How are investing and poker alike?

  1. They’re both quantitative disciplines requiring an understanding of probability and of working with partial information.

Both investing and poker are highly dependent on math, probability, statistics, and knowing what you don’t know. With poker, there are 52 cards in a deck, four suits and 13 cards in each suit. The chance of picking any particular suit in the next card is 1 in 4. The chances drawing an ace is one in 13. And the chance being dealt a royal flush in a five-card hand is one in 650 thousand. Everyone at the table knows these facts. Everyone at the table knows their own cards. And no one knows anyone else’s cards. But we can make educated guesses.

With investing, we know each company’s business strategy, their targeted return on investment, their profit margin, their revenue growth over the past five years. We know management’s history, their incentives, their track record. We know the assets the company holds. We don’t know their trade secrets, their proprietary formulas, or what consumer tastes will be next year. We don’t know what the economy is going to do – although we can make educated guesses.

We don’t know what the next hand will be like, and we don’t know what the future will bring. But the only way to win in either case is to be present at the table.

  1. Long-term success in both cases depends more on managing ourselves and less on our circumstances

There’s a phase that comes up when people play poker: “if only.” If only my opponent didn’t have three-of-a-kind. If only I hadn’t folded early. If only I had a better night’s sleep. When a poker player starts thinking about things happening to them, rather than what they’re doing, it’s time to stop. No one is ever forced to increase their bet; no one is ever forced even to play. Poker is all about what what we do, how we play the hand we’re dealt. If we’re too conservative, we never advance, but if we’re reckless, they we everything. Managing the stake – what’s on the table, and what we take off – is critical.

Royal Flush

In the same way, the most important element of an investment portfolio is the investor – our goals, needs, concerns, and limitations. A sophisticated investment strategy is worthless if we can’t stick with it. Two very different stocks make this clear. If you had purchased Berkshire Hatheway or Amazon stock early in their public issuance, you would have enjoyed massive, massive gains over the long run, multiplying 53-times in the case of Berkshire, and an eye-popping 2400-times in the case of Amazon.

But the road to riches is never smooth. Berkshire shares declined by 50% in the late ‘90s and during the financial crisis. Amazon shares also fell 50% during the financial crisis, but they also fell 95% during the dot-com bust. One popular blog labled Amazon shares their “Stupid Investment of the Week”! And with each decline, it wasn’t clear what the company’s path forward would be. Without a clear financial plan that fits into the rest of our lives, it would be hard to hold onto our positions in the midst of such uncertainty.

Source: Bloomberg

Managing ourselves is the most important part of managing our money. If we have a plan, we’re far more likely to keep our heads when all the world seems to be losing theirs.

  1. Neither investing nor poker are gambling.

This is no surprise when it comes to investing. After all, investing is putting your funds into the economy – as a partial owner of a firm (stocks), by lending it to the government (bonds), or by holding the funds in the bank (cash). That’s not gambling or speculating, it’s prudent money management.

But how is poker not gambling? For one thing, you get to see your cards before you place a bet. There’s uncertainty, but it’s “bounded” uncertainty. You may not know what will happen next, but whatever happens will be within the rules of the game. Most importantly, there’s a significant amount of skill necessary to win at playing poker – knowledge of yourself, knowledge of the cards, and knowledge of your opponent. In fact, the skill component of poker is so critical that in 2012 Federal Judge Jack Weinstein issued a 120-page ruling declaring poker to be a game of skill, not chance.

That’s why there’s a “World Series of Poker.” That’s why the best players rise to the “high stakes tables.” That’s why people can improve over time.

Judge Weinstein

So how are they different?

Poker is entertainment. It can be exhilarating. It can teach you about yourself. But at the end of the day, no additional money is ever added to a poker table. The money is just redistributed, from the losers to winners. Poker is a “zero-sum game.”

Not so with investing. Investors put their wealth to work in stocks, bonds, and cash, and that money gets recycled through the economy, increasing as the economy expands – or as businesses adapt to new circumstances and new technologies. That’s why the market can grow, even when the economy doesn’t seem to do very well. Investing is a “positive-sum game.” When we put our funds into a company with good ideas, and that company delights customers and provides a healthy place to work and thrive, everyone wins: investors, customers, employees, and the larger community. It’s also why investment thrives on innovation.

Investors and poker players can both learn from each other – how to manage their stakes, how to control their emotions, how to improve their skills. In both cases, both need to know — in the words of the famous song: “When to hold, ‘em; and when to fold ‘em; know when to walk away, and know when to run.” But investing, with all its challenges, really can make the world a better place. That’s why a well-structured investment plan can be so rewarding – in many ways.