Episode 40: Thomas Peterffy - Founder and Chairman of Interactive Brokers

0:00All right. Great to have you, Mr. Peterfi. Thanks for coming on for episode 40. Thank you for having me on. Well, I'd love to start off early in the beginning. Tell me about your kind of family's history in your childhood, and how do you think growing up in post-World War II Soviet bloc Hungary shaped kind of your beginnings and the person you eventually became? So, unfortunately, my family was classified as the enemy of the workers' class. And as a result, teachers discriminated against me in high school and elementary school. And so they didn't... I was kind of oppressed in a way that they maintained that the workers were oppressed before communism came in or socialism came in.

1:01So as a result, I did not excel in school. I basically didn't put any energy into studying.

1:20And as soon as I had an opportunity to leave, I did. And you were kind of a businessman from an early age. you got a piece of juicy fruit gum from one of your friends who got given it by a GI and you cut it up into five pieces and sold it. And then the metal bathtubs too. But where do you think that early drive came from? Where did it come from? I was always looking for opportunities to... I mean, if you can do something that benefits the people want, if you satisfy their desire, it's a good thing for them and it's a good thing for you. if you can get paid for it. And you kind of, one of your sayings is it's important to have kind of a long-term plan to stick to it.

2:08That's what you say. That's absolutely true. It's not that it's important. It's essential. Without it, you never get anywhere. And you came to New York in 1965. What was your long-term plan then and how did it work out? 65. 65, yeah. In 1965. I'm not that old. I mean, I'm 81, not 91. Okay, so what is the question? You kind of came to New York. What was your long-term plan then? And how did it kind of end up working out? I had no plan. I just told that I will do whatever I can to prevail, to get somewhere, to provide a living for myself and to eventually have a family and you know all those things that you probably want to do I wanted to do.

3:05And your kind of first job was programming a computer at a highway engineering firm if I'm correct? That is correct. And you thought it would be easier than learning English to kind of program that computer. So tell me about kind of the role that technology and computer programs played and you starting and scaling Timber Hill? It's a hell of a jump. Well, the kind of a role, the kind of a role, the kind of a role. I mean, that's not how it works. For me to learn to program in those days a computer, which was, you know, I had to digest all the manuals and create small programs that performed engineering kind of calculations that were useful.

4:09and how did that play a role in... Well... So, you know, if you look at business over history, you will find that most successful businesses take advantage of relatively recently emerging technologies. right and computing was one of those in the in the 1960s and 70s and and it basically still today so it is it is an emerging technology and in those days it was very few businesses that have taken advantage of it and today there are no businesses that that are able to run without it so that was basically a fortunate accident that I came across this computer although the fact is that that even back in Hungary before I came I already had was interested in computers I heard about them.

5:34I was not 100 % sure as to what they were and how they worked, but I had some vague idea and I read whatever I could about them. And tell me about the story of starting Timber Hill. What was the problem you saw? How did you go about solving it? And kind of what were the early days like? story of starting timber so at one point I I got a job as a computer programmer working for a metal steel repressions metals dealer and while I was working And then there I came across a fellow who worked for an options dealer. Options exchanges did not yet exist in those days. So he was working for an over-the-counter dealer and he was a salesman.

6:36And so he basically talked people into buying options on stocks. And then when I met him, he explained to me what he was doing and that it often happened that people who bought these options, when the stock moved in their favor, they didn't want to wait. these were European type options, namely you couldn't exercise them before expiration date. And sometimes these people who are making money on these options would have liked to get out of their position, take their profit and go somewhere else. And I said, you know, that's a thing that we do. And every time they call me, I say, I'm so sorry, You have to wait until expiration day to exercise.

7:39And I said, well, you know what? Let me look at this because I know that options have a value, even when they are in the money, in excess of the amount by which they are in the money. And so I started to think about that, and I ran some simulations on my computer, and I eventually came up with a formula to value options. And so it was the possession of that formula that enticed me to go and become a member on the American Stock Exchange, which by that time was listing options and so I thought that I will go down to the floor as an options trader and I was given my formula I would have an advantage over other people who did not have a formula that told them what the fair values there.

8:51So in possession of those fair values, I started to trade options. And what was it about that formula at that time? Did no one else, obviously the formula was some kind of edge, but did no one else know how to code it? Did no one else know how to program? Did no one else want to use technology? What was it about it, kind of you and your comfort with technology that made you able to find this formula and eventually kind of, you know, build success off of it? Well, you know, even an option was worth, say$3.50 and people and I was standing in this crowd and people were trading this option anywhere between $3.00 and$4.00 and you ex-oxidate was$3.50 so I could bid higher than others because they were more uncertain than I was so I would buy$3.38 cents, three and three eighths, because in those days options were trading in eights.

9:54I would bid three and three eighths and offer three and five eighths. And that was a tighter market than what other people could do. So I did more business than they did and I made more profit than they did. Why do you think you're so comfortable with numbers and programs? Why do you trust numbers so much? Why do you love numbers so much?

10:24I don't know. It's important to be able to measure the value of things, because if you cannot measure them, you cannot value them. So if you can measure the worth of something, then you are able to transact in those things, because you know exactly how much they are worth. Before we go back to the episode, I want to take a short break to talk about my sponsor, Rowe. The Generating Alpha podcast is presented by Rowe, the all-in-one banking platform for startups. Thousands of startups like Perplexity, Product Hunt, and more use Rowe. You get everything you need to manage your startup's cash. Fast banking setup, cards with up a 2 % cash back, and yield that turns company cash into extra runway.

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11:49Thank you and back to the episode. And tell me about those handheld devices that you created for Timberhill. I'd love to hear about how that came to be. Hmm. I actually have one here that I could show you. Well, but, you know, it's again was a computer that I could, my employees could use on the floor to get the values of options that in these handheld devices, I burned my formula into those chips and so those chips could calculate the value of any option that the person would ask you to calculate. And if I'm correct, during the kind of later days of Timber Hill, you started kind of letting computers trade on their own and put in orders on their own.

12:45And And then a NASDAQ employee came in and said that you have to have actual people put in the orders. So you built a mechanism to type in the orders. And my question around that is, that was kind of like going around the rules or pushing the boundary of the rules. Do you think people have to push boundaries and push the boundaries of the rules to be successful? Do you think that's what it takes to build something great? Well, certainly if you think that you have a better mousetrap and people would benefit from your use or their use of that mousetrap and there is something in the way that doesn't make any sense, then it's your responsibility to try to overcome those barriers.

13:35And I'd love to talk a little bit about interactive brokers. So if I'm correct, you started interactive brokers in 1993. And at that time, there was not that much demand for electronic trading, but you captured demand that came kind of a little bit later. What did you see at that point in time that told you you wanted to start it? Well, I didn't know any other way. So my idea was always to use technology to make things better and faster and more productive. So that's why I did that and the idea was very simple. In those days, people where the exchanges worked by open oddcry and stock indexes just became popular.

14:26and stock index futures where the S &P 500 futures which still today are the most frequently traded stock index. And if you ever want to know where the market is, people tell you about the S &P 500 index, whether it's an up or down, by how much. So it was traded at the Chicago Mercantile Exchange in a trading pit. And my idea was that I just was able to build a radio-driven handheld computer that could buy a radio waves, receive messages and data. So my idea was that I had my people standing in the pit, that I would be able to execute buy and sell orders for the future contract. contract if I could have my customers around the world wherever they were connected to my main computer via the internet which just started to really become popular in the early 90s, that I could give them a trading screen that they could download on their home computer, and they would see always what the markets were, because my people would stand in the pit.

16:29One of them would have all the buy orders, the other person would have all the sell orders, and they would stand in the pit being able to trade with the crowd and whenever somebody sent them an order they would have those orders and those orders when somebody sent an order everybody who was connected to my computer would see what these people would see in the pit and thereby they could interact with the pit and with the world, with other traders around the world. So that's why I called it Interactive Brokers. And so that's the idea. And you say you've never read a business book in your life. And I look around and I see a lot of books about history.

17:16If I'm correct, you started learning about capitalism through a lot of kind of classics of people like Balzac and Dickens. And so what did those books teach you about kind of the fundamentals of building something great, building something bigger than yourself, building a business in capitalism? So the problem was that when I grew up in socialist Hungary, there was very strict censorship. So books about capitalism were nowhere to be found, but my grandmother had some of these classic books. So that's why I could read these classics. And obviously these books were mostly playing out in London and Paris about people who wanted to get somewhere in life and they inevitably would get into business.

18:19and it was their story. So that's why they were important to me because that's why I realized that if life is all about, not life, but a productive life is about creating things that other people would benefit from and they are willing to pay you for it. And to that point, you said that building a big business business is simply about creating a really, really good product and just delivering it at a better deal to the customers. What factors go into building that excellent product? And how do you define an excellent product? Well, as far as investments are concerned, an excellent product is something that helps people to make money by investing.

19:11And as you scaled interactive brokers, you're running profit margins above 70 % above Visa, numbers unheard of in the world of finance. And you still own a... What did you say? Your profit margins are above 70 % for interactive margins. Yes, true. 70 to 80. And you still own a majority of the business. How did you build a business so capital efficient that you didn't need outside investors? By automation. So it's relying on computers more than my competitors do. So, you know, it's all about we try to automate everything. And when something is automated, it basically costs nothing to do except the electricity and the hardware.

20:00And you have, if I'm correct, over 3 ,000 employees at Interactive Brokers right now. In 10 years, as you keep automating and automating, how many employees do you think you'll have? Hopefully less than 3 ,000. And I want to ask a question related to Hungary, because you're Hungarian, George Chiaros is Hungarian, and there's a bunch of Jim Breyer, Andy Grove, there's a bunch of successful Hungarians in the United States. I actually hold a Hungarian citizenship, although I don't speak Hungarian. But what is it about Hungary that makes all of you so successful? What do you think is it about there and the childhood growing up there?

20:32What is it about? I think it's the language. The Hungarian language is very similar to a computer language. It's very clear, the words are very well defined. It's completely phonetic, so you don't have to worry about how you spell a word. All words are spelled the way they sound exactly. so it's a lucky language very simple, no kind of bullshit straight to the point you came to the US in 1965 and you obviously made an incredible living for yourself, building a 120 billion dollar business it took a very long time I mean I didn't become wealthy up until maybe 30 years ago do you think someone coming to the US today could build the same thing that you have?

21:30no, of course Do you think anything has changed about that? Do you think they have more opportunities? Do you think they have less opportunities? Or do you think it's just the same? Well, you certainly have to get up to date on what's happening in technological developments and get into a business where you can point at a technological development that nobody is using in the business and therefore you being the first one can do better and provide better goods or services than other people do by the use of that technology. And I want to touch a bit on efficiencies. What do you think is the biggest inefficiency you see in modern finance and what is that thing you want to solve next?

22:23Oh, the biggest inefficiency is still having to do with the laziness of people. People don't really try to find out what is most missing in any situation that they could then provide and take advantage of that. It's always, you know, whatever you do in life, if you can make something better for others or easier or, you know, cheaper or more profitable, if you do that, that's always what gives you the advantage. And over your, talking about humans, over your 81 years of life, what are the biggest lessons you've learned about human nature?

23:41I have a question. What is the best? Or biggest? What's the most important lessons or the most unique lessons that you think? People are incredibly gullible and lazy. Leave it at that. and you've been automating for your entire career with timber hill now with interactive brokers is there a point where there's too much automation is there a point where automation is not good no i mean that's what ai is basically about it's it's no automation is always good

24:22Automation is good. Nature is good. Being out in nature is a wonderful thing and you need time to do that. To the extent automation saves you time, you have more time to spend in nature. Over the building of Timber Hill and Interactive Brokers, what do you think was the hardest point you had across all of them? the hardest moment you had and I'd love for you to like just go into that and explain that hardest moment I had I had a few hard moments when I came very near bankruptcy and those are always the hardest moments is there is there anyone that stands out is there any like story you'd like to tell or yeah at one point I had a completely automated system as you just said and that was a market making system.

25:20In other words, it made bids and offers on computers and I had people on the exchange floors looking at those computer screens and acting on those bids and offers, buying and selling on those bids and offers. And for a specific reason, I could not go to work one day. And that was the day in 1989,

25:55when United Airlines declared bankruptcy and the market collapsed. And it was falling very, very fast. and my programs could not keep up with the speed in those days because that never happened before, so I never provided for it. And so the people on the floor ended up buying and selling and buying higher than they were selling and buying and selling and buying and selling, losing a lot of money in the process exactly the opposite as it worked on most days where they were making a little bit of money. On this day, they lost an awful lot of money. So by the end of the day, they lost over half the capitalization of the company.

26:52But by the time I got to the office and realized what was happening, because I had people that were... not as street smart and practically minded and they were sitting in the office working on esoteric stuff instead of pulling out the wires and stopping the whole music. On that day we lost over half of our capital and then I had to see what I was going to do, whether I would go back and risk the remaining amount, because you see,

27:41I never worked for anybody else except for the very beginning, and I didn't have a college degree, so I couldn't have gotten a job. I said to myself, here I am now. I think I had something like$10 million left, which in those days was fun. It was like 50 million today. So I said, well, maybe that would be enough to live on if I can never get another job. And I had a family, so I could provide for my family. And maybe I should stop now or go back and risk it. And after a while, I decided to go back and risk it. And through all those moments where there's kind of the risk of going bankrupt and those very hard moments, even the ones that are kind of early 2000s or mid 2000s, if there were any one of those, what do you think, even when you have enough money to just stop, what do you think keeps you going?

28:46Oh, the challenge and the potential achievement, of course. I mean, that's what keeps you going, right? It's like climbing a mountain and, you know, you want to get to the top, right? And you said that moment when United Airlines almost went bankrupt, it was an event you didn't plan for. It was kind of like a black swan event. How do you plan around, how do you think about black swan events and events that you just can't predict? How do you build models around that? Well, it's very simple. One thing you can do about it is just to stand up. And you have said that Interactive Brokers has positioned itself at the intersection of four historic trends.

29:25globalization, adoption of technology, spreading equity culture, and optimizing the allocation of resources. If you were building something today from the ground up, new, what trends would you be looking to build in between?

29:41Well, those trends still exist today. I would look at those same trends. those are very long-term trends. How do you spend your time at this point in your life? What does a day in the life of Thomas Petterke look like? I still work about eight to nine hours a day, every day, seven days a week. The rest of the time I'm with friends and have dinners and parties.

30:25And your question is, what does a day look like? So I still work, as I said, and I am developing something called forecast trading, where we ask, we have contracts, which are basically questions, and you can answer yes or no, and if you are correct, you get a dollar, and if you are incorrect, you lose the money you put up to buy the question, to buy the answer. So questions like what will be the CPI coming out next month, the cost of living index, or who will be the mayor of New York City? Will it be Mondani or Cuomo? And that is an insane question that this would be, that the socialist is very likely to become mayor of New York City.

31:37It staggers my mind. It's the regret that people never learn from history. I do not understand that. So as I said, what I think is a thing about human nature is people are lazy, they don't think, they don't look at what history could teach them so they could save a lot of pain for themselves. It's just horrendous. And as someone who grew up in a socialist country, if you were to give one message to the people of New York right now who are likely going to elect Mamdani as their next mayor, what would that message be?

32:21try to make this experience as short and painless as possible and my final question that i ask all my guests um and you've said people should use fewer words if you were to give one piece of advice i'm 16 today to a 16 year old today it can be about anything career life romantic whatever it is in just a few words what would it be

32:53my few words would always be always have a plan and work on your plan look at it every day change it when you need to but make a step no matter how small to progress along your plan and i want to ask one follow-up question to that do you think people should have a plan b

33:18if something doesn't work out if their plan doesn't work out you think they should have a fallback plan or is it just good to go all in on one thing well the fallback plan if if if your plan is such that it it it can become unrealistic then your plan should include uh an alternative but a good plan should never be something that cannot be achieved. Well, it's been incredible having you, Mr. Petrfi. Thanks for coming on for episode 40. It was a great conversation and thanks for having me at your beautiful home. Thank you.