Investing Lessons From the Poker Table

This week I beat a group of seniors and took $200 from them.

No, I’m not a purse-snatching hooligan who preys on the elderly. I’m just a guy who loves to play poker, and on Tuesday I took a day off to visit the local casino, where I played poker at a table with several amiable older gentlemen. The experience got me thinking about how poker and investing teach many of the same lessons:

Short-term results are meaningless. I’ve played poker alongside some truly bad players who always seem to hit miracle straights or flushes and scoop big pots. When these players beat you, it can make you wonder whether you should be playing differently — maybe you should start playing more hands, or calling big bets with weak draws, since it seems to be working so well for that guy. Investors fall into this same trap when they second-guess the Couch Potato strategy during every period of poor returns. In both poker and investing, you need to stick to a proven strategy: you will succeed in the long run, even if you have to suffer streaks of bad luck.

Play the percentages, not hunches. Succeeding at poker comes from understanding the odds. I often hear players say they “had a good feeling” about a certain hand, or that they’re “running good,” so they’re going to play a hand they otherwise would fold. This is nonsense. The odds of your pair of sevens beating my pair of kings are always one in five, regardless of whether you feel lucky. In the same way, if you invest based on hunches, intuition or forecasts, you’re likely to fare as well as the poker player with the long-shot hand. You might be one of the small number of active investors who beats the market, but most of the time you won’t.

Overconfidence will kill you. The casino table always includes a few 22-year-olds with backwards baseball caps who watch too much poker on TV. These guys are often good players, but they’re way too cocky. No matter how skilled they are, they can’t control what card the dealer will turn over next. I think of these players when I hear pundits making confident statements about why gold is going up, or the US dollar is going down, or why China is the place to invest. They may be experts in business and economics, but they have no ability to predict where the market is headed.

Success comes in spurts. I have had days when I lost for hours on end—then all of a sudden I drag three big pots and I have a pile of chips. Just as no poker player wins at a consistent rate, equity investors don’t earn slow, steady returns. Buy-and-hold investors will often go months of alternating small gains and small losses, only to enjoy sudden bursts of good returns — usually when they’re least expected. The reason market timing usually fails is that investors are often out of the market during the biggest days and weeks.

Emotional control is essential. It’s hard to endure a run of bad luck at cards, and lot of players simply can’t handle it. They get so frustrated that they start play badly, and they stop caring that they’re losing money. Poker players call this going on tilt. Emotional control is even more important in investing. No matter which strategy you use, success or failure usually comes down to whether you can hold on through the difficult months and years without losing your nerve.

The house always wins. You can have winning days and losing days at the poker table, but there’s  one certainty: the dealer always rakes a few dollars from every pot. If the house’s take is too steep, you may wind up losing money even when you win your share of pots. As all index investors know, even if your fund manager can beat the benchmark by 1% every year before costs (a rare feat, to be sure), he’s not adding value if he’s subtracting a 2% fee and leaving you with below-market returns.

10 Responses to Investing Lessons From the Poker Table

  1. Echo August 27, 2010 at 1:06 am #

    Definitely need to keep your emotions in check. Too often people chase after the new hot strategy, or have to get in on the IPO. There are many good investment strategies out there. The best strategy is to find one that works for you and stick with it for the long run.

  2. Canadian Couch Potato August 27, 2010 at 9:51 am #

    @Echo: I completely agree. Just completed a feature for the next issue of MoneySense that looks at six different investing strategies. The conclusion: they all did well if you had the fortitude to stick with them. If you bailed during the inevitable rough patches, you got killed.

  3. Echo August 27, 2010 at 12:59 pm #

    Sounds like a good article, can’t wait to read it. I have to admit, when I first opened a discount brokerage acccount it was in the Spring of last year and I was sold on the Dogs of the TSX strategy after reading about it from David Stanley. I was going to rebalance with the new dogs every Spring.

    At the time, many of the “dogs” were banks and telecoms and I picked up BNS, CM, BMO, T, BCE for really really cheap. Months later I thought to myself, why would I sell these companies? They grow their dividends and have good balance sheets, great for long term investing. That’s when I converted to dividend growth investing…the yield on cost alone for BCE and T are now over 7%. Hopefully we get some dividend growth in the financial sector soon too.

  4. Ian Brennan August 27, 2010 at 4:57 pm #

    You have a lot of credibility in my eyes, but are not doing yourself any favours by quoting the “best 10 days” statistical mumbo jumbo. This has long been used by sales people to support the idea of putting money into mutual funds. I have to believe they don’t feel people can think for themselves. As I see it, the best 10 days occur mostly during the periods of highest volatility in the market. This would also be the periods when we tend to see the worst 10 days. My experience says the market goes down a lot faster than it goes up, so I would rather be out of the market for the 10 worst days, than in the market for the 10 best days. Your passive investing approach obviously works, but it isn’t because of the best 10 days in the market. It would seem an advancing market has more up days than down days. Don’t take my word for it, check it out.

  5. Canadian Couch Potato August 27, 2010 at 8:10 pm #

    @Ian: Fair enough. I agree that the idea of “missing the best 10 days” is clearly impossible: no market timer would be so unlucky to miss only those days. My point was simply that being fully invested all the time offers the best chance of success for the long-term investor because market moves often occur quickly and unpredictably.

  6. PTDBD August 30, 2010 at 11:10 am #

    You neglect to consider that the game may be rigged. Not only does the house have advantage, but they may also have shills in the game that are dealt outstanding cards for crucial hands for which their chips are unlimited.

  7. brad August 30, 2010 at 12:17 pm #

    Interesting analogies with poker. Another area that fascinates me is the analogies that can be made between market behaviour and climate change (the field I mostly work in).

    Weather forecasters can predict the weather fairly accurately one or two days out, with accuracy declining rapidly beyond that. Predicting short-term changes in climate (which is essentially the “average weather”), such as predicting whether next winter will be colder or warmer than usual, is little more than a crapshoot even if it’s based on known factors such as the state of El Niño. This is similar to investors trying to predict how markets will behave over the next six months or a year.

    Over the longer term, climatic indicators such as global average temperature behave in similar ways to the stock market, with lots of ups and downs, random noise, and some apparent cycles that may or may not be truly cyclical. But long-term trends are evident amid the noise, and it’s actually possible to predict the general tendency of the global temperature over a period of decades with more confidence than you can predict next week’s weather.

  8. Financial Cents August 30, 2010 at 1:49 pm #

    Nice post!

    True – the house always wins – but you can be your own “house” if you stay invested…akin to whatever investing strategy you choose, stick with it, stay invested. On that note Dan, looking forward to your next MoneySense article.

    Cheers,
    Mark

  9. Steve in Oakville September 1, 2010 at 10:56 pm #

    If poker isn’t an analogy for life, I really don’t know what is. It’s the element of chance in poker, as in life, that keeps us coming back to the table.

    With respect to passive investing, the great thing is that the house doesn’t even have the edge! The evidence says that if you just sit at the table long enough, you’ll beat practically everyone else at the table.

    Good stuff Dan – hope you had a good summer.
    Steve

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