Vintage US dollar

Poker vs. investing

The beautiful thing about poker is that everybody thinks they can play.
– Chris Moneymaker, 2003 WSOP Champion

A friend and very good poker player asked me, “Why do less skilled investors keep trying to beat the market? Why don’t they figure out that they are the suckers and quit?” Winning players – in poker and investing – need less skilled players to stay in the game or for new casual players to try their hand.

If 10 poker players sit down with $1,000, there will be a total of $10,000 in play. The house takes a cut of each hand so, at the end of the night, there might only be $7,000-8,000 left. That’s divided up 10 ways so, on average, the players lost money. The best 1-2 players will take the lion’s share (over the long run).

So, why is it that less skilled players keep playing?

Some parallels between poker and investing

1) Entertainment: we might not care whether we win or lose as long as we have fun.

2) Overconfidence: we believe we are better players than we are. That is, we think we are in the top 10 to 20%.

3) We don’t measure our results: casual poker players and casual investors often don’t track their results. They may remember big wins or losses but don’t track overall performance, which is what matters.

How does investing differ from poker?

1) Positive expected returns: equity markets go up over time. So, the total pie – in investing – is bigger at the end (even after deducting the “house’s take”*). Only the best investors generate excess returns (“alpha”). But even bad investors can finish ahead, especially in a long bull market – e.g., see the last 10 years. So, less skilled investors may still feel like they “won” because they finish with more dollars than they started with.

2) Don’t “see” the competition: if you sat down at a poker table and each player was sporting a World Series of Poker bracelet, you might get up and try to find a weaker game. In investing, everyone is sitting at the same table. So, who is sitting down with you? You might prefer to believe a hapless amateur is on the other side. But institutions and professional investors make 90% of trades today. You are competing against world champion investors – Renaissance, Citadel, Appaloosa, Tiger, and many others.

3) Small sample sizes and long feedback cycles: in poker, you might play 20-30 hands per hour (more in the days of online poker). Over a few weeks or months, you’ll play thousands of hands and have a decent sense of your relative skill (IF you measure results). A prolific investor might only make a handful of investments a year and it often takes years for results to come in. So, it can take 15-20 years – a career – to accumulate enough investments to know if an investor was truly skilled or just lucky.

4) Easier to rationalize losses: poker is a “closed” system. Yes, there’s hidden information and luck in the short run. But markets are more complex and have unknowns and “black swans.” It is easier to rationalize investing losses – we would have done okay but for the ______ (pandemic, Federal Reserve, etc.). So, we often chalk up losses to bad luck and wins to our skill. In poker, if you keep drawing to inside straights (a long shot hand), you’ll eventually go broke and will only be able to blame yourself.

If you are sitting at a poker table for 30 minutes and can’t figure out who the patsy is…

*the direct and indirect costs of your investment program.

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