In “A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and The Market,” you’ll find the story of how Ed Thorp got rich using what he referred to as “edge.”
Nassim Taleb described Thorp’s process as:
“He cuts to the chase in identifying a clear edge (this is something that in the long run puts the odds in his favor). The edge has to be obvious and uncomplicated.”
The edge is any situation where we can achieve better than average financially results. This could be in the stock market, gambling, real estate, the lottery, or our businesses.
Once you find your edge, all you have to do is leverage it to your advantage.
In Ed Thorp’s life he found several financial edges through his understanding of mathematics, statistics and probabilities. Here’s Taleb describing Thorp’s edge:
“For instance, calculating the momentum of the roulette wheel, which he did with the first wearable computer, he estimated a typical edge of roughly 40 percent per bet. But that part is easy, very easy. It is capturing the edge, converting it into dollars in the bank, restaurant meals, interesting cruises, and Christmas gifts to friends and family – that’s the hard part.”
Once you’ve found your edge, you have to be able to convert it into actual cashflow. This isn’t as easy as it sounds. Many find edge in appreciating investments. You can’t spend appreciation without selling your edge. This means you can’t convert it into dolla dolla bills.
There are three primary areas where I want edge:
1. Investments – Identifying an investment opportunity where you can consistently generate higher returns without assuming significant risk.
2. Business – Starting a low-overhead business that generates significant cashflow not requiring your labor.
These two make sense and are fairly obvious.
Well, what most don’t see is the third edge opportunity:.
3. Marketing – You can use marketing to create an edge for your investments and your businesses.
An example might be a marketing funnel you have for your business that delivers high quality clients on a consistent basis. This marketing system gives provides an edge that others don’t have. Or a marketing funnel that generates income through upsells providing free leads for your business. Another example might be mobile home investments. I can generate significantly higher returns investing in mobile homes compared to other investments.
“Ed was initially an academic, but he favored learning by doing, with his skin in the game. Ed’s genius is demonstrated in the way he came up with very simple rules… Having an “edge” and surviving are two different things: The first requires the second. As Warren Buffett said: “In order to succeed you must first survive.” You need to avoid ruin. At all costs.”
This simply means you must control your risk. You must never do anything that could bring you down – borrow too much – break the law – take on too much business or personal overhead.
“Many successful speculators, after their first break in life, get involved in large-scale structures, with multiple offices, morning meetings, coffee, corporate intrigues, building more wealth while losing control of their lives.”
This is what I did when I had my first edge. I bought a large office building. I hired too many employees. I cubicles, the best copier and wiz bang phones on every desk. The overhead was significant and consumed a significant portion of the business’s income.
On top of this, I mortgaged every investment as much as I could. When the market crashed, I lost control and teetered on the verge of bankruptcy.
Ed Thorp didn’t do this. He didn’t start a big hedge fund. He didn’t put his reputation at risk. He used restraint and avoided blowing up like most people do. Thorp understood something very important:
“It is vastly less stressful to be independent – and one is never independent when involved in a large structure with powerful clients. True success is existing some rat race to modulate one’s activities for peace of mind.”
Peace of mind is important. It’s my most important Cashflownaire Principle.
I don’t think many people realize that we quickly trade away our peace of mind for more money without questioning whether it’s a good trade.
Is the money worth the stress, aggravation, risk and work?
I’ll finish this with one last quote from Taleb about Thorp:
“You can detect that the man is in control of his life”
If you’re not in control of your life, you don’t have peace of mind. Getting control of our lives is hard. It takes a lot of work. It takes self discipline and restraint.
It’s also worth it.