The Family Office Chronicle December 2022

A Cautionary Tale

Last month, the biggest news in finance was the sudden and historic failure of FTX, the digital coin exchange founded by the precocious Samuel Bankman-Fried, whose candle shed a brief but lovely light, only to be snuffed out in one of the largest financial failures in world history.

An Epic Fail Provides a Lasting Lesson

The rise and fall of Bankman-Fried demonstrates, in a very dramatic fashion, the difference between investing and speculating. It’s vital to understand the difference; it is possibly the most important distinction anyone striving to build real wealth should understand. 

SBF, as he is known, amassed a fortune estimated at over $25 billion in just four years. His enterprises included the cryptocurrency derivatives trading platform known as FTX and FTT, FTX’s token. No normal person could be blamed for wondering what any of that means. 

A crypto token is “a virtual currency token or a denomination of a cryptocurrency. It represents a tradable asset or utility that resides on its own blockchain and allows the holder to use it for investment or economic purposes.” In other words, a token is money, and SBF is responsible for losing a ton of it. 

To the unaffected, there is an air of unreality about it all. Even SBF himself does not seem to appreciate the scope of the disaster.  “I was responsible ultimately for doing the right things and I mean, we didn’t. Like, we messed up big.” How big? To phrase it the way the English commonly do, eight thousand million big. That’s the amount of money that’s gone missing from FTX customer accounts. 

Fraud or mismanagement isn’t the only cause of losses for digital coin investors; cryptocurrencies, like Bitcoin, have had a tough time lately. According to CNBC, “In the 12 months since bitcoin topped out at over $68,000, the two largest digital currencies have lost three-quarters of their value. The industry, once valued at roughly $3 trillion, now sits at around $900 billion.”

FTX isn’t the only disaster linked to SBF. Alameda Research, the cryptocurrency trading firm he co-created in 2017, has declared bankruptcy and lost billions in investor funds.

It will take investigators some time to unravel the mess, but it seems entirely possible that Alameda simply gambled away billions of dollars of FTX deposits that appear to have been improperly transferred in violation of the exchange’s terms of service. If true, that is bank fraud on a massive scale.  

As many as one million customers may ultimately be affected, according to bankruptcy documents. That includes Kevin O’Leary, the Shark Tank huckster who has termed Bankman-Fried a “savant.” We’ll have to see how much damage has been done to Mr. O’Leary’s reputation as a savvy investor. 

Savant may be overstating things. From a recent article in CoinDesk, a person close to the matter describes things this way: “The whole operation was run by a gang of kids in the Bahamas.”  

One of those kids, the waif-like, 28-year-old math nerd CEO of Alameda, Caroline Ellison, has made some telling remarks that should have given investors pause. On an FTX podcast in 2021: “I do think a lot of crypto projects don’t have much real value.” On another she said: “Young people tend to be too risk averse.”  And this post on Tumblr: “Oh thank god, I think I fooled them into thinking I’m a real adult.”

Ms. Ellison, Bankman-Fried and many others involved may have several decades to contemplate risk aversion and the meaning of adulthood while in prison.

If It Seems to Good to Be True…That’s FOMO

The rest of us can take away some critically important lessons from the FTX debacle. These include: if it seems too good to be true, it probably is; slow and steady wins the race, and the timeless there ain’t no such thing as a free lunch.

The investment philosophy that guides the wealth of the wealthiest Americans can be described as disciplined. It’s a discipline that is applied to measurable things, which include the costs of financial products, tax strategy, diversification, and risk alignment. Everything else — literally everything– — falls under the category of speculation. 

It’s not that the uber-rich don’t speculate; they often do. But with rare exceptions they allocate only a small portion of their total wealth to speculative things, like Bitcoin. According to Forbes, just 1% of the average family office portfolio is invested in cryptocurrencies. (A family office is an entity established to manage the wealth of a very wealthy family.)

Even major investors in FTX, like the hedge fund Sequoia, were careful not to over-allocate.  According to Bizjournal, Sequoia said “it will take a $150 million loss on its investment from one of its funds. But it said that loss is offset at that particular fund by about $7.5 billion worth of gains,” from its investment in companies like Apple, Google, PayPal, and Zoom. 

We doubt that Sequoia, or its limited partners, will suffer very much from the loss on FTX. And remember, before FTX blew up on November 11th, investors believed they had a winner, and a big one. 

Although FTX has a presence in the US, it is headquartered in the Bahamas, far from US banking and securities regulators. It seems clear that many investors in FTX simply took all they heard from SBF on faith, and allowed FOMO — fear of missing out — to affect what should have been a much more diligent inspection of the firm, its leadership, and its operations. defines FOMO as “anxiety that an exciting or interesting event may currently be happening elsewhere, often aroused by posts seen on social media.” Long before FOMO, or even social media, were memes, this essentially human bias fueled the mega frauds perpetrated by Charles Ponzi and Bernie Madoff.

Slow and Steady Wins the Race

Most of us are familiar with Aesop’s fable about the tortoise and hare. It should be the guiding parable for investing: you can be more successful by being patient and disciplined than by being impulsive and reckless. The simple truth is that most Americans cannot afford to risk their retirement security on speculation. Yes, the payoff can be big, but that’s because it usually isn’t. Speculation often ends in a total loss. 

A review of some of the risks that were assumed when investing FTX would be daunting for most:

That the underlying “money” of FTX, the FTT coin, would hold its value, which in our opinion, appears to have been based on literally nothing.

That FTX itself would be properly managed.

That the Bahamian regulatory regime would be up to the watchdog role on a technology–blockchain–that is designed to be untraceable.

That a bunch of 20-somethings with a background in math (but not in finance) would be able to lead a complex multinational organization conducting millions of transactions.

That various governments might at any moment pass laws or regulations that essentially remove the core protections of blockchain technology, and 

Concentration risk. That is a specific type of risk that financial analysts carefully consider; it is essentially cured by diversification. Concentration risk can exist when a single type of asset class dominates any portfolio, or when a group of asset classes move in unison in an unfavorable direction. 

FOMO is a powerful drug, manufactured as a stew of hormones in the human body. As diversification is a cure for concentration, transparency can be a  cure for FOMO. In the crystal clear light of hindsight, we can see that FTX was a spectacularly risky enterprise — few multibillion-dollar companies lose 100% of their value in a day or two.

Is this the end of crypto? No one can say. But one thing seems clear: putting your money into a cryptocurrency is not investing–it’s speculating. Until it becomes diversified and transparent, it will remain so. 

The Takeaway

Making massive bets on non-transparent speculations is not how family offices manage their affairs. The directors of family offices, which are typically led by accountants and estate planning professionals, have a fiduciary responsibility not to take uncompensated risks. 

Despite this sober approach, clients of family offices have enjoyed remarkable wealth appreciation over the past several years, as you can see in this chart, which beautifully illustrates the wealth gap we hear so much about:

If you’re thinking that this is all Elon Musk and Jeff Bezos, keep in mind that the top 1% of Americans is over three million people. Clearly they are doing something right.

You can, too. Here are some simple rules:

  • Focus exclusively on things that can be predicted and controlled. As mentioned above, these are costs, tax efficiencies, diversification, and risk alignment.
  • Avoid speculation and its dark rider, non-transparency. Avoid it if you can’t explain how an investment works or why it’s good for you.
  • Seek and accept advice only from true fiduciaries. These are people who are obligated to act solely in your best interests and whose personal goals are entirely aligned with yours.
  • Learn to recognize that FOMO feeling, and do your best to ignore it when it comes on you.
  • Always remember that success in investing is the result of discipline and patience. Over the long haul, a well-diversified portfolio will give you your best risk-adjusted shot at real financial security. 
  • If you would like an objective look at your own financial situation, we can help. We will be happy to prepare a TMA Report for you without cost or obligation. The TMA can reveal opportunities to lower costs, improve tax efficiency, eliminate concentration risk and inform you about your downside loss exposure. 

For your complimentary report, click here to book an appointment with me. I’ll explain how the process works and the information we need. This is a part of the service we offer, and we strongly encourage you to take us up on it. 

It’s the holiday season. We wish you and your family a happy, peaceful, and joyous one.