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.