Baseball, Poker and Investing

I would love to go back to the days when baseball analytics were only as sophisticated as Yogi Berra who said, “Baseball is 90% mental. The other half is physical.”

Baseball used to be a game where a manager could go with his “gut” to make his coaching decisions. But Brad Pitt changed everything when he glamorized using big data in baseball in the movie Moneyball where he played Billy Beane, the first general manager to use data analytics to great success.

Today, in a typical baseball game, teams will gather one terabyte of data points on everything from the arm angle of every single pitch, to exit velocity of hit balls.  Step two is to interpret the data with sophisticated algorithms that provide the manager with data to make decisions based on statistical probabilities. This relieves the manager of his need to make intuitive decisions on players based on his experience.  Big data analytics drives baseball decisions today on and off the field because it works.

The traditionalist in me revolts at this dehumanization of baseball. But, the investor in me sees opportunity to learn from baseball’s experience of moving away from “gut” coaching to probability-based decisions. What are the lessons that can make us wealthy?

First, it’s important to learn from what psychologists call the Dunning-Kruger effect. It is a cognitive bias which predicts that people who are the most ignorant about a topic will be the least aware of their ignorance, and thus have the highest confidence. Bad things usually happen when we suffer from this overconfidence.

I think there is evidence of this bias this year from the reported increase in the number of day traders. New apps have made it easy and fun to trade stocks and options. With the market hitting all time highs, this has been a fertile time for the new traders to assume investing is easy after they score a few wins with their trades.

And the media feeds into this belief that investing is easy. Headlines like, “8 Stocks to Buy and 5 to Sell” bombard us that investing is as easy as reading a monthly investment magazine for ideas.

I learned about investing by watching the popular PBS show Wall Street Week with Louis Rukeyser. The highlight of the show came at the end of the year when the stock pickers would wear tuxedos to be either exalted or humiliated by how their prior year stock picks had performed. And then they would confidently offer their new picks for the next year offering persuasive reasoning as to why the new picks would be winners.

It was great theater, but misleading to a novice like me. It never dawned on me that random luck may have been the biggest factor in the results.

My own moment of clarity came in an investment course I was taking in an MBA program. As I dove into the complex math of securities analysis, it dawned on me at some point that there were always going to be investment analysts much smarter than me. It was unlikely I would ever gain a true competitive edge investing no matter how much I worked. It was during that class that I found humility. I was not going to be the next Warren Buffett.  

A second lesson comes from poker. Good poker players focus on finding a process that puts the probabilities for success in their favor. They don’t panic about short term losses, but stay committed to a winning process.  In fact, poker players expect to lose often, but it doesn’t shake the confidence of the good ones who stay disciplined using the process. If they’ve done the math correctly, they know the odds for eventual success are in their favor.

Modern baseball and poker players recognize patterns exist in games that can be exploited by eliminating cognitive bias and sticking to a high probability strategy. As small investors, we may not have access to supercomputers to crunch big data, or have the ability to count cards and mentally calculate the odds of success at a poker table, but we have sufficient understanding to improve our probabilities for success. Here are four suggestions for your investing plan in 2021 using these insights:

1. Recognize that our brains are wired to bring order to chaos. Normally this is a good thing. But the markets are constantly in chaos and Wall Street advertisers know that they can appeal to this natural desire for order in our understanding of the economy. Just say no to listening to the reams of logical predictions of Wall Street firms for decision making about your investments. How many of them predicted the events of 2020?  Expect the same accuracy in 2021 and ignore them while sticking to a long-term process of investing wisely.
2. Don’t base your investing decisions on your own gut feel for how the market will move, but find practices that have worked throughout many different market cycles. Like a good poker player, don’t sweat the losses if you have a process in place that puts the probabilities in your favor for success. Focusing on low costs, tax efficiency, diversified investments and investing in line with your risk tolerance is a good formula for slow and steady wealth generation over time.
3. Manage your risks so you can absorb short term losses to stay in the game with enough time to let your investment edge show results.  If you want to fund a retirement decades away, you can ride out market declines because you don’t need the money in the short term. But if you want to have money for a honeymoon next year in Europe, you will be looking at a much lower risk alternative such as a short-term bond fund.
4. This has been a good year for the stock market. If you have a plan in place that allocates 60% to stocks, you probably need to rebalance as you are likely over that threshold. Yearend is a good time to look at your total investment holdings, rethink your risk tolerance and rebalance if necessary. In poker terms, it might be time to take some money off the table.

If you have a story about how you learned humility as an investor, I’d love to hear it!

Joe Kesler, Founder Smart Money with Purpose