Is Investing More Like Poker or Chess?
I started playing poker for pennies back in junior high school. One of our friends -- let's call him Lee (since that's his name and he's not on this distribution list) -- would often make highly questionable choices. Occasionally, he would win a hand after a bold move. When questioned, Lee answered: "I won, didn't I?"
Basing the reasonableness of a decision on what eventually happens is called "resulting." This perspective confuses the outcome with the soundness of the decision-making process. It fails to acknowledge that even reasonable choices can lead to negative results, while poor choices can sometimes achieve success.
Annie Duke, a highly successful professional poker player, who wrote the book "Thinking in Bets," advocates viewing the decisions that we make in life in terms of bets. Every choice we make involves aspects of luck, uncertainty, and risk. Duke suggests we employ a decision-making process that factors in multiple variables.
Betting seeks the best odds possible. As Duke puts it: "We don't win bets by being in love with our own ideas. We win bets by relentlessly striving to calibrate our beliefs and predictions about the future to more accurately represent the world."
So how does investing fit within this framework? It's been argued that investing is more like poker than chess. Duke views chess as purely mathematical -- you can calculate the route to victory. Poker, on the other hand, includes elements of the unknown and randomness. We should, therefore, acknowledge that our investment decisions may lead to a range of possible outcomes. Some choices have a higher probability of success than others.
Investing differs from poker, however, in a salient way. Each poker hand stands independent of the other hands. And each night of poker has a finite number of hands.
Investing, in contrast, lasts as long as your investment horizon. We know that losses occur on occasion, but they only exist at a point in time. Thus, for example, just because a stock is down three months after you bought it doesn't mean you lost; the stock can be up a year or two later. A longer perspective changes everything.
Diversifying your portfolio does not prevent losses; it can, however mitigate them such that you will stay invested over time to recover from the inevitable downturns that arise.
Words of Wisdom
The race is not always to the swift, nor the battle to the strong -- but that's the way to bet.
-- Damon Runyon (the source of the characters brought to life in the Broadway show Guys and Dolls, which features my favorite song about gambling "Fugue for Tinhorns.")