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Investing is More like Poker Than Chess

Several years ago, I heard an episode of David Stein's podcast, Money for the Rest of Us, in which he interviewed Annie Duke, winner of the World Series of Poker Tournament of Champions. In the episode, Duke argued that investing is more similar to poker than it is to chess. I agree with her and believe that there are important lessons for investors to learn from this analogy.

I've played chess for many years, probably spending more cumulative time doing so than I care to admit, including reading several books about it. In chess, there is no hidden information. Both players can see all the pieces on the board at all times. The outcome of moves can be calculated with precision, and there is nearly always a best move, though identifying it can be a challenge even for computers. This makes chess a game of pure skill, and as such, it is more of a computational exercise than a game, which is partly why computers have become better at the game than the best human players in the world. There is no randomness in the game, and a highly skilled player will virtually always beat a less skilled player.

Poker is very different. While there is definitely an element of skill to the game, as evidenced by the same individuals repeatedly winning over time, there is a big element of randomness to the game as well. Players don't know what cards the other players have, and they don't know which cards will come up next. This randomness means that nearly every decision in the game has to be made in probabilistic terms (i.e., the likelihood of an outcome) rather than deterministic terms. Highly skilled players are still expected to beat less skilled players over the long-term, but over the short-term, literally anything can happen, including a fairly inexperienced player beating a world champion.

Duke contends that investing is more like poker than chess, and I strongly agree. As investors, we don't know what the outcome of a given investment decision will be, though there is more uncertainty present in some decisions than others. We don't know how the markets will perform over any time frame; the level of future inflation or deflation; how much our own future contributions to or withdrawals from our portfolios will be; how much the future expenses we're investing to fund will be; which risks will manifest themselves, when, and how; and much more.

However, this does not mean that the oft-quoted statement that 'nobody knows nothing', which would make an English teacher wince, is literally correct. It's not that we know nothing about investing, our own circumstances, etc., but we don't (and can't) know enough about it all to predict the future with precision.

Lower Falls of Enfield Glen, Robert Treman State Park, NY

All too often, investors behave as if investing is like chess, looking for patterns, analyzing historical performance, Sharpe ratios, the efficient frontier, valuations, etc., as if there is a single 'perfect' solution to their needs (note that literally perfect solutions exist in chess, but they are extremely difficult for most humans to find unless there are very few pieces in play). While all these activities certainly can be worthwhile, we must be careful to never think that we can use them to predict the future with precision. Many understand this well when it comes to predicting the returns of assets like stocks, but it applies to literally every aspect of personal finance.

And given that there is randomness in investing, this means that it is not appropriate for us to evaluate the quality of a given decision based strictly on its subsequent results, an all too common practice which Duke refers to as 'resulting'. Using one of her analogies to demonstrate this, we all understand that blowing right through a red light in an intersection ten times in a row without having an accident does not make the decision a good one. An uncomfortable truth is that we as investors can make the 'best' decision possible but have a 'bad' outcome. Similarly, a very cautious and mindful driver may be seriously injured in an auto accident. Health-minded individuals can still suffer from a host of illnesses. And investors can have a 'great' outcome from a 'bad' decision. For instance, an investor put 100% of his portfolio into a single stock that goes on to have extremely high returns.

All this doesn't mean that the past is of no value to us, but we should never think that we can use the past to help us perfectly understand the future. We are never in complete control of our circumstances. Christians know that only God has that power.

Investing, and personal finance in general, is more like poker; to an extent, we're playing the odds while also trying to not be forced out of the 'game' due to the occurrence of an event we perceived to be unlikely. For instance, investors frequently need to allocate a sizable a portion of their portfolio to asset classes that are volatile but have been historically likely to have relatively high returns, but they should also try to hedge their bets so that they will not be wiped out if the volatile asset classes don't perform the way they are expected to. But even so, failure to achieve our goals is always a possibility.

Someone said in regards to how investors can and should form their own investment strategy, 'There are many roads to Dublin.' This is quite true. There is no single, 'best' choice to make, especially as it applies to an individual investor with unique circumstances. But it's vital to remember that all 'roads' carry risk.

While I really like certain elements of Duke's comparison of investing to poker, we shouldn't try to take any analogies too far. For instance, in poker, one player winning means that another player loses (i.e., a zero-sum game), while investing does not have this requirement (i.e., it's a non-zero-sum game). Also, I would argue that being a successful investor is as much about 'playing against' yourself (e.g., your own emotions, biases, etc.) as it is about playing against someone else.

And in this context, it's vital for Christians to remember Romans 8:28.

"And we know that God causes all things to work together for good to those who love God, to those who are called according to His purpose."

Things may appear random from our perspective, but we should have faith that God is using everything that happens, including humans' sinful actions and terrible circumstances, to ultimately do good for those that truly love Him, even though it may not seem or feel good in the short-term. The outcome of faith, prayer, and thanksgiving to God is His peace.

"Do not be anxious about anything, but in everything by prayer and pleading with thanksgiving let your requests be made known to God. And the peace of God, which surpasses all comprehension, will guard your hearts and minds in Christ Jesus."

-Phil. 4:6-7

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