Parallels Between Gambling And Investing

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I’m writing this while at the airport on the way to Las Vegas, so please bear with me. The analogies might be a bit of a stretch, but here are some ways I think gambling is a lot like investing… Debate as you like.

Costs matter. If you believe that the stock markets are very efficient, like I do, then the market is already priced with all the information publicly available. Any market moves are in response to fresh news like unexpected earnings report results, which are unpredictable unless you have insider information. Thus, the best you can do is try to match the market. Any costs like expense ratios, fees paid to financial advisors, extra taxes from turnover, or commissions, simply cut into your returns.

Take the house edge in gambling games. Obviously, the best way to keep your money is to simply not gamble. (Or maybe play the nickel slots slowly, tip well, and end up getting drinks for $1 each…) If you do gamble, then you have the chance to win money, but also a chance to lose money in the short run. But over the long run, your chances of winning get very very slim due to that house edge. All you have to do is look around Vegas to see this.

The house edge is like your investment costs. With investing, you try to pick your own stocks or go with actively managed funds which try to beat the market, usually with a significantly higher cost. Over the short run, they might beat the market handily. But over the long run, the odds of your fund beating a similarly allocated lower-cost index fund are very very small. (Not impossible by any means, but small.)

Most people don’t really understand costs. What’s the most profitable game per square foot in Vegas? Slots. What’s the most common game in Vegas? Slots. You see a bank of slots under a sign that says “up to 99% payout!” You know what that means? One of those machines is set to a 99% payout, and the rest are at 80%.

Why does everyone play slots? Lots of reasons, but one big reason is that they are really simple. You don’t need to learn any rules. You mash a button repeatedly. That’s it. But the odds are the worst by far. In fact, you don’t even know the odds. I hate playing the slots (again, except as a tool for getting cheap beers).

Personally, this makes me worry a lot about the self-directed nature of many people’s 401k/403b/TSP plans. Do they really know that they are investing in? The 401k industry seems to rely on the fact that most people just go with the default choice given to them. Few people question their investment choices. I don’t have the article on me right now, but something like 80% of 401(k) holders have no idea what expenses they are being charged on their retirement accounts.

People see patterns where there are none. One brilliant invention of casinos is adding the marquee display to roulette that displays the last 10 numbers hit. If a person sees 6 reds come up in a row, they might think “Oh, it’s due for a black” or “Red’s on a streak”. In fact, it remains an equal chance for red or black. One of my hobbies is listening to people’s wacky betting systems at tables. If there were any such patterns, you can bet people would exploit it greatly for profit.

Of course, Vegas is just entertainment. But losing 1% or more of potential return every year by paying excess costs is huge. Now that I have spouted all this analytical reasoning, wish me luck in Vegas! πŸ˜‰

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  1. “I don?t have the article on me right now, but something like 80% of 401(k) holders have no idea what expenses they are being charged on their retirement accounts.”

    They certainly don’t make it easy. I’ve tried to figure out how much my 401(k) ends up costing me, but they hide the data very well. My statements don’t show a breakout for costs, they just show the change in the fund value. I can look at the prospectus for each possible fund to find the costs, but there’s no way to check the claims against my case, nor do they make it clear how transaction costs are handled.

    I’ve resigned myself to putting all the 401(k) money in an S&P 500 index fund (which had the lowest expense ratio listed), and converting to an IRA as soon as I leave this job.

  2. Another interesting comparison would be to tournament poker. Generally the house takes a small piece over every pot but the rest of the money stays on the table and someone will win the money. A lot like investing where you have to pay to put your money in the game either through commissions for stock purchases or through fees in an ETF or mutual fund. One thing to think about though, while gambling is a zero sum game with distinct winners and losers, what about investing. I would hope that everyone who invests could be a winner but then is there a loser and if so who?

  3. It is my understanding that slots often return over 90% of their take back. But there is so little labor involved in running slots that even a 10% take or less is very lucrative.

    By the way, here are two analogies to slot machines for you. If a slot really does return 90% of your money, then over time you experience a 10% decay rate (yes, just like radioactive decay). That means your money has a half-life, some period of time at which point half you money is left. Wait another period and you are halved again. Halflives are good for radioactive metals, but not for money.

    Another case where your money exponentially decays is precious metal storage. Consider that an electronic currency like e-gold, even if it is backed by real gold is a bad investment. You pay a storage fee of 1% per year last I checked, so again your money is exponentially decaying, has a half-life, etc.

    You really want investments where your money is exponentially growing (i.e. where you have compound interest).

    I’ve found investing to have an element of gambling to it, different from the one you mention. I’m a pretty regular small stakes poker player. Now, many poker players feel like they win on average and are deluding themselves. Many investors share the trait, they feel above average.

    I probably am above average for my group, but I have also studied poker pretty carefully and have a reasonably library of poker books to show for my trouble. I’ve been ahead in every game I’ve played for the last 2 years, currently 8 straight.

    I made it a goal to pick two individual stocks last summer and invest $500 in each. I read prospectuses of I don’t know how many different companies. I remember when I finished one particular one, I had the same feeling in my stomach like when I hold a full house in a poker game. You know you can lose (and I’ve seen my share of bad beats), but you’ve got a pretty good shot at coming out ahead.

    If you study poker, you’ll find out that the small stuff is very important. The most common mistake is staying in too many hands. People are tempted to tag along because it’s small money at first, but you get nickeled and dimed to death, and you can’t make it back on the hands you win. An like baseball you lose more hands than you win.

    I’d personally draw the parallel between folding out your losing hands quicker to reduce your losses with working to keep your fees and expenses low. It seems like small change, but it’s a big difference between the good players and the poorer players.

  4. Joseph Sangl says:

    I think investing is a lot like gambling from the emotional side of things too!

    When the market is on a huge run, I can hardly convince myself that it really is time to get out. When gambling is on a huge run, I am sure that it is hard to convince oneself to get out while the getting is good.

    Have a blast!

  5. The only casino game I play is poker. There is no “house edge” per-say, although casinos do take a “rake”, or cut, which is a small percentage of the pot. Some casinos collect a small fee every half hour or so.

    What attracts me to poker is that you’re not playing against the casino but rather against other people. It does involve some degree of luck but in the long run it is a game of skill. It takes quite some time to develop the strategies and skill set of a consistent winning player, but the rewards can be huge.

  6. I have to say I’m not a fan of casinos in general. My wife and her mom are more interested. I and my father-in-law play Jiminey Cricket and remind them to cash out should they hit a decent run.

    Well, on the 6th of this month, I went with my wife to our usual Easter-time casino….only to have a particularly bad run of things. She lost her entire “gambling allowance” that she brought. So we were on our way out, when she gets the wild impulse to spend “just a little more”. The machine had a modest payout (I loaned her $5 and we cashed out what was SUPPOSED to be $15). If you can see where I’m going… I took the somewhat heavy bucket of $15 worth of nickels to the cashier…it came out OVER the $15. We tried it one more time before leaving…it cashed out higher….what we had was a ONCE-IN-A-LIFETIME crack at a malfunctioning coin hopper. Needless to say I made a return trip later that evening…..I tried to keep in low key, but the machine was still shutdown the rest of the weekend (A.K.A. someone noticed…) If I should ever see this chance again, I’ve got a revised plan that might prolong the fun.

    This is the ONLY time I’d consider gambling, but you’d have to play (and cash out) to notice the malfunction. This was one time, I didn’t regret playing the slots.

    (I just had to tell this story…it was just SWEET! compared to the normal house edge!!! Hopefully, no one from that casino is reading this blog…I don’t want CE-ment shoes courtesy of Mr. Capone III)

  7. Costs are the reason the casino and the stock brokerages exist — but I don’t think that factors into a person doing well vs. doing poorly with investments. A real gambler invests until he loses his shirt. That’s the way to go. I know a few people who were up more than $100K in the stock market (before the bad old days hit), but they wouldn’t cash out. I would never let more than $5K slip through my fingers (unfortunately I didn’t have a chance, since I picked all losers and slowly lost $15K over 2.5 years). I will never go back to thinking I can pick stocks like a magician. All my money is now managed by professionally (TIAA-CREF) led funds. I don’t think I’m stupid — but no, I am not the ultimate stock picker, nor am I lucky. But I know the some of the same people who lost a ton are now back in the market again. And now they are getting “educated” – so they don’t appear to be “gambling” anymore, but investing.

    I would invest in index funds (even by myself), but my funds are already spread over index funds and hedged in a much better way than I could do myself.

    Gee, I just realized that I think people can do a better job for me in so many ways; from managing my money, to doing my taxes, to selling me a house. I’ve done them all — and not so well — and now gladly hand these things over to a professional. I’m also ready to hand my house cleaning over to a maid :). I’d rather be programming than mopping the floors.

  8. Jonathan,

    I hope you have an answer for my question.

    Currently i am renting and am able to take a percentage of the rent as a business expense because my office is set up at home.

    If I were to purchase a home outright (with no mortgage), can i still claim part of the home as an office expense?

  9. Jonathan,

    Basic strategy and card counting allows you to break even or even get a slight edge w/ some practice. If you play table games a lot, it’s probably worth learning.

  10. I think a closer analogy is poker, which is skill based but has a heavy short-term bias toward luck.

    As a serious amateur online poker player, I’ve made a nice profit over the long term, but the short term fluctuations are quite a ride. In poker, just as in investment, an only moderately skilled person can beat the game simply by understanding and applying a handful of winning techniques consistently. The key is to keep emotion out of your game and always take the long view.

    Greatly talented players can take any two cards and play them in a way as to be +EV. The rest of us (winning players) make hand selection the first line of defense against losing all of our chips. Simply put, some hands in some situations are tempting, but likely to get you in trouble if you don’t know what you’re doing. The same can be said about investing. Know your limitations, select your companies carefully, and don’t succumb to what us grinders call “fancy play syndrome.”

  11. Sorry, I’m falling behind in the comments. Vegas is great, I’m up some $$, and got our room upgraded to a room with a hot tub. Score!!

  12. When playing table games…and you mention loudly…oh there should be 1 more Ace left coz 7 aces are already out….does that constitute as card counting? Can they kick u out of the casino?

  13. I am sure that gambling can be equal to investing if you call that betting. And it is not just a words play. If you gamble, play cards, casinos, whatever, yes, it is a question of luck and it can not last forever. But, I have been investing in sports betting since 2005 and I have one very good long term profit. Why? Because i have a strategy, the same as I would have on the stocks market, pretty much. I do researches, i do verdicts on “is that team going up or down”, i put my money down on bets that answer a long list of criteria.
    Of course, It happens i lost some money, but no more than i can afford to lose. So build your strategy and follow it closely, than you can call that investing, does not matter gambling or playing on the stock exchange.

  14. They can kick you out of the casino for any reason or no reason at all. You don’t have to mention anything. They are studying how you play. If it even LOOKS like you are counting cards, they’ll throw you out.

  15. I suppose if they knew who you were , you’d be getting COMPS like the “Whales” down there. πŸ™‚

    Is the hot tub shaped like a heart?

    I’ve had the best luck going further down the strip (towards downtown) and finding $3 blackjack. I love the game but can’t bring myself to play at $10 tables in all the “BIG” casinos. If you end up splitting the cards or doubling down, it makes you sweat at those $10 tables.

    One of my favorite things to do down there is to wander over to the high dollar tables to watch. I’ve seen guys play $50K per hand blackjack. Talk about drooling.

    I hope you have a good time down there. Check out the Pirate show at Treasure Island. It has gotten a lot more risque in the last year or so. One tip is to go to “Tangerine” (club at Treasure Island) early. You can get in pretty easy and then watch the Pirate show with really good seats, and a drink in your hand. Last time we were there, the big celebrity was “Principal Belding” from Saved by the Bell. (Yeah, pretty pathetic). Then Robin Leach showed up with a bunch of skanky women on his arms.

  16. investing = gambling plain and simple.

  17. Hazzard, is Jonathan a big shot in the west coast? Why would he get tons of comps?

    In vegas, if u want something to happen, u gotta slip them a twenty.
    That simple!!

    I rented a $50 room and instead got a presidential palace with 2 floors that could have fitted around 100 people easily.

    Its all about the money.

  18. I was joking about Jonathon being a WHALE, although, maybe he will be someday!

    Of course, once he becomes a whale, he’ll have to lay off the coupon runs…… πŸ™‚

  19. I think about this comparison a lot. But I think the big difference is that market returns 110% (per year minus expenses) while the casino returns 90% or less on each bet. So the fees are important but it’s relative to the baseline of a winners game (by 10% or whatever) in the market.

    There are obviously plenty of ways to lose money in the stock market and not get your 10% but thats a matter of self control or not investing in index funds.

    The biggest similarity in my mind is the principle that causes people to lose 100% in the -10% game of vegas – if you keep betting until you lose it, your return rate is very a predictable 0%. That also applies to the stock market.

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