Skip to main content

Longboard

Insights: If You Can’t Beat the House, Join The House
Share:

If You Can’t Beat the House, Join The House

Can thinking like a card shark help you win the investment game?

Economist and Nobel Prize winner Paul Samuelson has a famous quote about investing: "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."

That’s true – a balanced portfolio means you can apply the “sell in May and go away” principle at any time if your investment allocations truly are accessing different types of risk – and therefore hopefully different return streams, at different times.

But there are some Las Vegas-like principles you can apply to your understanding of investments to put you head and shoulders above the rest.

 

The odds aren’t always what they seem

People intuitively know that the odds are in favor of the house at a casino. When it comes to basic portfolio math though, most investors still think more risk always means more reward.

In reality, fortune favors more cautious portfolio construction.

The simplest of 50-50 odds proves my case: a coin flip.

With odds that good, it would be natural to just bet it all every time. Ten flips equals 10 chances to double your money, right?

Taking half the risk each time actually makes you more in the end. What’s more, the ride toward higher returns will be smoother as well.

That paradox is due to a principle in portfolio math called volatility drag.

If your account suffered a 20% loss in the front half of the year due to volatility, gaining 20% in the back half still puts you behind. You suffered a 2.25% loss—even though your average return was zero. That’s why Wall Street reports annualized returns so frequently.

Now imagine that happening in your portfolio quarter after quarter and year after year. Good performing investments, poor portfolio results.

 

Probabilities aren’t just for card games

Someone heading to Vegas might think of poker or blackjack when considering card games. However, Three-card Monte – that classic game of finding the Ace – might be one of the most educational when it comes to something called conditional probability.

This game is a take on the Monty Hall problem, a concept that academics have debated for 80 years, and it’s still a powerful teaching tool. When you pick one card out of 10, you have only a 10% chance of being right, and a 90% chance of being wrong.

Those probabilities don’t change when I start to reveal the cards they didn’t choose. There is still only a one in 10 chance they picked the right card to begin with.

Imagine if you played this game 1,000 times. How often would you expect the first pick to be right?

One Harvard-educated player of the game told me that she had figured out the probability she was wrong was 90% whereas the odds she was right were only 10%. But she then revealed that if she switched — and ended up being wrong because she switched — she would not be able to sleep that night.

Humans are hardwired to like consistency and commitment. But that bias often prevents us from calculating conditional probability correctly. Our emotions get in the way. It’s just too painful to switch and be wrong, even when the math overwhelmingly says it’s the right thing to do.

So investing may be a little more exciting than watching paint dry and a little less exciting than rolling the dice. Maybe it’s more like watching the water show at the Bellagio: a great result that takes a bit of understanding, but at the end of the day, the best thing to do is simply sit and watch.

Also published in:

What’s Trending Now?

Commodities continue to push higher as the leading asset class this year. Our trend observations as of May 14, 2018.

What’s Trending Now?

Market uncertainty has become a growing theme this year. Our trend observations as of April 23, 2018.

What’s Trending Now?

Looming trade wars and quantitative tightening. Our trend observations as of March 26, 2018.
Disclosures

Longboard Asset Management, LP (LAM) is registered as an investment advisor with the Securities and Exchange Commission (SEC) and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission, nor does it indicate that the advisor has attained a particular level of skill or ability. LAM is also registered with the National Futures Association.

This website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications and links. The information on this site does not involve the rendering of personalized investment advice. You should consult a professional advisor before using any of the information, pursuing any of the investment ideas or implementing any of the strategies presented. We believe the information we present is factual and up-to-date, but we do not guarantee its accuracy and you should not should not regard it as a complete and exhaustive analysis of the subjects we discuss. Our opinions reflect our judgment as of the date of publication and are subject to change.

Prospective clients can view the firm’s Form ADV and Part 2A Disclosure Brochure as filed with the SEC at http://www.adviserinfo.sec.gov/IAPD/Content/IapdMain/iapd_SiteMap.aspx or contact us for a copy.

The content of this website is provided for informational purposes only, and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. Longboard Asset Management, LP does not provide legal, tax, accounting, actuarial or pension consulting advice or services.

Images and photographs are included for the sole purpose of visually enhancing the site. None of them are photographs of current or former clients. They should not be construed as an endorsement or testimonial from any of the persons in the photographs.

Please see our online privacy policy.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THERE IS NO GUARANTEE THAT ANY INVESTMENT WILL ACHIEVE ITS GOALS AND GENERATE PROFITS OR AVOID LOSSES.

Definitions

Alternative investments: strategies that produce returns by taking risk other than equity and bond risk.

Bond: A debt security that shows ownership in a corporation or represents a claim in the corporation assets and earnings.

Correlation: a statistical measure of how two securities move in relation to each other.

Long: Buying an asset such as a stock, commodity or currency, with the expectation that the asset will rise in value.

Short: Buying an asset such as a stock, commodity or currency, with the expectation that the asset will decrease in value.

Stock: A security that shows ownership in a corporation or represents a claim in the corporation assets and earnings.

True diversifiers: investment strategies that have historically provided investors with at least 70% of the return of the traditional 60/40 stocks and bonds portfolios while having less than .30 bear correlation to traditional 60/40 stocks and bonds portfolios.