The
gambler’s guide to everyday
life.
updated edition by dan bergevin
You, my friend, are an inveterate gambler. You gamble
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everything you have, and you do it repeatedly, often without remorse or regret. The above statement is often received either with casual acceptance (“so what’s your point?”) or with vehement denial (“what makes you say that!?”). But whatever your reaction is, it’s not a matter of choice. You are a gambler, plain and simple. This is easier to swallow once we define gambling as something not involving casinos and online poker, but as the process of betting on uncertain outcomes. And while this definition encompasses the world of horseracing, roulette, and securities trading, it also includes everyday choices such as driving to the store or solving a problem at work. In fact, gambling includes every decision you make, as no matter what the odds seem to be, you can never know all the facts. There is simply too much randomness in the world for anyone to make a decision with any real certainty. All around you are the beginnings, middles, and endpoints of countless chain reactions. Some will directly affect you, some will not. Some will affect you in ways you could never foresee, some won’t affect you at all. And it isn’t just what you don’t know that surprises you, but what you thought was true that ends up being false. This is why simply getting out of bed and going about your daily routine is really a complex series of gambles that you must take in order to accomplish anything or even survive to see the next sunset.
2 It makes sense, then, that everyone would benefit from some form of gambling strategy, based on a solid foundation of personalized decision rules Decision rules are nothing more than a set of governing principles that determine what risks you are willing to take and how you allocate your assets. They must be personalized because you have your own values and objectives and cannot base everything you want on what other people want without getting confused and very, very lost. This book is about creating decision rules that work for you, so you can become a better gambler and increase your odds of success in any undertaking, whether at work or at play.
All decisions are based on incentives If no decision could change your current situation, you wouldn’t have a reason to make a decision. If you did, you could just make any decision at random as its outcome would be completely neutral. Obviously, this is not the case. Decisions do indeed change the situation, and you pick the option that you think will change the situation favorably. To be more precise, you likely have a specific benefit you are seeking to gain by making a choice. The achievement of this benefit tells you that you made the right decision. Failure to achieve the benefit may tell you that you made the wrong decision, or chose the wrong benefit to pursue. The fundamental principle is that, when making a decision, everyone attempts to exploit a perceived gap between the odds of success and the cost of pursuing it. In other words: Value = Probability x Price This is everyone’s base gambling strategy, whether implied or explicit. Even when you make a decision based on personal preferences, you are assuming your value will be higher based on the higher probability of you liking your bet. So, if the price is acceptable, you will make a bet based not on the mathematical probability of success, but on your perceived chances of favoring the bet versus an alternative option.
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Accounting for subjectivity is important in some situations, and anathema in others. If you are betting at the racetrack, betting on a horse you like is a terrible strategy that will actually lower your chances of winning. On the other hand, if you are betting on what movie to watch, accounting for personal preference is essential to the outcome as no amount of so-called objective analysis can account for taste.
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Never create a gambling budget Budgets are used for spending money. And if you view gambles as spending money rather than growing an investment pool, then you’ll indeed spend money. But as opposed to going on a shopping spree, you’ll have nothing to show for it. The only reason you should ever gamble is to make profit. So whether you want to profit from your time, personal effort, money, social contacts, or other assets, you should never begin with the assumption that you’re “spending” your assets in order to create profit. You’re doing nothing of the sort. The whole purpose of a gamble is to win in the long term. If you bet to win on a single hand, you’re a fool, even if you win. The idea isn’t to win every hand, or even win the majority of hands. The idea is to walk away with more than you started with. If you think of spending assets instead of allocating them for future earnings, then you’ve missed the point and will find a lot more missing when you check your bank statement.
Always play to win
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If you want to play to win, and not just to play, you have to be cold-blooded about it. If you play to “be in on the action,” then you won’t understand what you’re involved in, nor will you understand the true difference between a profit and a loss. You’ll equate elation with winning and depression as loss, and down the slippery slope you’ll go. Thinking in terms of investment and strategy may take the fun out of gambling, but when you’re making the gambles that determine your long-term wealth and sanity, fun should not be the point. The point should always be to create a better process.
Process always trumps results One of the major themes of any probabilistic endeavor is the quality of the betting process compared with the quality of its results. Which do you think is more important? Of course, it is easy to say “good results are most important” because results are easy to perceive, define and measure. Processes typically are not. Many peoples’ decision-making processes are ill-defined and based on psychological cues they aren’t even aware of. Because of this, they shoot for excellent results and use hindsight to determine whether a process was good or bad. But this is exactly opposite of what you should be doing. This approach will lead you to believe you had a great process because of the clear evidence of the positive result, when in fact your process may have been terrible. But isn’t a good result indicative of a good process? Absolutely not. Luck is always a factor, which we’ll soon see. A good process is defined as one in which the overall value you expect to gain exceeds the total cost of creating that value. Here, probability cannot be considered in the short term. An activity can fail 15 times in a row but succeed on the 16th try. Was it a mistake to continue trying after 15 failures? It depends on the overall expected value gained when the single win and the 15 losses are factored into the final result. If you expect to succeed almost always, but a loss will cause you a catastrophic
6 setback, then it’s a bad process and thus a bad gamble. But if you expect to succeed only rarely, with any losses minimal enough to be deflected or absorbed by the gains, then it’s a good process and thus a good gamble. The long term perspective always prevails.
Know your loss aversion It’s important to understand how averse you are to loss, and how to control this aversion instead of the other way around. If you are gambling on a rare outcome because the overall expected value exceeds the cost of creating it, it will be very easy to give up since you’re likely to fail repeatedly before you succeed. Even if you know it will be worth it, you might still give up because your ability to endure continuous losses will be tested to the extreme. As a general rule, most people don’t like to fail repeatedly. The very thought of failure leads many people into careers and other personal and social arrangements that they would consider less than ideal, but “safe”nonetheless. But this doesn’t create better results than finding something of high value and then dealing with the losses that will come as a result of making it happen. It’s all a matter of adaptation and emotional fortitude.
Luck isn’t skill Most people believe that if something bad happens, then it’s bad luck. If something good happens, well that’s because of their awesome skill. This line of thinking is easy to perpetuate because it is egotistically convenient. It’s also completely wrong. Luck is present in both good and bad processes and results. And skill, at any level, is present as well. So if something bad happens and you blame the whole thing on bad luck, you’re cheating yourself out of a wonderful learning opportunity. And if something good happens and you think it’s because you’re highly skilled, then you’ll be blind to any stupid mistakes you made. It takes acute perception and steely resolve to run with good luck even when it was totally unexpected, and it takes humility to recognize when skill is a factor and when you are simply lucky enough to not suffer the consequences of your errors.
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Experts don’t have all the answers If you were to ask a chemist to explain the physical properties of potassium, you don’t have to worry too much about whether the answer will be true or not, or will retain its truth in the future. Potassium is precisely defined and is not likely to morph into something different without any prior warning. On the other hand, if you ask a meteorologist to predict the weather tomorrow, you will not get such a precise answer. You may get an answer, and it may be a very well-reasoned one, but it is not possible for it to be precise. Unlike potassium, atmospheric conditions are constantly in flux. They are a complex system of pressure systems, temperatures, and other factors that continuously rise, fall, and change location. So your local meteorologist may be pretty good at guessing the outcome of current and anticipated weather conditions over a fairly short span of time, but in the long term it is impossible to predict, regardless of his or her experience. Experience and knowledge do not compensate for randomness. As long as there is complex variability, there will be factors at work that cannot be foreseen and effects that cannot be anticipated. This is true in any probabilistic field, whether it is weather, stock prices, poker, or a trip to the local market. An expert may have valuable insights based on improved pattern-recognition and refined processes, and these are the areas where you should seek their advice. But an expert can never know what will happen with certainty, so details are speculative and will become increasingly opinion-based as they become more specific (“it will be 65 degrees a week from Tuesday,” or “MegaCorp will go up $5 per share this week”). An expert’s opinion is just an opinion. It may be based on years of research and personal experience, but it is never based on certainty. No matter how good the odds are that an expert is right, no one really knows what stock will outperform the market average or whether you will get tails on the next coin toss. What’s the moral? Expert advice can be used to improve processes, but cannot eliminate the uncertainty from an outcome, no matter how good the expert seems.
Know your opportunity costs
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Whenever you make a decision, you do so at the cost of the next best option. So if you spend $100 on some gadget, you do so at the cost of spending that same $100 on that pair of shoes you really wanted. In some cases you can have both. You can spend $100 on a gadget and another $100 to get the shoes. But you don’t get the option to spend the first $100 on both the gadget and the shoes. There are many cases where the opportunity cost is far less mundane. If you choose to work as a middle manager at a global corporation because it seems like it would pay well and offer job security, you do so at the cost of becoming a botanist, which is something you know you’d truly enjoy. And if you get laid off or fired after six years on the job, you don’t get to press rewind and use those same six years to study plants. If you don’t know what your options are, or assume you don’t have any, then opportunity costs are hidden. But when you are always aware of the next best option, you can make choices based on what you think will benefit you the most. Subsequently, your opportunity costs become more explicit and can thus be strategized.
Balance long term objectives with short term advantages With so much randomness in the world, and so much uncertainty to whether your actions will lead to your desired results, how can you even function, let alone pursue specific objectives? We know that the closer something is, the easier it is to predict. If you predict that you will be able to reach out and grab a cup of coffee off of your desk, you’re almost always going to be right. And in most cases the weather five minutes from now shouldn’t be terribly hard to predict. So what is the definition of “long term?” It is the summation of an extended chain of short-term events. The same applies to many things that are big and generally messy. If your room is disorganized and dirty, you know you can dust, stack up some books, fold some clothes, and little by little make the room neat and clean.
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The same applies for long-term events. If you base when you leave for work on the weather forecast the night before, you’re more likely to be prepared for a bad storm than if you tried to plan your departure time weeks in advance. Thinking far in advance makes sense if you are thinking in terms of well-defined objectives that may take a long time to accomplish. If you know you want to be a millionaire in ten years, you may not know exactly what will get you there, or whether it will even happen. But this “north star” leads to decision rules that allow you to make short-term decisions consistent with your overall objective. Thus, you will be more likely to make consistently smart money decisions, even in the face of setbacks and uncertainty. And as these small advantages compound over time, the larger objective becomes a reality. Live is lived in the moment. You take it in small pieces, not as a whole. And if you seek the seemingly insignificant advantages that these small pieces provide, under the guidance of a larger objective, then you will end up with a much bigger whole and in much less time. On the other hand, if you simply focus on the long-term view and let small advantages pass you by, you’ll find yourself in a much different situation than the one you had hoped for.
Curb hindsight bias Hindsight bias is a psychological hobgoblin that hinders on your ability to learn from your mistakes. It is the tendency to see the past from the present point of view and not from the point of view that prevailed at the time. In other words, people tend to make up the past as they go along in order to deal with the unpleasant memories of fear, loss, and mistakes. When an outcome occurs, the human brain busies itself with reorganizing facts so it seems as if it knew what the outcome would be prior to it happening. So even when people are wrong, they can conveniently become right by changing their minds after the fact. Hindsight bias makes poor choices easy to swallow by assuming they never happened in the first place.
10 Eliminating hindsight bias is next to impossible, as it is an innate feature of our minds. But it can be mitigated and managed by keeping a gambling log. This can be a simple notebook where you write down when you make decisions and what logic you use to arrive at your conclusions. Then you can revisit your entries once you receive feedback from your actions, and use this feedback to determine whether you were using a good or bad decision process.
Using a gambling log The first rule about a gambling log is that you have to actually use it. You cannot just write in it and move on. Revisiting your decisions every few days or at the end of each week is an excellent way to improve your processes and avoid overconfidence and self-deception. The second rule is to find a consistent way to log your decisions. Cover all the aspects of the decision that you will need to improve process and results as well as obtain a clear snapshot of your thinking process for future evaluation. The following items may prove to be useful: Define the bet – What is it exactly that you are gambling on? The clearer you can define it, the easier it will be to act on. Divvy your chips – You have a finite amount of assets available to you at the moment of your decision. And you only have a subset of those assets you can – or are willing to – invest in your gamble. Define the floor limit (the minimum investment required to make it worthwhile) and the ceiling (the maximum amount you are willing to lose if you fail) so you know whether the bet will be worthwhile and what it will take to make it pay off. House rules – What are the outside factors that will influence your success and guarantee your failure if you ignore them? The next move – What will you have to do, right now, in order to commit to this bet? Lock-ins – What series of actions will your next move commit you to? Remember, you shouldn’t try to look too far in advance. Simply think about the obvious – if you decide to get fit by going to a gym, you have to pay for the membership, buy any equipment and clothing you need, come up with a schedule, and stick with it until you achieve the desired effect.
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Know when to quit There comes a point in any game where quitting is the best option. This doesn’t necessarily mean you have to quit the whole game, it just means you cut your losses from particular bets and move on. There is a strong urge built into humans to stick with initial decisions even after they prove to be unprofitable. Part of this is because people in general don’t like being wrong. But being wrong is inevitable, and the more often you can admit to it, the more you can learn from, and adapt to, new situations. Another problem is people tend to get into grooves and resist the urge to leave them. This can happen long after the grooves become ruts. It’s often difficult to take on the unfamiliar risk of untested waters as opposed to the familiar risks of swimming in the same polluted lake you’ve been jumping into for the last five or ten years. But you have to do it anyway, or you’ll never get ahead, you’ll just keep digging that trench. Don’t throw good assets – whether they are money, time, energy, or whatnot – after bad ones. Your past decisions are sunk costs, and you should never use what made sense yesterday to justify making a poor choice today. Remember, it’s all about the process.
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If you accept your gambling habit and embrace it as an essential aspect of getting what you want, you’ll be much more capable in all aspects of your life. You’ll know what games to play and which ones to avoid. You’ll know when to increase your bet and when to cut your losses. And you’ll know how to get what you really want, by gambling on the small advantages that add up to huge gains. You’re never going to know for certain what will happen in the future. But if you don’t actively design your future by gambling on your highest value objectives, then your future will be left entirely to chance. And if you’re going to pay to play, you might as well play to win.
Copyright Š 2010 by Daniel Bergevin All rights to content reserved by Daniel Bergevin. No part of this book may be reproduced, stored in any retrieval system, or transmitted in any form, or by any means, electronic, mechanical, photocopying, recording, or by similar or dissimilar methods now known or developed in the future, without written permission of the publisher, except for brief excerpts in connection with reviews or scholarly analysis. Published by Capitalized Living Post Office Box 2172, Layton, Utah, 84041
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