Author: Victor Haghani and James White · Published: 2023 · Genre: Personal Finance, Investing
The Missing Billionaires tackles a question most investing books skip: not what to invest in, but how much. Its biggest strength is making position sizing and expected utility intuitive through clever puzzles and a memorable experiment. Its biggest weakness is that the framework depends on inputs, such as expected returns and your own risk aversion, that are hard to pin down, and the math will lose many readers. It is worth reading for numerate investors and anyone curious about the economics of risk.
The big idea
The title comes from a thought experiment. Around 1900 there were roughly 4,000 American millionaires. Assuming about a quarter of them had at least $5 million, the authors calculate that if those families had simply held the broad US stock market, spent and given away 2% of their wealth a year and paid taxes, their descendants today should include close to 16,000 billionaires. In fact they could find essentially none among today’s richest Americans. Families mostly didn’t lose fortunes through bad investments, the authors argue, but by spending too much and sizing their risks badly.
The authors know the subject from both sides. Haghani was a founding partner of Long-Term Capital Management, the hedge fund whose 1998 collapse led to a bank rescue organized by the Federal Reserve Bank of New York. He later founded Elm Wealth, where White is chief executive.
Their main tool is the Merton share, from the economist Robert Merton’s work on portfolio choice. It says the fraction of wealth you put in a risky asset should rise with its expected excess return and fall with your risk aversion and with the square of its volatility. The Kelly criterion, familiar to gamblers, is a special case. On spending, they argue that spending should move with wealth, as a fraction of it, and be set together with investment policy rather than separately.
What’s great
- The coin-flip experiment. Haghani and a colleague gave 61 participants, mostly finance students and young finance professionals, $25 to bet on a coin that landed heads 60% of the time, with winnings capped at $250. Betting a steady 10% of the pot would have reached the cap more than nine times in ten. Instead, 28% went bust, 18 people bet everything on a single flip, and two-thirds bet on tails at some point. It is a vivid demonstration that smart people size bets badly.
- Clear puzzles. Short chapters use brainteasers, such as whether buying huge numbers of lottery tickets makes sense when a jackpot’s expected value turns positive, to explain utility and risk.
- Practical range. The framework is applied to spending, dollar-cost averaging, insurance and inflation-protected bonds. The investment writer William Bernstein called its treatment of the equity premium puzzle the best he had seen.
What’s weak
The framework is only as good as its inputs. The authors estimate expected stock returns from valuation measures, so their approach can call for much lower stock exposure when markets look expensive, and that depends on estimates that may be wrong for years. Bernstein, in an otherwise admiring review, argued that asset returns are not stable enough for this to work reliably, that people’s risk tolerance shifts in panics rather than staying constant, and that the authors overrate math as the path to better decisions. He also noted that the book says little about why LTCM failed, the most obvious case study in mis-sized bets the authors could have offered.
Readers without some comfort with formulas will also find long stretches heavy going.
Who should read it
Read it if you enjoy finance with numbers and want a rigorous way to think about risk, spending and how much is too much. If formulas put you off, start with the coin-flip chapter. This review describes the book’s arguments and is not financial advice.
Rating: 4/5
Image credits — In-article images: Photo by Aidan Howe on Pexels.
