So You Won the Lottery — What’s Next?
In August 2017, a hospital worker from Massachusetts won the biggest undivided lottery jackpot in U.S. history — $759 million. A few weeks later, while at a dinner party in Manhattan, I jokingly lamented that I had not been the fortunate winner, who instantly qualified for Bill Gates’ Giving Pledge. Without that Powerball windfall, I was not sufficiently wealthy to attract the attention of Mr. Gates’ and his group of billionaire philanthropists.
That evening, I thought about a scenario in which I was in possession of the winning ticket — would $759 million be enough to catch the eye of Mr. Gates or would I need greater wealth? If I did need more, how would I obtain it?
I also came to realize that, had I won the lottery, my newfound financial freedom would be accompanied by new responsibilities — to myself, to my heirs and to my community. Relationships with friends and acquaintances would evolve and given my likely loss of anonymity, no less than a plethora of financial professionals would be eager to make my acquaintance.
The sobering realization was this — if I suddenly came into life changing wealth, I would need a framework in place for how to handle it.
Growing up, I learned two important life lessons from the cub scouts: (a) always be prepared, and (b) if using the woods as an impromptu toilet, be completely certain the area is clear of poison ivy.
In the spirit of the former, I pulled together these very thoughts on creating a philosophy from which to manage a new fortune. Hopefully, by following this approach, we can transform our initial lottery winnings into a truly grand estate, something worthy of the late F. Scott Fitzgerald’s awe (more from him later).
Fortunately, many up and comers in Silicon Valley don’t need Powerball to move up a few tax brackets. While I can’t promise that readers of this post will win the lottery, I can promise a picture of a cheerful baby at the end. I should forewarn you that the aforementioned baby is being used as a prop designed to soften up consumer opinion on a once thriving monopoly… manipulative marketing!
Mo’ Money, Mo Problems
JP Morgan always cleans up its mistakes
In the mid-20th Century, the world was a simpler place — sleepy banks and trust companies were typically entrusted with one’s hard earned (or inherited) wealth. In contrast, in the 21st century, the only way to realize excess investment returns from a bank is if they err in your favor.
The modern era is a free-for-all and the deluge of propaganda from investment firms and the financial media is relentless. A consequence is that the management of wealth can feel complex and stressful, in particular to those unaccustomed to filtering out signals from noise.
There is considerable “noise” generated from Wall Street. Financial advisors have distinct opinions on how to manage wealth and these varied opinions can differ in dramatic ways — some favor index tracking, others prefer real estate, a few push alternatives and the bold embrace speculative endeavors, like cryptocurrencies.
The optimal choice is not necessarily clear but it is clear that plenty of people will try to tell us what we should do with our newfound wealth. Yet, this fictitious fortune doesn’t belong to them, it belongs so us. We must therefore develop our own point of view and decide what should we believe.
The concept of “belief” typically is relegated to the realm of the spiritual, but it is not entirely out of place in the context of the investment houses of Wall Street or the venture firms of Silicon Valley. It is the degree of fervor and passion with which the sales men and women of Wall Street and Sand Hill Road proselytize their self-interested worldviews that necessitates we ground ourselves before we accept their involvement, necessary as it may be.
As a former electrical engineer, I chose the term “ground” deliberately — in the physical world, a ungrounded electrical distribution system can rapidly become unsafe due to the buildup of excess voltage, for example due to lightning or static electricity. Grounding a system mitigates potential risks, as excess voltage can safely dissipate.
The analogy to our fictional lottery windfall should be clear — to oversee this new estate, we must ground ourselves mentally, creating a path through which the buildup of excessive spin, hype and misinformation can safely dissipate.
To do so, we will ask ourselves a few leading questions to help frame our approach:
Question 1: Should we place our faith in those with the loudest voices, or in mass market brands, such as those that advertise during the Super Bowl?
No.
No, we should not.
Rhetorical Questions
What do you get when you cross a joke with a rhetorical question?
Wealth management advice for the mass market usually follows a relatively standard template. However, for those with Powerball-level wealth, these common interrogatives become rhetorical (at best) or irrelevant (at worst):
- “What is your risk tolerance” — This is the equivalent of finding oneself stranded in a small town, asking the mechanic how much to get the car fixed, and being asked “how much you got?” While the spirit of the question is not malicious, one should not concede an amount of ‘acceptable losses’ at the onset.
- “When do you want to retire” — As a result of our fictional lottery winnings, we are “retired” in that we have the capacity to live off our wealth. That being said, we want to make the most of this newfound fortune and we want to continue to achieve — intellectually, economically and philanthropically.
- “What do you want your money to do after you die” — I intend to live forever, or die trying. Should these efforts at achieving immortality fail, our estate planning must confront a daunting challenge — aggressive lobbying from Bill Gates and his Giving Pledge disciples and I have yet to find a roboadvisor trained in the art of fending off guilt-shamers or one trained in educating heirs on the nature of the financial markets.
In the mid-1920s, F. Scott Fitzgerald wrote: “Let me tell you something about the very rich. They are different from you and me.”
Author and adventurer Ernest Hemingway, known for traveling extensively yet being most at home on a bar stool, responded thus: “Yes — they have more money.”
In terms of grounding ourselves, we must accept and embrace our new station in life. Whether you favor Mr. Fitzgerald’s figurative perspective or Mr. Hemingway’s more literal, their observation is sound — the rich are different, and solutions for the masses don’t take into consideration the options the wealthy have that the masses do not.
Since the dawn of capitalism, the wealthy have been trying grow their fortunes and expand their empires. Surely there must be lessons to be learned from history — copious amounts of data is available for analysis on the economy and financial markets over the last century. Perhaps the past can be our guide and we can seek wisdom from academia, since academics rely on objective facts and are theoretically insulated by brands, hype and marketing.
Question 2: Should we embrace the platitudes of ivory tower academics? Can tenured PHDs, authors of concepts such as efficient market theory and modern portfolio theory, lead us to financial nirvana?
No
No, they can not.
Be Wary of Clever Arguments
Narrator: “Tyler, you are by far the most interesting single-serving friend I’ve ever met. … See, I have this thing: everything on a plane is single-serving …”
Tyler Durden: “Oh, I get it. It’s very clever.”
Narrator: “Thank you.”
Tyler Durden: “How’s that working out for you?”
Narrator: “What?”
Tyler Durden: “Being clever.”
— Fight Club (1999)
The Greek philosopher Zeno’s paradox of motion posits that motion is impossible. His argument begins as follows: traveling a fixed distance requires one to first move half of the desired distance.
Fair point!
His argument continues: to make it halfway to the original destination, one must first move half of that distance and to make it to that halfway point, one must first move half of that distance, ad infinitum. Therefore, to move any finite distance requires one to complete an infinite number of tasks, which is mathematically impossible.
Yikes!
Of course, despite Zeno’s argument, even a young toddler (such as the one depicted at the end of this article) knows that it is empirically possible to move across a room. The point — empirical, real world observations trump clever theories.
Hooray Calculus!
Academics seek to predict the movements of markets as they predict the movements of the planets. Unfortunately for academia, financial markets don’t behave like celestial bodies. Financial markets are human constructions and are subject to the whims of human nature and politics, and influenced by human emotions, most obviously greed and fear.
Some academics have a tendency to become dogmatic and incapable of evolving as events dictate. While undoubtedly there are valuable lessons to be learned from the past and many academic works have created useful frameworks for modeling financial markets, our belief system needs to be more forward looking and flexible than academics typically allow for.
In Hemmingway’s era, ambitious American salesmen peddled physical products — aluminum siding or a set of encyclopedias, at least until Bill Gates killed them with Encarta (the encyclopedias, not the salesmen).
Gates!
Since the Reagan era, ambitious American salesmen have increasingly pushed financial products, with particular emphasis on that which was in favor and most readily saleable:
In the 1980s, equity mutual funds…. until the market crashed
In the 1990s, tech stocks…. until the market crashed
In the 2000s, real estate…. until the market crashed
In the 2010s, passive ETFs… until …
I am not predicting a market crash, but rather simply pointing out that markets tend to mean revert over time. However, in the short term, there tends to be a correlation between positive returns and popularity, which brings us to our next question:
Question 3: Must we reflexively buy into whatever is the most marketable and popular in the prevailing financial climate?
No
No, we must not.
Biased Arguments
Biases tends to exist in any professional field — for example, studies indicate that surgeons are more likely to recommend surgery and radiation-oncologists are more likely to recommend radiation than other physicians. These biases are not necessarily malevolent. To continue to ground ourselves, we must acknowledge the following — virtually every piece of investment advice we receive will be biased.
No need to fret — acknowledging and accepting these biases is liberating — rather than worrying if advocates of a particular financial product or service are trying to ‘put one over’ on us, we can safely assume their biases cause them to act in their own self-interest and therefore we need not take anything personally.
The fact that rational self-interest is at the forefront of financial transactions is strangely reassuring — everyone’s motives are transparent. Marketers will throw every trick in the book at us — the best defense is to be informed and dispassionate when hearing them out.
Recency bias is especially prevalent in financial product marketing. That which has generated positive returns recently tends to be popular and is therefore most readily pushed by commissioned salesforces. History indicates that popularity, as measured by investor fund flows, often portends bad things with respect to future long-term returns.
Passive fund marketers use this data to make the argument that the best decision investors can make is not to make decisions — simply trust the market. This brings us to the next question:
Question 4: If we can’t fully trust brands, academics or biased salesmen pushing popular products, is our best course of action to give up and passively accept market returns?
No.
No, it is not.
Don’t Nobody Bring Me No Bad News
“Bring some message in your head
Or in something you can’t lose
But don’t you ever bring me no bad news”If you’re gonna bring me something
Bring me, something I can use
But don’t you bring me no bad news”— The Wiz, “Don’t Nobody Bring Me No Bad News” (1978)
Passive index fund managers argue the merits of their index-based philosophy with self-evident smugness:
- The market is a zero sum game (total market gains and losses must be equal)
- Active managers charge fees and incur expenses
- Therefore, active managers cannot beat “the market”, in aggregate
- Consequently, prudent investors should avoid active managers
This conclusion, while seductively constructed, is off the mark. The argument reminds me of Zeno’s paradox — individual pieces seem sensible but the totality of the argument is not.
The assumption that the market is a zero-sum game is overly simplistic. The theory ignores the fact that capital moves in and out of various markets over time. Considerable wealth transfers result from the timing of capital flows into assets and by taking advantage of less efficient markets.
It is an empirical fact that the market can be beaten, particularly if scale is not an impediment. Certainly, some successful investors benefited from luck but that doesn’t seem to be a sufficient condition to cause investors to give up the chase for outperformance.
Therefore, here’s a non-rhetorical question — why is indexing, which guarantees merely average performance, so widely embraced?
Glad you asked — by recommending a passive index-oriented strategy, the advocate effectively can’t be wrong — an index can’t underperform itself! There will never be a period of relative underperformance and therefore there will be… no bad news!
Advisers hate delivering bad news.
Index funds do have merit. However, their broad acceptance is influenced by business considerations having less to do with maximizing investor returns and more to do with keeping clients from changing advisors.
Question 5: Is there no single philosophy, algorithm or “one stop shop” to whom we can entrust our newfound fortune?
No.
No, there is not.
Going The Wrong Way
“If you don’t know where you are going, you might wind up someplace else.”
— Yogi BerraNeal Page: “He says we’re going the wrong way.”
Del Griffith: “Oh, he’s drunk! How would he know where we’re going?”
— Planes, Trains and Automobiles (1987)
To recap, we have touched upon a handful of traditional decision making heuristics (rules of thumb) that consumers often rely on to help choose products in a crowded market. We have also concluded that their value is somewhat limited with respect to defining a belief system for the oversight of our multi-generational wealth:
- Brands — we shouldn’t simply rely on the brand message of others to provide comfort for our financial decision making
- Research — we shouldn’t rely entirely on academics who believe that markets are efficient and unbeatable (four out of five academics recommend…)
- Popularity — we shouldn’t necessarily buy that which is most easily sold, and
- Low-Cost — we shouldn’t give up and blithely accept whatever “the market” is offering to everyone
- Universal Fit — there is no “one size fits all” approach that works with regard to managing considerable wealth
Final Question: In pursuit of investment excellence, should we attempt to forge our own path, informed by a cadre of advisors and investment managers with a goal of maximizing the potential of our accumulated wealth?
Yes.
Yes we should.
We are not seeking the financial market equivalent of a participation trophy — our goal should be to provide our heirs independence, stability and means to excel in their future endeavors. Devising the ideal portfolio will require some effort as, axiomatically, there can be no outperformance without active management.
Unfortunately, for growing wealth, there is no simple shortcut, no single algorithm we can rely on. Things worth doing rarely easy — we will need to find a handful of partners we can trust, but how we go about that can be a discussion topic for another day.
Would You Like to Know More?
There is new generational wealth being generated every day — entrepreneurs selling businesses, entertainers and athletes signing lucrative contracts and, yes, people winning the actual lottery.
The takeaway is this — anyone can craft a clever story to sell financial products. The wealthy therefore we must be discerning, though not fearful, with regard to wealth management decisions. We should evaluate alternatives from a variety of advisors offering a variety of approaches. We should make sure their goals align with our goals, and be sure their business objectives are not in conflict with our desires.
Then we should buy a winery, because we did just win the lottery, after all…
I enjoy investing, markets and helping folks make sound decisions and welcome the chance to continue to discuss such topics with anyone interested — family offices, entrepreneurs or individual investors being obvious candidates. In terms of content, I would be happy to increase the depth of the discussion of topics touched upon herein or pivot to something new if there are any other topics of common interest.
In terms of personal background, I have worked on Wall Street for roughly twenty years. I have worked at large firms and small firms (including my own) and have been witness to remarkable successes and failures over that time frame. I am currently advising friends, wealthy individuals and businesses in a variety of capacities and thought this might be an interesting format to employ to make some new connections, particularly from outside of the Northeastern US.
I studied electrical engineering and computer science at Duke twenty years ago and there can be occasional challenges when interacting with computer scientists. The other day, I was asked to go to the store and pick up a gallon of milk, with the requester adding — if they have eggs, get a dozen. I still maintain I was technically correct in bringing home twelve gallons of milk (since the store did have eggs in stock that day), but most non-programmers don’t see things my way.
With that in mind, please feel free to reach out and touch me at ir@jjncapital.com.
