All posts by Daniel Egan

Strategic faith

Would Dumbo have been a good investor?

For the uninitiated: Dumbo is an orphaned elephant with embarrassingly large ears. He is made to work with a quite unpleasant circus, where a Timothy (a clever mouse) tells Dumbo that he could be a star if he used his huge ears to fly. But Dumbo isn’t convince he couldn’t pull it off.

So the mouse gives Dumbo a ‘magic feather’, which allows him to fly. Dumbo later learns (mid-flight!) that the feather isn’t magic. He could always fly. He just needed to believe.

Religions appear in almost all societies in some form. But the details vary dramatically. The formation of the world, the names and organization of god(s) and interactions with humans, the ideas of souls and death. It’s clear what the big questions are.

Religion and spirituality help cultivate a system of ethics, a story about how the world, how life and death work, a supportive community to join, a way to cope with life’s foibles. It’s very valuable.

The benefits of religion don’t seem to depend on the exact theology. The details of the story aren’t critical. But belief in the story is.

What if a critical ingredient to being a successful investor isn’t exactly which strategy you follow? It’s that you have faith in that strategy?

By faith I mean the ability to take the leap into risking your money without guarantees, and to continue to adhere to the strategy,  even in the face of disappointing results.

Markets must crash. Active strategies must underperform. Chasing performance produces lower returns. Buffett underperformed by 67% at one point. Even a clairvoyant who knew exactly what stocks would perform best would get fired, because the journey would be so terrifying.

An investor without a faith is doomed.

Most of us will invest for about 50 years, from age 30 to 80.  Over that period the primary driver of non-savings growth will be that you invest in a reasonably diversified, risk-aligned portfolio with low cost and tax drag.  

Once those boxes are checked, the exact flavor you choose isn’t hugely important. Market-cap, SRI/ESG, Smart Beta, Trend, Risk Parity, Global CAPE, home biased. Sure, sounds good. Go for it. Bikeshedding

They’ll all have periods where they look best, and periods where they under-perform.


Except if you don’t stick with it. Except if you flop in and out of strategies with each glittering fad and temporary disappointment. In U.S. large caps, performance chasing lead to a 2.3% underperformance. Over a period where the U.S. market went up about 7% on average, the average investor underperformed by 1.6%. The most active 20% of accounts underperformed by 6.5%. Net return: 0.50%. They would have been better off working a minimum wage job than trading their brokerage accounts. 

Distill most investing mistakes down, and you get a simple story: the single biggest factor is simply cumulative time invested. Anything we can do which increases the total time an investor holds a reasonable portfolio, is a win.

It is better to have any reasonable faith, than none at all.

The cardinals of quant on the benefits of faith

Perhaps you think this is just hooey psychologist talk. If so, may I quote some (highly quantitative) professional investors?

trend has allowed me to stay in an expensive market to capture ~100% more return than my behavior would have otherwise allowed. – Jake

The evidence would say momentum, but because I’m a human, when I incorporate System 1 risk, I’m gonna say value. When momentum stops working for a while… well, value is something that you could put 50 guns to my head, and I will never.. Even if it goes 99% negative I will still hold my value stocks.Wes Gray ~34m

Faith allows you to hold on when the pain is sharp. It gives you a story of trial and redemption. Only the faithful shall reap the mana of heaven. Drawdowns (absolute or relative) separate the believers from the poseurs. The weak hands that fold ensures the true believer’s profit.

Why faith, not rationale

A common response will be “I follow {my strategy} because it’s rational. Here’s the evidence”. Hello economists and engineers! Welcome!

Did you know that purely rational people have a really hard time making decisions? In a series of studies of people with brain lesions, Anthony Demasio found that if you disconnect the simple, emotional, motivational part of the brain, people can’t make decisions. These people understood pros and cons. They considered options and explored alternatives. They weighed and measured. They were rational.

But they deliberated endlessly. They wanted more evidence, more time for analysis. They simply couldn’t come to a conclusion. An infinite filibuster.

The crux of making of a choice is not about logic and evidence. It requires emotional activation, a focus on execution towards an end, rather than if that end is right. We often seeks out information to justify our pre-existing views. We are drawn to ideas which makes us feel good.

Logic and evidence are two of our best allies in this confusing world. That said, they aren’t perfect. They can help us filter out bad faiths, but they do not guarantee the results of what’s left.  

Past performance is not always predictive. Publishing an arbitrage anomaly is the best ways to exterminate it. The market abhors alpha. “The worst 10 year period of any backtest is the next 10 years”.

Markets are not governed by physics. There are no universal constants. To believe an evidence based strategy will continue to perform moving forward either requires an odd belief that the future will be indistinguishable from the past, or robust underlying mechanics that do not undo themselves as we learn about them.

In all cases, a faith to act is the foundation. The intellectual house is built on top.

Religious virality

Not all religions are created equal in terms of their capacity for growth. If you are not born orthodox jewish, it’s very hard (impossible?) to become one. Key characteristics of different religions enable them to grow memetically. The quants of today would say different religions have different virality and capacity factors.

I think this is (partially) why “passive” investing is such an attractive faith. It is the lowest-barrier-to-entry investing religion. It says “you don’t have to be an expert to win. You don’t have to trade and monitor things all the time. You don’t have to pay a high fee to get good returns.”  Just get invested, avoid these stupid mistakes. It requires the least doctrine, the least assumptions to work. The idea that you can win without beating others is central to getting millions of new people comfortable with investing.

It may have enlarged the pie. It  helped with the adoption of retirement programs like auto-enrollment by providing a fairly universalist default investment. It made a large balance of investors move their focus from recent performance, to costs. Because recent performance had nothing to do with future returns, but cost did, this was an improvement.

There are other faiths. Dimensional Fund Advisors (DFA) and to a lesser degree AQR (AQR) require converts to pay a steep entry price to be welcomed into to faith, and my impression is they have lower churn for having invested in their converts.

Finding our faiths

The truly disadvantaged are the investors who don’t have a mental model or scaffolding for understanding the world. They will simply look at the stream of returns, listen to the news, and react.

How do the faithless find a faith?

This is tough. You can’t tell someone “just believe in something, and you’ll be better off”. They need to actually believe in it. And if they believe that the only reason to have a committed faith is to get better performance… that is not true piety.

I don’t have a great answer, but I do believe we need help find or even define virtue in struggle, and salvation through constancy. Pain must be part of the story, which leads the hero to success. They must value their faith for the peace it gives them during their trials, regardless if it works financially. 

The faith-less often want to know what the best faith is. There is no such thing. There may be a best religion for each of us, but no single story that will allow all of us to make the leap that will confront us over those 50 years. Put a boglehead in a trend-following algorithm and they will bemoan the turnover and missed rallies. Put a risk-parity acolyte in a market-cap portfolio and the world might end. No one size fits all. 

If this piece feels like a work in progress, that’s because it is. Sometimes I write ideas out to see if still believe them. While my arguments are now more refined, I’d put myself at 68% confident. The gestalt came together over time by reading a few key books. 

The True Believer

Big Gods

Descarte’s Error

I bet you thought I wasn’t going to do it. But I am. 

The wealth of Sapiens

It’s 2am, and I’m curled up in a ball on my bathroom floor crying. I’m trying to do this without waking up my sleeping wife and daughter in the next room. And I’m pretty happy about that outcome.

True wealth is not money. It’s the option to buy what you truly need. If money can’t buy what you need, you’re on even footing with the poorest person out there.

My daughter got the flu. No biggie. We kept her home from school for two days, and the fever broke. She was back to running, jumping and singing her friends names. On Thursday I left  on a ski trip with friends.

Saturday, at 3am, my wife called from the emergency room. My daughter had a 105 fever and hadn’t eaten in 36 hours. She was whimpering in pain and not drinking water. Chest x-rays revealed not the sharp white and black lines of ribs and air, but white lines and splotches of cloudy white: liquid in her lungs.

Fifty three children have died from the flu this year. Fifty three parents started out their week with an annoyingly sick kid, and ended up grieving for them. The last time flu season was this bad, 56,000 people died from it.

I found a car rental that allowed 1 way trips, and booked it online at 3am with a credit card. My friend drove me to there at 7am when they opened. I got directions from Google. I dropped the rental off at LGA, grabbed a Lyft to the hospital, and was hugging my wife and looking at my daughter at 12:30pm Saturday.

“Decreasing marginal utility”

In economics 101 you learn a simple model of happiness: more wealth makes you happier, but by smaller and smaller amounts. The first $10,000 you spend is awesome. The second $10,000 is good too, but not quite as great as the first. And so on.

Water, food, shelter, clothes and a bed. Those are all really important things. Without them, you’d be pretty miserable.

The most important money we spend is not the Lambo money. It’s avoiding-misery money.

The modern world has gotten pretty good at providing the avoiding-misery money. Not perfect. But good.

But now, we must also contend with hedonic adaptation – we seemed evolved to never be happy. With each increase in our standard of living, we adapt, and it no longer brings us the same happiness. We seem to quickly forget what living without most of our current consumption would be like. We focus on the rich and their luxuries, and take for granted our warm beds. We’ll come back to that.  

Ars Longa, Vita Brevis

The ingredients for the treatment for pneumonia:

  • IV fluids
  • oxygen
  • antibiotics

This is not brain surgery. It is not gene therapy. We’re basically talking about water, salt, sugar, air, and mold.

Oh! And generations of accumulated knowledge. To know which mold to use. To build an air compressor. To keep fluids sterile.

The ingredients are banal. The recipe is magic.

Ars longa, vita brevis means “Art is long, Life is short”. It refers to the fact that as part of the human colossus, we have the ability to contribute to a body of knowledge that outlives ourselves, and bootstraps the progress of future humanity.

Humans are small. Humanity is large.

At the beginning of the 20th century, out of every 1,000 infants born 100 were dead by their first birthday. By 1997, that number dropped to 7.

Pestilence’s children: Diphtheria, Tuberculosis, Typhoid, Cholera, Malaria, Ebola, Yellow fever, Smallpox. Those names used to be death sentences. They killed millions throughout history. The human colossus conquered them. They are now confined to history books, a few unlucky countries and random outbreaks amongst luddites and homeopathists.

Consider a hospital. It’s one of the truly impressive things humanity has created. Mount Rushmore is neolithic next to a modern hospital.

Cornell Hospital in Manhattan is huge. Billionaires donate to build wings, wards, and specialist facilities. It houses thousands of patients across all ages and infirmities. It has MRIs, and X-ray machines, and others which I don’t understand.

Each nurse and doctor inside it represents a minimum of 20 years of education. That education represents centuries of distilled trial and error, scientific progress and engineering, and optimization of how to get as much useful info as possible into a human brain.

They operate together with amazing efficiency at taking in humans with any infirmity, and as fast and effectively as possible, fixing them and pushing us back out.

One success metric: a 90% reduction in infant corpses.


The wealth of Sapiens

True wealth is not money. It’s the option to buy what you truly need.

If money can’t buy what you need, you’re on even footing with the poorest person out there.

Wealth is living in a society where you have the option of spending money on the things you need. The greater the number of options, and the more aligned they are to you needs, the wealthier you are.

The wealth we have all inherited is knowledge and social institutions. It’s taken generations of work, the sacrifice of many, and it’s not a foregone conclusion. We’re lucky we were born when we were.

Wealth is genuinely understanding how the world works, so that we can have a high degree of control over it. So you know what mold to use, when, and why.

Wealth is a society where you can trust complete strangers with your child’s life.

Wealth is having friends, colleagues and family who support you. Who take care of the things you can’t, without hesitation.

Wealthy is when strangers rent you cars for 1-way trips at 3am over the internet.

And one wealth we have more of now than ever before, is an open invitation to contribute to Ars longa. To add to that compounding body of knowledge. So that in the future, one less child is on the wrong side of a statistic.

Enjoying wealth

It’s easy to feel like you’re not wealthy. How can we keep ourselves baselined to how good we actually have it?

Find ways to viscerally remember what life is like without the modern marginalia.

Go camping. Not in a cabin. Not from a car. Put a pack on your back, and walk. And then clear a space in the woods. Sleep on the ground. Feel the cold. Worry about rain and bears. Eat a cold tasteless meal. Smile at sunrise. Groan at your aches. 

Vacation in poor countries. Pay attention! People are still happy. They are kind. Children play outside. Teenagers flirt, parents stress, and old people sit around and watch it all. You do not need the latest smartphone to live well.

Then come back, and appreciate: hot showers. potable water, electricity, pizza, family.

The benchmark is “my family and I are alive, safe and fed”. The rest is luxury.

The Business of Emotion

The Business of Emotion is a paean to the era of big data by Big Data: monetizing attention, addicting users and somehow creating loneliness in the biggest, most sociable crowd ever seen on earth. It’s dark, dystopian, dehumanizing. It’s about how faceless organizations use data to turn people’s attention into money.

I love it. It might be my career’s theme song. But to understand why, you need to sing it with conviction. 

Bear with me. I need to take you on a brief, nerdy, detour.

This is one of my favorite scenes from Star Trek. (I warned you). In it, Patrick Stewart learns that a god-like being Q is testing all of humanity through a game. Q expects humanity to fail, and quotes Shakespeare at Stewart. So Stewart quotes Hamlet (a pretty negative guy all around) right back at him: 


“What he might say with irony, I say with conviction”. 

That stuck with me. Stewart takes a cynical, sarcastic judgement of humanity, and with full appreciation of current  shortcomings, and chooses to bet on progress and growth as the core of what we are.

It’s easy to be cynical. Pessimism seems smarter than optimism. The ability to say “we’re going to work hard to do the right thing for our customers” can sound naive, and some in finance would outright snark and smirk at it. Well, plenty of people live their lives shorting virtue, I’m sure they’ll get along fine. That’s just not my bag, baby.

I’d rather speak with conviction.

Back to our main act. The Business of Emotion. Listen to it or read the lyrics.

Now, let me say with conviction what he says with irony.

Oh I been watching you/ I’m gonna get you high

The things I do to you/ They’re gonna make you cry

So, yes, behavior is tracked. At some level, any web company has to. We need an auditable trail of if/when a client or employee did something. Timestamps, location data, pageviews: it all automatically generated from the fact that your interacting with the web service. 

So, how do you helpfully get people high, and make them cry? Encouragement, positive feedback, relief. I once received an email from a client who was a long-distance trucker, who used us to save before he spent the money. He was proud of how much he’d saved up, and how it meant he was more secure and less stressed than before. When clients withdraw money to make a house downpayment or buy a new car, that’s a reason for rejoicing. 

That email was better than cocaine.  (I’ve never done cocaine, but I’d hope so. )

Doesn’t matter if you like it or not

Doesn’t matter if you don’t wanna play my game

You signed up, You gotta participate

Ok. so this one is a bit trickier, but it’s worth discussing.

I’m helping design a piece of technology that will run, automatically, for (hopefully) millions of people. Mistakes scale up just as fast as successes. It’s important to pay attention to not just the median client, but the whole distribution, and try to make every change a Pareto improvement.

We test new products and services, we do it as an experiment, and we try and learn and iterate. Most of the time, the people who are experiencing the ‘alternative’ design or service won’t know about it.

That can be important. We act differently when we know we’re being watched. Placebos are surprisingly powerful. I want to know people are acting honestly, and that if if a new design is ossified into the system, it’s not unintentionally hurting anyone for years.

Second, and equally if not more important, is adverse selection. Suppose we let clients opt out from ever seeing the ‘alternate’ design while it was being tested, and that people who opt out tend to fall on the extreme of some behavior relating to investing. A design might deployed into the world which has a disproportionately large effect (good or bad) on the very group who we have no data on. That’s scary. 

Doesn’t matter to me cause you’re all the same

By default, all clients are just a number. Or a whole bunch of numbers, really.

And I’m not sure as a client, I’d really want it any other way. Do I really want service providers treating me differently because of how they perceive me? Their biases about my name, ethnicity, gender, skin tone, or taste in music? Should I help more attractive clients first? Or perhaps the wealthiest?

Doesn’t matter to me, cause you’re all the same.

That said, I likewise think they’re all different. We should make left-handed and right-handed scissors. We should create a service which is systematically personalized, not ad-hoc or haphazardly personalized based on the perceptions/biases of one person.

I do respond to client emails and take phone calls, and at that point they become more than a number: a voice telling me how they understand the world, where they find themselves, and where they’d like to be. And that can hit you in the gut with emotion. But you have to take that fire that this actually matters and keep it burning for all the people who don’t call in, who didn’t raise their voices.

Because they’re all the same. They all matter equally. 

Feel good

Make you feel good

I’m looking for emotion

So I know just what to show you

Yes, duh, of course, come on. I want to make people feel good. People who feel good persevere longer, solve problems better, and I want people to enjoy the time they spend with my product, and tell their friends about it.

What he says with irony, I say with conviction.

It’s worth noting that this shouldn’t just depend on the good will of the designers. Incentives matter. I chose to work for a company with a client aligned compensation strategy so that I don’t get paid to be the investing worlds version of an attention merchant

And remember, I’m not only a Betterment vice president, I’m also a client.