Allianz Guru Series by Henry Yang: Are you an investor or, unknowingly, a gambler?

When I was growing up, my parents and other older relatives would reiterate that gambling is bad. I didn’t understand them, but I accepted what they said without asking questions. In retrospect, I should have asked – a trait of a good investor, or to put it broadly, a good decision maker, is to keep asking questions, especially “Why?”, but that is a topic for a different article.

For many people, gambling is harmless fun. My wife’s grandmother loves going to the casino or inviting her friends for mahjong every now and then.  The problem with gambling is if it becomes an unhealthy addiction with a negative financial impact that can spill over to other areas of the gambler’s life.

What is gambling?

When we say gambling, what comes to mind usually are dice, cards, roulette wheels -- the typical casino. As defined by Wikipedia (don’t do this for more important research, I only did this to define the word better): Gambling is the wagering of something of value on an event with an uncertain outcome with the intent of winning something else of value. The key word there is uncertainty.

Remember the scene from the Hangover movie? I don’t really recall what happened but strapped for cash, the buddies turned to the casino with some sort of mathematical gameplan to win some money. There’s also the movie “21” where the whole film revolves around counting cards to “cheat” the game of Black Jack. These are inspired by actual people who were able to do it ,the MIT Blackjack Team. Edward Thorpe wrote a detailed book called “Beat the Dealer” to prove that it can be done mathematically. Mind you, Edward Thorpe isn’t your usual geek, he applied his research using $10,000 and his theory was verified since he won $11,000 in a single weekend. During his Las Vegas casino visits, Thorp frequently used disguises such as wraparound glasses and false beards!

Long story short, gambling is when you leave your financial fate to change. Casinos – yes, this is gambling (unless you know how to “beat the game”). Lotto – yes, this too, is gambling. Investing in bonds, stocks and funds – probably!

Wait, what are you talking about? I INVEST, how can I possibly be a gambler? Here are the ways that you may be one.

Not enough diversification

How many securities are there in your investment portfolio? Is it only a handful of companies? Then you’re vulnerable to whatever happens to those select businesses. Is it limited only to one country? Then if something goes wrong with that country, there’s a good chance that your investment is also in a precarious situation. Only one asset class? Same thing.

The solution for this is to spread your bets. One thing that investors and traders learned from gamblers (wink, there’s a lot) is that position sizing (or how diversified your portfolio is) is usually a neglected key concept. Losing is always part of the game, whether gambling or investing. Properly sizing and spreading your bets allows you to survive losses and come back stronger when the opportunity opens up.

Mismatch of investments to financial goals and constraints

Let’s say you will have to pay for a condo turnover 3 years from now – having a stock-heavy portfolio may not be the smartest move as typically these positions need to stay for at least 5 years. Typically, stocks are good for longer plans such as education or retirement. The same can be said for buying bonds that have longer than 3 years to mature as they will need to be sold for you to have funding.

Another way you may be gambling is if there’s a mismatch between your risk-taking behavior and your portfolio. If you’re naturally a conservative investor, don’t suddenly jump into the latest high performing fund. You may be pressed by FOMO (Fear Of Missing Out) to catch up with the bandwagon. Gradually increase your comfort level by getting more investing experience and asking a lot of questions.

Deciding on investments based only on hype

Sure, hearing about a friend who made 50% from Stock XXX last week would make you feel like you’re probably the worst investor ever.

Here is where asking “why: until you really understand what's going on counts a lot. Verify facts and verify sources. Pause and listen if the rationale makes sense in your head. In the trading room, we usually watch out for the “weak hands” – these are typically the first to sell if there’s some negative news since they don’t really have a high conviction of their positions, probably because they don’t understand it or they didn’t even try to dedicate the time to understanding it. Playing devil’s advocate helps sharpen your thought processes as you challenge your own ideas to stress-test them. Research every opposing opinion and keep only those that passed the test.

Warren Buffet once said that Risk comes from not knowing what you're doing. Learn from each investment decision you make whether it’s a win and more importantly if it’s a loss. Do not go for what if’s and what could have been, focus on making the best decision using all available information at that time. Remember, not all gamblers are in the casino, some are in their homes or offices “investing”. 

IMPORTANT NOTICE: This document is for general information purposes only. It is not an investment advice and does not constitute any offer, or a solicitation to buy or sell any investment product. Further, any opinion stated by the author does not necessarily reflect the position of Allianz PNB Life.