Love him or hate him, Tynan is back with a second installment in his series describing how to manage money like a professional gambler. Once again the article features sound advice. But once again Tynan’s personality may rub some people the wrong way!
For six years I was a professional gambler, during which time I learned valuable lessons about personal finance that I still use today.
In my first article I talked about how professional gamblers need to get the payout over 100% in order to profit. One way to get the payout over 100% is to play a progressive video poker machine. Normally Jacks Or Better, the standard variant of video poker, pays out around 99.5%. This is a losing game, with the expectation of losing $5 for every $1000 wagered. To assess the payout value of video poker, multiply the payout of each individual hand by the probability of getting that hand and adding them all up. The payouts for hands vary from $5 for a single pair to a whopping $4000 for the highly unlikely royal flush.
Progressive video poker is different. Its payout varies because the prize for the royal flush varies. It starts off low, sometimes even below the standard $4000, but as more and more people play a machine without hitting the royal flush, the prize increases. Since the overall payout of the machine is based on the payout of all of the hands, as the royal flush becomes more valuable the payout of the machine rises. Somewhere around $4600 it breaks over 100% and becomes worth playing.
Let’s say that we have a gambler named Bob. He sits down at the machine when the progressive royal flush payout is at $4600. Because the payout is so high, he’s making a smart move. He plays and plays and plays, losing $500 in the process. A positive payout is no guarantee of winning in the short term. He takes a quick break to go to the bathroom and when he gets back, someone else has won the jackpot and it has been reset to $4000.
If he’s like most amateur gamblers, he thinks, “I already have so much money in, I may as well keep playing.” This is an incorrect move because the amount of money he has in the machine has no bearing on the payout. When the payout is good, it’s worth playing. When it’s bad, it’s not. The difference between a pro and an amateur is that the pro doesn’t care how much of his money is in the machine — when it’s worth playing he’ll play, and otherwise he won’t.
There are two fantastic examples of how people make this mistake in everyday life.
People love to play the stock market. I’ve played it a bit, but quickly learned that I was an amateur, and that it’s more like gambling than most people give it credit for. Now I let Warren Buffet manage my money for me.
When stocks go up, people are thrilled. When they go down, they make poor choices. Let’s say that Bob decides to invest his money. He invests in a solid company named Acme Widgets, and watches his investment increase. Suddenly there’s a change in management and Acme starts going down the tubes, along with his investment. He invested $1000 in Acme, but now his holdings are only worth $100. He thinks to himself, “I know I should sell, but I’ve got $1000 in, so I may as well see if I make it back.”
What he doesn’t consider is that Acme has no idea how much money he has invested, and that original investment has nothing to do with the prospect of Acme going back up. If he wouldn’t buy Acme with its shares at 10%, then he shouldn’t hold them at 10%. Not selling is the same thing as buying. That isn’t to say that you should sell when stock prices drop, but only that you should sell when it’s no longer a good investment by whatever decision process you use.
The same principle applies to real life purchases, and is commonly exhibited when people buy cars.
Bob makes a stupid move and buys a brand new truck for $25,000 from the dealer. A year later its value has declined to only $15,000 and he’s is in bad need of money. He looks into selling the truck, but people are only willing to pay $15,000 for it now. Disgruntled, he refuses to sell and thinks “I paid a lot more for it. I may as well keep it.” Again, the market doesn’t care what he paid for his truck. Whether he paid $5,000 or $50,000, it’s still only worth $15,000.
If he was to shop for a car today, on his limited budget, he would probably buy a car that cost only $10,000. By that metric, he should sell his depreciated car for the fair market value of $15,000 and buy a cheaper one for $10,000.
In fact, purchases should be sold if you wouldn’t buy them today for their current value. I bought a monitor for $800 a year ago that is now only worth $600. I still like the monitor a lot, but I use my laptop most of the time now so the monitor isn’t as valuable to me. Even though it was a good purchase a year ago, if didn’t have the monitor today I wouldn’t buy it. Thus, it gets sold.
The only other factor is my time expenditure to sell the item. If I have a computer mouse that I don’t use anymore, but it’s only worth $5, it’s probably not worth my time to sell it.
I think this is terrific advice. Too many people “let it ride”, or worse, throw good money after bad. Based on Tynan’s advice, I have several items I should be auctioning on eBay. And you know what? I think I might.
This article is about Choices