Personal Finance and Poker

I’m certainly not a pro in regards to the stock market and personal investing, but as I learn more I constantly find myself thinking, “Hmm, that’s exactly like poker.” (In fact, there’s actually a ton in common between investing and gambling. And when I say that, I don’t mean investing in a stock is like putting $500 on 31 at the Roulette table, though there’s a corollary for that in investing too.)

Some observations:

Data-based Decision Making
The core of good poker play is making the best possible decision with the information that is available to you. If you’re not leveraging available information, then you’re doing yourself a disservice. This is not unlike investors who blindly invest in a company without looking at simple things like its P/E ratio, 52-week high/low, cashflow, etc. The corollary to those simple numbers in poker are hand ranges, betting patterns, and positional tendencies.

Human ‘Competition’
In poker, you’re clearly ‘competing’ against other players at the table, but it’s a little more difficult to see that investing in the stock market is also essentially ‘competing’. At any given time, a stock’s price is a reflection of its value as perceived by other humans. In essence, it’s a game to figure out what other folks are doing/thinking.

The Rake
In stocks, most brokers charge you a service fee to buy or sell stocks. ‘The Rake’ is a similar percentage fee (w/ a cap) in poker that’s charged by the house on every hand. Players (in either case) who don’t pay attention to the size of ‘the rake’ can get screwed by the house.

‘Bad Beats’
Whenever you see a player flip out because he took a bad beat, you should compare him to a stock investor who buys a stock and sees it fall 5% the next day, with no relevant news about the company. In some cases, the ‘bad beat’ is a result of poor decision-making on the part of the ‘player’. But in many cases, it’s just simple statistics, probability, and *gasp* luck. The important thing in poker and in investing is making sure to distinguish between a real ‘bad beat’ and a real trend.

Short-term Variance
The result of all those ‘bad beats’ and fluctuations in the market is ‘Short-term Variance’. Let’s say that tomorrow you invest $10k in a good variety of stocks that you believe are good long-term investments. Now let’s say for the next month after that, you see a 10% loss in those stocks. Well, it sucks but it may just be a result of short-term variance. It’s no different than ‘running bad’ in poker - simple fluctuations that aren’t representative of long-term value. Theoretically in the market, in poker, and in most other types of gambling, you will eventually see that variance smooth out over time. In other words: short term results don’t mean shit.

Diversification (or Bankroll Management)
That variance and risk make the concept of diversification really important in investing. Interestingly, proper diversification is a lot like bankroll management. A poker player with good bankroll management has much more money than what he’s playing with at any given time. This number varies dramatically depending on who you talk to, but a reasonable guess is that a player might have 10% or less of his bankroll on the table at once. In the same way that you’re supposed to diversity your investment holdings to limit your risk, it’s a good idea to practice good bankroll management in poker to limit the possibility of walking home in a daze with that sick feeling in your stomach. You know the one.

Beatable games and Positive Expected Value
In both poker and the market, there are, in a sense, beatable games. In other words, there are investment/game choices that you can make which will give you positive expected value. The trick is, of course, 1) making the right decisions about which game to play in, and 2) making good decisions for a long enough period of time for the law of averages to kick in. Poker players talk about Positive EV all the time, but it’d probably make sense to use the same term for investing.

Patience
It seems that the most relevant emotional characteristic to have in both investing and poker is patience. Generally speaking for both, if you practice good game selection, make smart (Positive EV) decisions, properly bankroll yourself, and exercise patience, you will probably do well in the long-term.