, you know that we know that. That people came to us like we were aren’t doing any real marketing, you know, people came to us we didn’t do any touting like we have a dream team or anything like that we were there. And people knew about us and people wanted to give us capital, and then we stopped taking capital after a year or so. So there wasn’t I don’t think there was really I think touting wouldn’t be the right description of what’s going on. It wasn’t we weren’t a money gathering operation, we were trading operation and people wanted to give us money, people, you know, that we were unknown. We were unknown quantity in the marketplace. And you know, institutions wanted to invest with us. So yeah, I mean, and as I say, we don’t we closed, we were closed to new investments very shortly after we got started.

Adam Taggart 15:41
That’s fascinating. So this was so interesting talking to you here, right is, you know, a myth grows over time, right? And you’re sort of helping us understand what was real and what wasn’t. So basically, a spin out team was already together, they came over, you guys weren’t even kind of dialing for capital, the dollars were finding you people saying we like you guys, please take our money. Okay, so now you’re funded your, your, your independent from Salomon Brothers. Tell us the story, what were you doing, and then what went wrong in the model that ended up, you know, ending the firm?

Victor Haghani 16:15
Sure. So while we were doing the types of things that we had been doing at Salomon Brothers, we were doing, you know, Relative Value trading, sometimes it’s called arbitrage trading, although the the pure definition of arbitrage is doing risk free, you know, finding, you know, risk free ways of making money. And clearly what we were doing was not risk free. And we knew that and, you know, we didn’t call it arbitrage, it was relative value trading of finding two things that are very, very similar, and buying one and selling the other. And, and, you know, in the, in the hope, and the expectation that, that their pricing will become more similar or converge over time, you know, very often these things have a date with destiny, where they actually become the same thing at some horizon, you know, not just that they start to price similarly, but they actually become the same, you know, that you can take this one and deliver it there. And, you know, as long as you’ve held it, as long as you’ve been able to hold it till that horizon, you know, that it actually does converge, of course, the holding it to that horizon is the is the catch in the in the whole thing. And, that, when you’re finding things that are very similar to each other, right, the more similar things are to each other, the closer their prices are to each other. And yes, there’s this convergence, that, that you hope is going to take place, ultimately, and there’s risk, you know, it’s sort of there, since they’re not the same, they’re moving around, you know, relative to each other, and then eventually, you hope they converge. But when they’re very similar to each other, that discrepancy in prices, is going to be very small. And so, you know, to make it attractive for people to give you capital to do these things, you wind up using leverage to take a small difference in price and a small convergence that you hope will happen, and to make that, you know, give, you know, an adequately high return on capital for people to want to take some of their capital and take it out of the stock market or other things, and have it be invested in this type of activity. And so typically, you know, depending on how close those things are together, you might use five times leverage or 10 times leverage or 20 times leverage, depending on how similar they are, how risky they are, relative to each other, etc. And you’re sort of hoping, you know, when we started LTCM, we told investors that we hoped that we could make, you know, a 10 or 15% Return on capital from doing this activity, you know, with a level of risk of, you know, 10 or 15% per year, something like, you know, in that in that vicinity. Now, it turned out that in our first four years of operation, you know, that on a before fee basis, we made like 40% a year, which was very surprising to us, you know, we realized that, you know, what was happening is that, that, that, that more and more capital was coming into the sorts of things that we were doing and sort of that we were doing them and we were riding this wave of other capital coming in and doing the same sorts of trades and forcing convergences faster than then then we would have expected and so returns were much, much higher. And we kind of felt that the opportunity set was not really growing. And so we decided to return. I don’t know about a third of our capital, we returned it to investors at the end of 1997. Your investors weren’t very happy with that they they wanted to keep their money and they wanted to still be in the game. Again, but of course you know, it turned out to be They have to sell, you know, to, to, to have a silver lining for them. And that, you know, they wound up getting back, you know more than they’re even original investment. And so even after the firm, the value of the hedge fund went down 90% in 2000, in 1998, that those investors that got those big redemptions at the end of 97, you know, still wound up with like a 20% IRR on their investments. Now, you know, sort of just cutting to the chase, you know, at the end of 1998, or towards the in the summer of 98. And then, you know, into September and October, the fund suffered dramatic losses of down, you know, down 2030 50%, you know, and as this was happening, we were trying to raise more investor capital, there were a lot of investors that wanted to invest with us. But once we were, you know, sort of in this downward, steep downward trend, people were changing their mind. And so we weren’t able to raise that capital, we felt we were close to it, but it didn’t ever materialize. And then ultimately, our biggest bank counterparties took over our portfolio, they put in three and a half or so billion dollars, and they bought the fund at down 90% on the year. And, and effectively recapitalized it, and then we helped them to, to liquidate that fund over the next year. So from by the end of 1999, we had pretty much liquidated all of the positions of LTCM. And, you know, they were, they were good positions, and so even over that ensuing one year, the returns were okay. We, I think we made like 10% for that consortium of banks and a lot of the trades, then, you know, longer term went on to be, you know, very good trades for, you know, the different pools of capital that owned them afterwards. So, so the fun, you know, the fun, basically, so the the management company, went out of business, you know, after that LTCM went away, the, the biggest investors in the fund, in 1998, were the partners or, you know, we the partners ourselves, we still had outside investors, but as I was saying, you know, the outside investors had gotten most of their capital back at the end of 97, but they still had capital with us, and that capital went down 90% in 1998, it was very traumatic and, and, you know, very traumatic for everybody involved in it. And, but, you know, I think that the, you know, that, when you started the, when you started the discussion on this, you know, it’s like, well, you know, sort of what went wrong, or whatever it well, you know, that investments are risky, you know, and so, like, I think that the, the, the books and articles and so on, that were written afterwards, were like, well, how can you lose 90% on your investments? Well, lots of investments go down, 90% lots of investments go down. 100% You know, that that more than, you know, the number of companies that have started in, you know, in business, you know, and become public companies, you know, that many, many public companies failed, you know, despite having really good businesses and really good businesses, ideas, really good business ideas, you know, at their inception. So, like, in some ways, yes. It’s kind of it’s, it’s, it was a really big deal. It was a really interesting story, you know, how did, how did LTCM How did this fund go down so much and lose so much money? But, you know, I think in some ways that’s just investing, you know, that sometimes, it was, it was, it was particularly interesting, because this was such a great case study of like, really good trades, but in too big of a size, you know, leading to a bad compound return, you know, that the that there was just too much ultimately, there was too much risk and the size of the trades were too big, but that the trades themselves were overall good sound long term investments, you know, just they changed hands, the owners of those trades changed hands from the LTCM investors to other investors out there wound up, you know, benefiting from the fact that they were good investments longer term. So, so, you know, bringing it bringing it back to you know, I think where you started is like, what are the lessons that can be learned? For your listeners and your viewers? You know, I think that getting you know, that that markets are great very hard to predict so that selecting the good investments, you know, is one part of the investment process. But the other part is, once you’ve identified what you think are good investments, you have to decide how much of those investments individually and an aggregate you want to own. And, you know, that’s this how much question. So there’s the what question, what should I invest in? And then there’s the how much question the risk question. And and LTCM is this kind of wonderful case study? That really is, you know, that I think people can agree that the one that that LTCM kind of had the what question more or less correct, you know, that we identified good things, but you can see that if you identify good things, but you get the how much question wrong, that can end in a terrible outcome. Whereas if you get the what question wrong, but you get the how much question, right, you survive, and you get another chance in the future to to try to make your selection decision, your what decision and the book that we’ve written, which I guess we’ll start talking about soon, the book that, that me and my partner, James White, have just published,

you know, is really focused on trying to get people to think about this, how much question, there’s so much, you know, 99, we say that 99.9% of the discussion that’s out there in the media, or even in the main academic flow of flow of ideas is about the the what question, and we feel that this how much question doesn’t get enough attention. And so we wrote a book that’s really focused on the how much. And LTCM, as I say, is, I think, a really great case study in how important it is to get the how much question right, or how critical it can be when you get that wrong.

Adam Taggart 26:55
Great. So, Victor, we have financial advisors that come on this channel, week after week, to help people kind of kind of let them crawl in the minds of a professional, you know, client capital manager. And one of the things that they stress an awful lot is position sizing. And I have a sense that that’s sort of a lot of what you’re talking about here, right? Which that’s the how much and it is, it’s something that I think is very much under appreciated. Everybody wants to know what to be in. But getting that question of okay, yes, you might want to be in this, but how much of it should you be in? Right? So anyways, you probably gonna get a nice fruit basket from those advisors at the end of this discussion. So yes, let’s let’s go into the key insights of your book now. And a couple quotes from it. I want to read here real quickly, just because it’s kind of scratching at my brain. I’m suspecting it’s scratching at the brain of a few other people. Just going back to the LCM story in a moment. For a moment, it sounds like it sounds like concentration, maybe over concentration of position might have been an issue. And of course, you said you used a lot of leverage, if you can, if you can just tell us your best assessment of like, what changed in the wins, right? You you had a model that was making great returns 40% returns, it sounds like annually for the first four years. Enough that to your credit, you gave enough back to investors that even with the subsequent 90% loss, they still had a positive gain on their initial investments. I mean, that’s that’s amazing. But was there something that changed in the market that that sort of invalidated the main thesis of what you were investing in? Was there? Was there a macro change that all of a sudden made the assets that you were buying perform differently? You know, was there some rogue wave like that that happened?

Victor Haghani 28:43
No, no, I wouldn’t say I wouldn’t say like a rogue wave or some crazy thing that happened. That, I mean, first of all, right, that you mentioned the model, you know, we didn’t we, you know that our investing was not a model based form of investing that I mean, we use, we use valuation models to assess the value of different things that we were looking at. But the decision to do trades was really a very, you know, was was much, much beyond any sort of quantitative model that we were looking at flows. And, you know, what’s the explanation for this divergence and value? What’s going to happen to make it go away? What are the micro? What are the micro features of the market that caused the market to be sufficiently segmented for this to happen? Are there tax things? Are they going to get worse? Are they going to get better, you know, et cetera? So so there was a lot that went into the decisions. And, you know, that that that what happened in 1998 was that there was a pullback in liquidity that the banks were reducing the balance sheet that they wanted to have exposed to counterparties like us, and, you know, within their within their own balance sheets as well. So, in early 1998, for instance, Citi Group that was then being run by Sandy Weill and Jamie Dimon decided that they didn’t want to have so much of their bank balance sheet in these proprietary trading sorts of positions that were similar to what that what we were doing at LTCM. So they sort of disbanded the the group of people that was doing it, and they started to liquidate those positions and put pressure onto those decisions. Sorry, on to those positions. There was a pullback in liquidity. Other firms like Goldman, or Lehman, were also losing money, we were losing money. And and, you know, it was it sort of just became, you know, a very bad time for these trades. And so, you know, we’ve seen that we had seen that before. And we saw that in much bigger waves in 2008. You know, the, the divergences that happened, then, were even bigger than what happened in 1998. So, you know, I think that what happened, you know, in 1998, LTCM, was not especially unusual, you know, I think it’s something that happens, you know, every 510 15 years, you know, since the 1970s. You know, it was unfortunate that, that we, you know, that eventually the market started to look at what LTCM had, and, you know, God worried about those different trades, you know, that, you know, who, you know, I don’t know, I mean, you know, if we had been smaller, if we had had different trades, you know, we would have survived that and kept going, you know, maybe somebody else would have gone under I don’t know, but you know, no, I don’t think that it was I don’t think there was like a major macro event that happened or rogue wave.

Adam Taggart 31:55
But I think you’ve answered the question, which is it basically was a change in liquidity flows he had mentioned, you were expecting to make 10 to 15% for your, you made more because more more parties were starting to put money into this space, they started taking money out of the space, and it just changed the game a bit it sounds like and of course, you were over concentrated and over leveraged or highly leveraged. And that kind of made it all worse once the market got jittery. But okay, that was what I was looking for. So okay, so getting to your book here, you and your co author, James White had this to say that that was a really concise way to put it. Collectively, we face a really big and pervasive problem when it comes to making good financial decisions. Even the most financially successful members of our society, at least some of whom were smart and capable, and all of whom could afford the, quote, best financial advice, consistently made atrocious financial decisions, what should we expect from the rest of us? Right? So you go from that, and you talk about, you know, some of the key lessons from from long term capital management, which is that almost as much as you can get is almost never the correct answer to how much of a good thing is right for you? Right? So we get into the Okay, you gotta manage your exposure, you gotta manage your position sizing. But this this higher level question, which I think most people watching, you know, this current video listening to you saying is my gosh, you know, even if the pros can kind of get caught by that and can fall guilty of not making the best financial decisions, what chance do is the little fish have? So how is your book helping people learn to make better financial decisions?

Victor Haghani 33:36
You know, that I hope what our book is doing is getting people to really focus on this how much decision, you know, as I said, as I said earlier, and that, that the how much decision, like people might think that Well, you know, as long as I, you know, if I have 60% of my money in the stock market, you know, as to how much decision really that important to me. You know, like, I’m not going to lose all of my money, I’m not going to, you know, I’m not taking that much risk where it’s a problem. But, you know, it kind of depends on how you have your money invested in the stock market, too, if you have a lot of idiosyncratic risks. So you have you have 60% of your money in the market, but you know, you have a lot of Tesla and apple, and in the video, you know, whatever. And it’s like, oh, this has been great, you know, and all of a sudden, you wake up one day, and it’s like, well, well, now those things have done so well. I started off with 60% of my money in the market, but now it’s more like 80% of my money is in stocks, 20% in bonds. And my portfolio is got a lot of concentration. And so instead of the 15 to 20% risk of being and the fully diversified global stock market. You know, instead I have sort of a you know, I have I have a portfolio that’s got a fair amount of concentration to it. And I have an I’m running like twice as much variability twice as much risk as I would have from a very diversified stock portfolio. Remember that, you know, that one individual stock tends to be two to three times riskier than a diversified holding in the stock market. And, and it’s like, okay, well, so So what, you know, is that really a big deal? Well, yes, it is really a big deal. Because if you let’s, let’s say that I, let’s say that I guarantee you that you’re going to make, you know, a 5% extra return relative to the safe asset, on average, over the next 30 years, I’m going to guarantee that to you, right, I say, no matter what, when you add up each year’s return and average them all together, that you will have made 5% More than, than the safe asset, okay. And let’s say the safe asset is yielding zero just to make it easy, which not too long ago, it was just to make the math easy, but it’s going to be five, it’s going to average out to 5% a year, there’s no risk whatsoever in that outcome. But each year, there’s you know, that you have a pretty concentrated portfolio, and each year is going to have volatility of say, 30%. You know, just to make this a little bit more extreme, you know, even less extreme, you still have this effect. And you say, Okay, well. So what does that mean? It means that really one year, the market goes up 35%. And the next year, my portfolio goes down 25%. So if over two years, I made 35%, one year, and the next year I lost 25%. Well, my average return is 5% a year, right, because 35 minus 25 is 10 divided by two years, that’s my 5% return. So just let’s say the market just keeps doing that every every two years, you know, for 30 years. So there it is, I had a 5% extra return relative to the safe asset. But what happens is that that risk is eating into my compound returns. So actually, if I have $100, and I make 35%, the first year now I have $135. And then if it goes down by 25%, the next year, I only have $101. And so my compound return is only half a percent a year, per year. So if I have 5% a year of extra return each year, but I’m taking all this risk of 30% a year, my compound return is only a half a percent a year, I’m losing four and a half percent per year in, in the risk eating into my compound return. And so and compound return is what matters to us. And that’s what we eat, you know, we don’t eat this arithmetic average return, we eat the compound return. So even investors who are not taking any leverage in their portfolio at all, if they just have too much risk in there that they’re not getting compensated for. It really eats into their compound return. And then they can really make that whole situation much, much worse by by adopting a spending policy that’s kind of built over that expected return. So they say, Well, geez, I’m making 5% more per year than the safe assets. So geez, I, you know, like, let me do let me spend, I’ll spend based upon those expectations. But if you start spending based on this average expectation, but your compound return is much lower, but you’re spending at this higher rate, you’re dissipating your wealth really much more quickly than you think you are or you think you will. And, you know, I think that’s, I think those are these subtle effects that are really hurting the preservation and growth of wealth in in many, many people’s portfolios, I think, you know, that’s really what they think that’s, that’s really the lesson that we’re trying to, or the ideas that we’re trying to get across in the book. You know, it’s not about how big should you be in leveraged hedge fund positions? You know, that’s not that’s not relevant to 99.9% of people, but what is is like, how much risk Am I running in my own portfolio and and realizing how important it is to get that right, and how to have a spending policy and an investment policy that are consistent with each other. Those are the main ideas we’re trying to get across in the book, and they’re relevant for everybody. So

Adam Taggart 39:38
yeah, that’s a great explanation. And you know, our this is a rant for a different day, Victor, but our education system does a terrible job of teaching financial literacy. And most people and I know this very well because I hear it every day from viewers of this channel. You know, most people feel like they’ve kind of been thrust out into their adult life unprepared to be good capital managers of their own wealth. And the average American is choose math is, I think, a polite way to say it, you know, when things get a little mathy, they did, it starts to get really confusing and complicated for folks, which means they either just don’t think about it or in your case, you know, maybe they they’re doing math, it’s just too basic, right, that’s leading them to faulty conclusions like, Oh, if I’m going to get roughly 5%, if I’m going to beat the the safe asset by 5%, every year, I can spend more, but they’re not realizing that the compound returns a lot less than they’re actually probably, you know, putting themselves on a path of failure without being aware of it. So I’m going to guess and correct me if I’m wrong. But I’m going to guess that you are probably a big fan of, you know, people developing a financial plan, whether it’s working with a financial professional, who’s got software to do that, or using some of the the tools and software that are available for DIY folks. But actually looking at the math itself, not doing back of the envelope cocktail math or fuzzy number in your head math, but actually, like really putting, you know, hard numbers and estimates into calculators that will project for you. So you can make truly factual decisions about, you know, important decisions, like how much to save, to your point, what to put it in, and what are what a rational position sizes for the the investment you’re going to have. But then more importantly, okay, what are my expected returns? What should I be trying to do from a cost management standpoint? And my budget? You know, what can I afford to spend? All that type of stuff? You’re sort of nodding as I’m saying this, but I said to me, that’s a big conclusion I’m taking from your work here.

Victor Haghani 41:39
Yeah, I mean, we, you know, we think that, that we think it’s really important for people to give hard, hard thought to, to their investment portfolios, their spending policies. And, you know, I don’t I don’t think it has to be complicated, or, you know, I don’t think that you need sophisticated software packages to do this, you just need to have a grasp of the basics that are there. And so, but yeah, I mean, we’re really advocates of people, either, you know, we’re advocates you have of people sort of really figuring things out, and being masters of their own of their own financial destiny, that it’s not that complicated. You know, if you feel that you need a financial advisor, that’s, that’s great. They can help you in many different ways. But, you know, our basic, you know, our basic belief is that, that finances not, is not like being your own doctor, or being your own surgeon, or being your own dentist, you know, it’s, you know, maybe it’s more like being your own hairdresser. Like, can you blow dry your own hair? Or do you need somebody to blow dry? Maybe the professional blow dryer does a better job, but you can blow dry your hair? If, if you if you have any. So I think that we’re at, you know, we’re definitely advocates, though, of thinking about things in a really systematic in a systematic way, and not, you know, sort of all fuzzy and, you know, all fuzzy and sort of accepting, you know, like, we don’t believe that, you know, we don’t believe that somebody can that if you say, if we say to somebody, like, look, let’s assume that stocks are gonna give you an extra 5%, relative to safe assets, and that, you know, stocks bounce around by 15 to 20% per year, and every once in a while they go down by 50, or 60, or 70%. That stocks now, given that, how much stocks do you want to own? And if somebody says to us, like, oh, I can’t answer that question. Well, if you can’t answer that question, you can’t, you can’t invest. You can’t own any stocks, like, you need to think about that. And find a way to answer that you can’t you know, that if you can’t answer that, then you can’t just say, Well, I’m just gonna have 60% in stocks, you know, like, you need to be able to answer that question. I don’t think it’s, I don’t think it’s beyond people to answer, you know, it’s like, Okay.

Adam Taggart 44:17
Well, let’s dig into it if we can, because I think probably a number of folks watching, you’re saying, I don’t necessarily know what the right percentage for me is, how would you counsel them to sort of think it through?

Victor Haghani 44:28
Well, the, you know, if it’s easier to think about it in, you know, away from the stock market to begin with, and just think about how they would feel about seeing their wealth go up or down by a certain amount, you know, sort of take, maybe take the stock market out of it a little bit and say, Okay, well imagine you know, you’re flipping a coin, and you know that the coin has a 70% chance of landing on heads and a 30% chance of landing on tails. And, you know, how much of your wealth do you want to bet on that? You know, Let’s say you got to bet on that, you know, for five flips, you know, each one of them representing one year over the next five years or, you know, so that by thinking about that, you know, it starts to help you to think about, you know, what’s your, what is your personal trade off between expected return. So 7030 coin and bedding on heads has this really nice expected return to it right, you’re going to, you’re going to win more than two times as many times as you’re going to lose, but there still is a risk of getting three tails in a row. And so by thinking about things in this very more more abstract, simplified world of coin flips, it helps you to start to get a feel for your own risk preferences. And once you get that, once you start to calibrate just how risk averse or not you are, you know, then you can start to bring in the more realistic world of stock investing, you know, where it’s not like a coin flip, but there is a risk, and there is a return, and you need to think about what those are to reach your decision. So, you know, I think that’s just one way. I mean, there’s a lot of different ways of coming at it. But effectively, you know, in the end, you’re going to be thinking about, okay, I want to get compensated for taking risk, and how much compensation do I need? You know, given my preferences and my financial situation, and you know, that’s gonna take into account also how old you are? And how big is your human capital? And what’s the nature of your human capital? What, you know, what’s your family system? Well, you know, what’s your family support system? What’s your health? How many dependents Do you have all these different things eventually come into it. But, you know, fundamentally, you know, we all are risk averse, we all should require compensation for bearing risk, if we’re not risk averse, then we’re not going to have our money for long. You know, that if we’re risk seeking, there’s plenty of ways to find risks that that you’re not compensated for. And you can just, you know, flip flip fair coins to your flip coins that are biased against you to your heart’s content until you have no money left. Right.

Adam Taggart 47:13
That’s the Jim Grant return free risk, right.

Victor Haghani 47:17
So yeah, I think that people can really, I think that everybody can can do that. And, you know, we hope that our book helps people to, to realize how important it is to do that, and how doable it is, it’s not, it’s not super complicated. It’s something that everybody can do. And again, you know, if you need some help from financial advisor, that’s great. I mean, financial advisors can can be super helpful, in you know, in personal financial decisions and helping you to be sensible and strict and disciplined about what you’re doing.

Adam Taggart 47:53
Thanks. Yeah, I mean, I look at it sort of like, maybe auto maintenance, or maybe, you know, sort of handiness around the home, right, which is, neither one of those is rocket science, you know, you can, you can learn to get good good at both. And, and you should, you should have some, at least met a minimum, some basic fundamental understandings about how your car works, you know, know how to change a flat tire, or your battery or the oil or whatever. But there may be a level of sophistication of repair that maybe at some point, you’re like, you know, maybe I shouldn’t be doing that maybe actually should be calling taking the car to the mechanic, or, Hey, I can do some basic woodwork around the house. But you know, if I’m going to muck around with the plumbing, I should probably get a plumber in for this job. Because that could really, the downside risk is too high for my level of confidence in this yet, right. So I think it’s very similar, you know, for with finances, which is we should all be invested enough in learning the process to have agency in it and to at least know what intelligent questions that we want to ask of our advisors if we pull them in. But increasingly, if possible, be more and more masters of our own destiny as we get better and better. I think that’s a big crux of the problem today, where I sort of talked about how bad the education system fails us in teaching this is that people have no confidence. And so they just abdicate it, all right, and they don’t even have the wherewithal oftentimes to know the difference between a good or a bad advisor. And I can’t tell you how many horror stories we have people who are coming from an advisor who basically just took their money and, you know, probably would have served them better by throwing darts than what they did with it, right. But the person that at the time didn’t have enough knowledge to be able to discern whether that advisor was quality or earning their their fees. So anyways, I’m a huge fan of people developing as much personal agency in the story as well. It sounds like that’s a core message of your book is beginning to wrap up here in a minute. I’m going to ask where people can can get the book but you do talk in the book about wealth building for young people, and if we could just talk about that for a moment. That’s where you can make the biggest impact over the course of a lifetime, right is the greatest asset that an investor has is time, right. And the youth obviously have the most time hopefully ahead of them. But in a lot of ways, when they’re being disturbed by the education system, as I talked about, but they also, you know, I think it is true, every, every generation thinks, you know, they’re getting a raw deal, versus the previous one. But I think it’s, it’s very true in today’s younger generations, especially from an affordability standpoint, right? When you look at multiples of the income it takes to afford the average home, that type of thing. It’s, you know, it’s a tough slog for today’s younger generation. So I think anything we can do to help them out, in getting started on a better financial footing is really valuable. So I’m curious, you know, what are some of the key things that you wanted to impart through your book about this?

Victor Haghani 51:01
Yeah. So, you know, you know, I think that the financial decisions of young people in their 20s, or early 30s, is probably like, the area where academic finance is, is kind of, perhaps the most at odds with good common sense advice, right. So the, you know, from an academic point of view, you know, when we think about these lifecycle models, you know, the idea is that, like, over a lifetime, that we should try to sort of smooth out our consumption, you know, that, that, you know, smooth it out, you know, maybe it’s slowly growing, or whatever. And so if you really want smooth consumption, and you’re starting off early in life, you know, and we’re at the early part of life, you know, that’s going to tell you that, oh, you know, you should borrow money to spend it, because later on, you’re gonna make more money and save more money, and so on. And I think that, you know, I mean, that’s sort of just the very sort of high level, you know, theory of lifecycle investing, but, you know, academics and practitioners realize that, that that’s not really such a great way to go about it. And so, like, developing, you know, a saving program, even from a young, you know, from a young age, even when your income is relatively low, you know, we think is a really great approach to the financial decisions, you know, your lifetime financial decision, so even if there’s like, some argument that yeah, you know, you’re young, you have a lot of human capital, you want to smooth out your, your consumption. So actually, why don’t you, you know, borrow against those future earnings that you’re going to have, you know, we think that no, I mean, try to save, you know, 10 15%, you know, put it into a tax advantage, you know, you know, a 401k If your employer is offering it, or an IRA, if not, and just get into this, you know, just develop this habit of saving, you know, 10 to 15% of your of your income and whatever that means in terms of consumption, you know, so be it, you know, you have to make those sacrifices to start to build up, you know, some financial capital, both for emergencies, but even more so, you know, for, you know, for for for later in your life,

Adam Taggart 53:23
those are your future. Yeah, so this is sort of the pay yourself model, right, which is, write that check to your 401 K your IRA first and then figure out how you’re going to pay the rest of your bills.

Victor Haghani 53:34
Yeah, so I think, you know, developing a good saving habit from from the beginning is important, you know, not having credit card debt is important. You know, I think the, you know, getting on the housing ladder is not is not critical, I think that sometimes people, you know, feel like that’s an imperative, or they might just live in a place where there’s very little good rental stock that’s available. So that’s, uh, that’s, uh, you know, that’s, it’s hard to give really general advice around, you know, getting on the housing ladder. But, you know, I do think if anything, you know, maybe people are a little bit, you know, people, you know, sometimes people get a little overextended there. And then, you know, just have a really simple investment plan, you know, invest in global equities, try to choose a percentage that you think you’re comfortable with and make sense, I wouldn’t use leverage, but at the same time, I wouldn’t be at 20 or 30%, you know, you have a lot of human capital, you’re young, so it’s okay, you know, assuming that your human capital is not super correlated with the stock market. You know, you could have a pretty high equity allocation stick to that, keep it simple. You know, don’t worry about it too much. Because your financial capital is small, you don’t need to worry about it a lot. And you know, like, don’t trade zero day options, and don’t be a mean stock investor, and this sort of thing, like, just don’t waste your time. It’s not productive. It’s not fulfilling. You know, it just it just is just terrible use of time, and there’s so many other things in life that are so much more rewarding and satisfying, you know, and you know, I know how much fun it could be, you know, I know. I mean, I, I used to play video games when I was younger, I love video games, you know, and yeah, this trading of stocks, zero commission and so on, you know, it feels like a really fun, like, maybe the most fun kind of game, you can play so much better than going to Vegas and playing slots. But, and probably the odds are better that you win, you know, doing it, you know, in your brokerage account. But even so, you know, that’s a really low bar to say, well, this is better than going to Vegas. Okay. Maybe it is. But,

Adam Taggart 55:42
but that doesn’t mean that doesn’t mean the odds stored in the houses favor? Yeah.

Victor Haghani 55:44
Yeah. I mean, it’s just, it’s not as bad, but it’s, it’s just really bad. So you know, it’s a, you know, just avoid all of that. That is not I mean, I know, some people say, Oh, this is really good, because it’s part of your financial education, like, No, you know, you can get financially educated many other ways, you don’t need to lose most of your savings to get financial education, you can benefit from the experience of other people, you can, you know, learn in many other ways. So I’d say just, you know, stay sensible, stay disciplined, and put your, you know, put your, your bandwidth and mental cycles into the many other things out there that are going to be much more potentially rewarding than than that. So I think I’m sure that I’m echoing, you know, what many, many people say, Yeah, I’m 61 years old. So, you know, I’m sure that this message sounds, you know, won’t won’t sound maybe that convincing to younger people. But you asked,

Adam Taggart 56:44
why, you know, there’s a reason why some advice is timeless, right? So I get the impression last question on this, this thing, and then we’ll we’ll get to where to buy the book, I get the impression that for most people, you would encourage them, especially earlier on in their their investing journey, to be investing in ETFs versus individual stocks, for the diversification standpoint, and, therefore some risk reduction. A, is that true? And if it is, where do you think the line is between when an investor you know, can and should potentially start graduating to thinking about adding individual stocks to their portfolio? So, yeah, or individual individual securities? Because you could be buying bonds as well.

Victor Haghani 57:38
Yeah. So you know, yes. You know, I think that, that low cost, low cost, very broad market cap weighted ETFs are terrific, you know, it’s a terrific, terrific innovation, that, you know, really has only been with us, you know, for the last 15 years or so. And, you know, we just we had an s&p 500 Index Fund, going back to the early 90s, or whatever, or ETF going back to the early 90s. But in terms of really being able to build a diversified low cost tax efficient portfolio, it’s a relatively recent phenomenon, I think it’s wonderful. I think that people should never graduate. I mean, I’m 61, and I don’t own or buy any individual equities, or bonds, you know, all of my investing is in low cost diversified. ETFs, you know, super low cost, you know, you know, in cases, they’re costing three basis points per year, you know, that’s $300 per million dollars of investment. And, you know, very professionally and well managed. So, you know, what I was saying earlier, about, you know, how excess risk or how risk eats into compound returns, you know, I think that’s a really, really important thing, that if you don’t think that you can get extra returns by taking more risks than you shouldn’t take more risk. I mean, that’s the, the golden rule of investing is that, you know, I think that the starting point of everything is that that risk and return are connected to each other. And then the corollary to that, though, is that you can get, you can get more risk without more return. But to get return, you have to take risks, but but that taking risks without getting return is is actually costly in terms of your it’s not a freebie. It’s not like oh, well, I’m taking this extra risk, but you know, so what if it’s a fair risk, you know, it’s not hurting me, you know, that I’m not losing money that doesn’t it doesn’t have a negative edge, but it’s eating into your compound return as per the example I gave earlier. So Right. Yeah, I mean, I don’t think that you know, I think that it can be interesting to follow. You know what’s going on? Dealing with different companies and so on. But, you know, for non professional investors who aren’t making their living trying to beat the stock market, you know, I think that, that there’s really no time to graduate. I think there’s there’s probably a, you know, a more more pithy way of saying it, but yeah, I don’t think, you know, I don’t, I don’t,

Adam Taggart 1:00:20
that’s pretty easy.

Victor Haghani 1:00:22
I don’t view it as a graduation, you know, I view it as a is going backwards, you know, it’s like that, that I think the older we get, you know, the more we should appreciate how great it is to be able to own a little bit of all the 10,000 companies that are doing business all around the world, you know, is, is a wonderful gift of our current financial system, and that we should all, you know, drink from that cup.

Adam Taggart 1:00:47
Okay, well look, one of the more higher echelon investors of the past several decades, you yourself, Victor is saying, hey, for my personal money, I just don’t stick in these ETFs probably says more than anything you could say. So anyways, thank you so much for sharing your perspective there. All right. Now on to the book. I assume it’s sold wherever books are sold. But if if folks want to go get a copy of your book, where should they go?

Victor Haghani 1:01:15
Yeah, I mean, it’s, it’s out there sort of everywhere. It’s published by Wiley Wiley is a big publisher. You know, it’s available on Amazon. It’s in hardcover. It’s on, you know, it’s ebook Kindle as well. And there’s an audio version, which is like, uh, you know, but but the hardcopy, you know, is is available everywhere, you know, it’s probably not, it’s definitely not stocked as much as like the Elon Musk book or Michael Lewis’s book on Sam Venkman. Free, but it’s, you know, it’s out there, so you can find it anywhere you can find it. My mom bought a copy on target, I think, was so so you know, it’s around I think, you know, it’s pretty, pretty easy to find the missing billionaire’s a guide to better financial decisions. And yeah, you know, it’s getting good, it’s getting good reviews, it’s been at the top of the investment category. And, and the number one or two spot in the business and finance category. So it’s been doing really well within its within its categories. We’re really excited about that. We got a great review in The Economist, and Bloomberg has written about it. So yeah, we’re, we’re hoping people will continue to, to buy it and enjoy it. And, you know, it’s we, we had to convince Wiley to get it out there at a nice reasonable price as well, you know, so it’s not like a textbook sort of price. It’s at a just the regular sort of price of popular, popular high selling books right now.

Adam Taggart 1:02:46
Right? Well, as you’ve been talking, we put the book cover up. We’ll have a link to that book in the description, folks, too, so you can go buy it with one click. Sounds like it’s doing just great. And hopefully, you get an additional Wealthion Viewer bump from this video. Victor, thanks so much for coming on. For folks that have really enjoyed this conversation, and would like to follow you and your work is there. Is there any place they can go? Sure. I

Victor Haghani 1:03:09
mean, the we have a website for our business. It’s called lm wealth.com elmwelth.com, lm wealth.com, you can find, you know, you can also find me just you know, with a Google search, we also have a YouTube channel with a couple of short videos there. I did a talk that sort of gave us the title of the book called The Missing billionaires. And why we the puzzle of the missing billionaires and why we should care, which is a TEDx talk that you can find as well. And another I’ve done another TEDx talk, too. So if you say Victor magani TEDx, you would find that. But yeah, I think our Ellen wealth.com website is a go to place that has links to everything else.

Adam Taggart 1:03:52
Alright, great. When we edit this, I’ll put that URL up on the screen. Victor will also put links down to all those things, your website, the YouTube channel, the book, etc. On the descriptions, folks know where to go. Stick around just for one second Victor, I just want to give folks some quick resources, additional resources to go look into folks, just a reminder, that Wealthion Fall online conference is coming up like a freight train in just a little over a week on Saturday, October 21. If you haven’t signed up for it yet, go to wealthion.com/conference. And if you do that before this Sunday, you’ll lock in our last chance to save price discount. And also just as a reminder, I won’t go into my usual spiel because Victor helped me mentioned a lot of it throughout the conversation. But if you are a regular person just trying to figure out you know, how to help your wealth grow for you in the future, particularly if you’re worried about some of the macro issues that I talk about on this channel a lot with the experts that come on, you know, if you’re if you’re not a complete di wire, which again, both Victor and I think that everybody should be developing their own agency and how to manage their own money, but you’d like some some potential help either and figuring out, you know how to set your position sizing amongst the investments that you want to be invested in, or, you know, something more more hands on and turnkey than that, highly recommend that most people should be working with a good professional financial advisor, who can do all of that for them. If you don’t have one, or you’d like a second opinion from one that does take into account all the issues we talked about in this channel, feel free to schedule a free consultation with the financial advisors endorsed by Wealthion. To do that, just fill out the short form@wealthion.com only takes a couple of seconds to fill out. These consultations are totally free. There’s no commitment to work with these advisors. It’s just a free public service they offer to help as many people as possible, get started on the path that Victor has explained for us in such great depth throughout this, this whole discussion. If you’ve enjoyed having Victor on this program, and been fascinated by both the story of the formation of long term capital management and the lessons learned from it, please encourage Victor to come back on this channel in the future by hitting the like button and then clicking on the red subscribe button below. as well. There’s that little bell icon right next to it. Thanks for your patience. Victor, I’d like to give you the last word here in the discussion. Any parting bits of counsel for the viewers?

Victor Haghani 1:06:19
Oh, no, thank you. I don’t know. I love what you guys are doing. And it’s really a pleasure to to get the chance to talk to so many people about these important ideas.

Adam Taggart 1:06:30
Right. Well, thanks so much for coming on. Best of luck with the book and really look forward to having you back on the program again sometime soon. Everybody else? Thanks so much for watching.