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Investment Lessons Learned from the Poker Table

“I don’t know.” These three words don’t inspire a lot of confidence in the messenger and probably will not get me invited onto CNBC, but that is exactly what I think about the topic I am about to discuss.

I received a few e-mails from people who had a problem with a phrase in one of my blog posts this fall. In that article I examined various risks that other investors and I are concerned about. The phrase was “the prospect of higher, maybe even much higher, interest rates.” These readers were convinced that higher interest rates and inflation are not a risk because we are not going to have them for a long, long time, that we are heading into deflation. These readers basically told me that I should worry about the things that will come next, not things that may or may not happen years and years down the road.

I am pretty sure that if that phrase had addressed the risk of deflation and lower interest rates ahead, I’d have gotten as many e-mails arguing that I was wrong — that we’ll soon have inflation and skyrocketing interest rates, and deflation is not going to happen.

I don’t know whether we are going to have inflation or deflation in the near future. More important, I’d be very careful about trusting my money to anyone holding very strong convictions on this topic and positioning my portfolio on the basis of them.

Any poker player knows that the worst thing that can happen is to have the second-best hand. If you have a weak hand, you are going to play defensively or fold (unless you are bluffing) and likely won’t lose much. But if you’re pretty confident in your hand, you may bet aggressively (god forbid you go all-in) — after all, you could easily have the winning cards. Four of a kind is a great poker hand unless your opponent has a straight flush.

Generally, the more confident you are in an investment, the larger portion of your portfolio will be placed in that position. Therefore superconvinced inflationists will load up on gold, and superconvinced deflationists will be swimming in long-term bonds. If their predictions are right, they’ll make a boatload of money. If they’re wrong, however, they will have the second-best-hand problem — and lose a lot of money.

The complexity of the global economy has been increased by monetary and fiscal government interventions everywhere. There is no historical example to which you can point and say, “That is what happened in the past, and this time looks just like that.” When was the last time every major global economy was this overlevered and overstimulated? I think never. (Okay almost never, but you have to go back to World War II.) What is going to happen when the Fed unwinds its $4 trillion balance sheet? I don’t know.

Also the transmission mechanism of problems in our new global economy is so much more dynamic now than it was even a decade ago. Just think about the importance of China to the global economy today versus 2004. That year U.S. imports from China stood at $196 billion. Just in the first eight months of 2014, they were $293 billion. China was single-handedly responsible for the appreciation of hard commodities (oil, iron ore, steel) over the past decade as it gobbled up the bulk of incremental demand.

I don’t want to sink to the level of the one-armed economist — but conversation about inflation and deflation is just that, an “on one hand . . . but on the other hand” discussion.

Just like in poker, second-best hands may be tolerable if, when you went all-in, you did not leverage your house, empty your kid’s college fund or pawn your mother-in-law’s cat. Even if you lost your money, you will live to play another hand — maybe just not today.

In the “I don’t know” world, second-best hands when you bet on inflation or deflation are acceptable on an individual position level (you can survive them) but are extremely dangerous, maybe fatal, on an overall portfolio level.

Investing in the current environment requires a lot of humility and an acceptance of the fact that we know very little of what the future holds. I’d want the person who manages my money to have some discomfort with his or her economic crystal ball and to construct my portfolio for the “I don’t know” world.

As a writer, you know you are in trouble when you have to quote both Albert Einstein and Mahatma Gandhi in the same paragraph, but when I ask readers to do something as difficult as I am in this column, I need all the help I can get.

“It is unwise to be too sure of one’s own wisdom,” Gandhi said. “It is healthy to be reminded that the strongest might weaken and the wisest might err.” Einstein took the idea a step further: “A true genius admits that he/she knows nothing.” Smarter and humbler people than me were willing to say, “I don’t know,” and it is okay for us mortals to say it too. Repeat after me . . . • •

Leave a Comment    (7)

  • POST

Well written and thoughtful - thank you!

Jan 13 2015 at 12:30 PM EST

Tere Throenle

Your second best hand analogy is useless for investment purposes. It just happens on occasion. Better question is how to you protect yourself from a second best hand scenario, or better yet, a bad beat? Or multiple bad beats in a row? Bankroll management. I haven't met a poker player yet who went broke with proper bankroll management and discipline.


Jan 12 2015 at 9:08 PM EST

solly cholly

Dear Roger,

I completely understand why you wrote this comment. After you mentioned it, I read the Pilgrims Pride write-up; and you are right, we are both using the “second-best-hand” analogy, and the Pilgrim’s Pride piece was published on October 21, 2014, a month before my article went live. Since you don’t know me personally, your conclusion is logical. But let me be perfectly clear: I did not “rip” my article from the post on Value Investor Club!

1. I wrote the first draft that mentioned the second-best-hand reference a week before the Pilgrim’s Pride article was published. My “Investment Lessons Learned from the Poker Table” was published in Institutional Investor on November 13th; however, I sent my first draft of this article to Michael Peltz, editor of Institutional Investor, on October 10th at 10:03 am, 11 days before the Pilgrim’s Pride write-up was published on Value Investor’s Club.

Here is a partially redacted screenshot of that email .

2) Though I am a proud member of Value Investors Club, I did not read the Pilgrim’s Pride write-up until after you mentioned it.

Why I am spending my time answering this comment? Two reasons:

1) My reputation and my accent are all I have. I am not concerned about losing my accent, but my reputation is very important to me. As Buffett puts it, reputation takes decades to build and minutes to lose.

2) As a person who creates a lot of content, I would not want my content to be bluntly plagiarized.

Best, Vitaliy Katsenelson

Dec 11 2014 at 6:31 PM EST

Vitaliy Katsenelson

You should acknowledge somewhere here that you largely ripped off this post from a recent writeup on Value Investors Club on Pilgrim's Pride.

Dec 11 2014 at 12:06 PM EST


"Ignorance more frequently begets confidence than does knowledge" Charles Darwin

This is one of the best articles advocating diversification that I have ever read.

Dec 11 2014 at 10:59 AM EST


Wow ken. You invested a lot of emotions in that....

Dec 11 2014 at 12:05 AM EST


Question by you: When was the last time every major economy was this over-levered and overstimulated?

Answer: At the end of WWII

And your answer of "never", is most definitely wrong!

Since I warned you about the risks of deflation, oil has dropped in price by 25% !!!!

People who are paid to KNOW, cannot simply sit back and say they have NO CLUE!

When the most important commodity in the world drops in price by 25% over a period of a few weeks, the CURRENT situation surely canNOT be called inflationary.

You position is: I have NO clue!

I suggest you read this: Marc Faber= A Broken but Noisy Grandfather Clock

EVERYONE constantly discusses the US FED's 4 Trillion balance sheet....

How about discussing the FACT that the most valuable and important commodity in the world just decreased in value by 25%?

After WWII most of the largest economies in the world were smoking heaps, with the exception of the U.S.

Clearly the world's largest economies are in far better shape than after WWII.

The U.S. Govt was much more leveraged against GDP than today!

Consumers are far more leveraged today, but nobody wants to discuss them... because the "sheep" are to busy talking about the FED.....

Nov 13 2014 at 8:20 PM EST

Ken Luskin