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Introduction:? The Puzzle of the Missing Billionaires

Any fool can make a fortune; it takes a man of brains to hold onto it.

-Cornelius "Commodore" Vanderbilt

A beautiful statue of Cornelius Vanderbilt, the nineteenth-century rail and shipping tycoon, adorns the outside of Grand Central Station in New York City. It's there because "the Commodore" ordered the station's construction. Although partially obscured today by an eyesore called the Park Avenue Viaduct, the statue sits right at the heart of midtown Manhattan, the global center of finance, regularly visible to many of today's financial titans.

When Vanderbilt died in 1877, he was the wealthiest man in the world. His eldest son, Billy, received an inheritance of one hundred million dollars-95% of Cornelius' fortune. Unfortunately, it came without even the most basic of instructions on how to invest and spend this wealth over time. Within 70 years of the Commodore's death, the family wealth was largely dissipated. Today, not one Vanderbilt descendant can trace his or her wealth to the vast fortune Cornelius bequeathed.a The Vanderbilt clan grew at a higher rate than the average American family, but even so this outcome was far from guaranteed. If the Vanderbilt heirs had invested their wealth in a boring but diversified portfolio of US companies, spent 2% of their wealth each year, and paid their taxes, each one living today would still have a fortune of more than five billion dollars.

What went wrong?

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The Vanderbilt experience is noteworthy in scale but not in substance. The dissipation of great wealth over just a few generations is a common enough occurrence to warrant its own maxim: "from shirtsleeves to shirtsleeves in three generations." The truth of this dictum can be seen in how remarkably few of the billionaires in the news these days are the scions of old-money wealth. From these observations, we can tease out a valuable insight: the wealthiest families of the past were not equipped to consistently make sensible investing and spending decisions. If they had been, their billionaire descendants would vastly outnumber today's newly minted variety.

To get a rough count of these "missing billionaires," let's turn back the clock to 1900. At that time, the US census recorded about four thousand American millionaires, with the very richest counting their wealth in the hundreds of millions. If a family with five million dollars back then had invested their wealth in the US stock market and spent from it at a reasonable rate, that single family would have generated about 16 billionaire households today.b If even a quarter of those millionaires in 1900 started with at least five million dollars, their descendants alone should include close to 16,000 old-money billionaires alive today. If we include the private wealth created throughout the twentieth century as well, rather than just a snapshot in 1900, we believe the tally of potential billionaires is vastly greater.

But as of 2022, Forbes estimated there were just over 700 billionaires in the United States, and you'll struggle to find a single one who traces his or her wealth back to a millionaire ancestor from 1900. We needn't go so far back in the past to find this pattern. Fewer than 10% of today's US billionaires are descended from members of the first Forbes 400 Rich List published in 1982. Even the least wealthy family on that 1982 list, with "just" $100 million, should have spawned four billionaire families today. We recognize that some wealthy families purposefully chose to give away or consume virtually all of their wealth in their lifetimes, but we believe these cases were relatively rare and do not account for the near-complete absence of "old-money" billionaires we see today.

We're not lamenting a scarcity of billionaires in the world today. Our point is that, collectively, we all face a really big and pervasive problem when it comes to making good financial decisions. If 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 "best" financial advice, consistently made atrocious financial decisions, what can be expected from the rest of us? There's a Persian proverb Victor's father was fond of, which seems improbable at first, but the truth of which has become a main motivation for this book: "It's more difficult to hold on to wealth than it is to make it." This book sets forth our framework for addressing the challenge faced by all families-not only potential and actual billionaires-to find a path to better financial decisions.

In the chapters that follow, we're going to explore in detail the most common ways in which these missing billionaire families discarded their enormous head start: taking too much or too little risk, spending more than their wealth could support, and not adjusting their spending as their wealth fluctuated. Above all, they did not have a unified decision-making framework, which left them susceptible to chasing whatever was hot and dumping it as soon as it was not, anchoring spending decisions on hoped-for portfolio returns, and paying exorbitant fees for poor advice.

Notice that among the primary errors we listed, we did not include choosing bad investments. That's because one thing that did not cause these billionaires to go missing was a poor investment environment. Indeed, it's hard to imagine a better one. The US stock market delivered a 10% pretax annual return over the period, turning one million dollars in 1900 into roughly one hundred billion dollars at the end of 2022, a 100,000x return. Instead, perhaps the heart of the problem is one of misplaced attention. In investing, the natural tendency is to focus on the question of what to buy or sell. Nearly 100% of the financial press is dedicated to this question, so it's reasonable to suppose that the "what" decision is the most important thing we should be thinking about. It isn't.

We'll explain that the most important financial decisions you need to get right are of the "how much" variety. How much should you buy of a good investment; how much should you spend today and over time; how much tax should you defer to the future; how much should you spend to insure against low probability, high consequence events. Implicit in these questions is the recognition that risk is present in just about every good thing we come across. So, whenever we're trying to figure out how much of a good but risky thing we should do, we need to weigh the greater expected benefit from doing more versus the cost of taking more risk. We hope to leave you with a practical framework for making these sizing and risk-taking decisions consistently and confidently.

Why do we think sizing is so important? Consider this: if you pick bad investments but do a good job sizing them, you should expect to lose money, but your losses won't be ruinous. You'll be able to regroup and invest another day. On the other hand, if you pick great investments but commit way too much to them, you can easily go broke from normal ups and downs while waiting for things to pan out.

Our own personal experience backs up the proposition that the sizing decision, often an afterthought, is actually the most critical part of investing. We've both experienced first-hand the impact of getting the "how much" decision wrong, losing the majority of our personal wealth in the process. Victor was a founding partner at the hedge fund Long-Term Capital Management (LTCM). In 1998, at age 36, he took a nine-figure hit when LTCM was undone by that decade's second financial crisis. The monetary loss was compounded by the psychological blow of the business' failure and its impact on the 153 employees who worked there, as well as the impact on the reputations of all involved. A decade later, James at 28 lost a smaller sum but still a material fraction of his wealth in part through his investments in the hedge fund where he worked.

In each case, we believed we'd selected investments with an attractive risk/reward profile that were highly likely to pay off in the long run. The trades that took down LTCM in 1998 were money-makers over the ensuing years, and the hedge fund that employed James also bounced back to generate strong returns following its precipitous swoon in 2008. Unfortunately, the short run always comes before the long run, and neither of us got to enjoy the rebound of these investments. The lesson: good investments plus bad sizing can result in cataclysmic losses.

The LTCM story has been told countless times-several books, many articles, and even a Harvard Business School case study. It was colorful, involving Wall Street traders straight off the pages of Michael Lewis' Liar's Poker together with a band of highly respected professors, including two Nobel Laureates. To the outside world, it appeared that they had built a money machine (one of the books about LTCM was rather hyperbolically titled Inventing Money), so it's not surprising that most of the LTCM partners were heavily invested in the fund they managed. The fund had returned more than 40% per year...