Lessons from Vegas on Behavioral Finance
A group of advisors from our firm recently attended a conference for 401(k) plan advisors and that conference happened to be in lively Las Vegas, Nevada. The conference demanded much of our time, but of course, if you walk just about anywhere in Vegas, you’ll see your fair share of poker tables, blackjack tables, slot machines, etc.
Not being much of a gambler, I decided to become a spectator at a nearby blackjack table. I sat down and made some new friends, asking about the strategy behind the game, odds and probability, etc.
As I was sitting there, a gentleman came and sat down with a couple hundred dollars in chips. After about 20 minutes, he had steadily increased his chip count. Then, he made a monster bet on a single hand. He was splitting and doubling down and there was a lot of money on the table. And, with great luck, the dealer busted and the man raked in what seemed like a mountain of chips. In reality, he had just more than doubled his initial chip count.
In my mind, I felt that would have been a great time to cash in and call it a day! But, he kept playing. The momentum from that hand was quickly taken away when he made another large bet on the very next hand, and lost. He continued with the large bets and even started playing two hands at a time. But, neither the large bets nor the multiple hands were helping.
Over the next 10 minutes, I saw that man go from doubling his money, to losing every chip he had come to the table with. This reinforced the first major difference I noticed between gambling and investing.
Staying in the Game Doesn’t Necessarily Improve Your Odds at the Casino
You might have heard the famous Kenny Rogers song, “You got to know when the hold ‘em, know when the fold ‘em.” When your gambling, that couldn’t be more true. Why? Because even though gamblers use odds and probability, in order to be a winner, you have to get up and walk away at the right time. There is no academic data that shows the longer someone sits at the table, the more they’ll win. In fact, the house would love if it everyone stayed and played more, because in the end, the house always wins. The only way the house doesn’t win is if you walk away before the house gets a chance to win. So, in gambling, it’s all about timing.
Diversified and responsible investing, however, is completely different. Yes, there are short-term periods of volatility. But, a simple review of long-term returns will show that the longer you “stay in the game,” the more likely you’ll have a positive experience on average.1 Also, the more diversified your portfolio is, the less likely you will walk away with “no chips.”
Investing in a capitalist market is done on the premise that people will continue to demand goods and services. That demand may change and shift to new goods and services, but the ultimate idea is that companies will continue to innovate, creating new products and services that people will pay for. In doing that, companies will continue to profit. It’s an investor’s job to maintain sufficient diversification in large, small, domestic, and international companies, so that they can also share in those profits.
Gambling isn’t based on innovation, supply and demand, or fundamental analysis. It’s based purely on luck. Gambling for longer periods of time doesn’t necessarily mean your odds will improve. Historically, the longer you invest, the more predictable your long-term average outcomes will be.1
There’s No Cashing Out in Retirement
While cashing out at the right time is incredibly important when gambling, it’s essentially non-existent in retirement planning. In other words, a portion of your money may always be invested in some type of interest-earning vehicle. As long as you have sufficient cash reserves, we tend to recommend that even clients that are later in their retirement years keep putting their money to work for them. We believe it’s important to do so in order to earn more interest as opposed to leaving money in a bank savings account or buried in the backyard.
But, all investments have some type of risk. Stocks have volatility risk. Bonds have interest rate risk. Annuities have liquidity risk. CDs, money markets, and savings accounts may have inflation risk. Even burying your money in the backyard comes with inflation risk and theft risk. Proper investing is simply about balancing these risks to fit your situation.
And, prudent investors realize that there is no cashing out. They know that the allocation and the flow of their money is something that needs to be continually managed for their entire lives.
Lastly, Something off Topic
As we walked through our hotel, we noticed an abundance of high-end designer clothing and jewelry stores. For mere entertainment, we walked through some of these stores (the ones without security guards at the entrance), and took note of some of the outlandish prices.
As we did, there was a comment that came to mind that I heard at our conference. That comment was about the challenge we have as advisors to help people reach a point that they can safely retire. One of the biggest hurdles people face in accumulating wealth is the inability to control their living expenses. The speaker captured this by eloquently stating “People buy stuff they don’t need, with money they don’t have, to impress people they don’t like.”
As we watched people take their winnings and purchase watches, bracelets, and purses, items that could’ve equaled a week’s pay, it was evident that this is something that not only happens in the casinos of Vegas, but in every city of America. People fail to exhibit that ever-so-important trait of self-control when it comes to their money. As soon as it comes in, it goes out. For some, it’s going out even before it comes in. Those that reach financial independence get there because they not only build up the asset side of their balance sheet, but they also minimize the liability side as well.
I was told Vegas was great for the people watching. Whoever said that was absolutely correct. The lessons I took from Vegas, that came as result of observing others, reinforced what we educate our clients about every day. Investing is not a timing game, but gambling is. We don’t gamble with the stock market. We leverage evidence-based investing strategies like diversification and cost reduction. The longer you stick around in the market, the more predictable your average return becomes.1
Lastly, if you can control the expense side of your financial equation, you’ll be able to build your wealth more quickly. Minimizing your expenses may also create a habit that can lead to a reduced income need in retirement, effectively helping you retire sooner, with less.
So, when you’re creating a plan for your investments and retirement, I don’t recommend looking to Vegas for help.
1 Historical Market Returns via MacroTrends. https://www.macrotrends.net/1319/dow-jones-100-year-historical-chart
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