Tuesday, October 16, 2012

Gamblers Anonymous is for Losers

Visit your local country club and you might be tempted to draw inferences about what traits lead to financial success. You might walk away thinking that risk-taking is the key. This is misleading, since you are only looking at the risk-takers whose risks paid off.

The key distinction, it seems, is to determine whether a certain choice will increase the expected value or just the variance. For example, imagine twenty fraternity brothers on a high-roller roulette website. Each sells his Tahoe and combines his student loan money to form a pot of $62,500 per brother. After four red/black bets letting it ride, one of these guys is probably a millionaire. If all of the guys who win this get together and form a club, then it would look like reckless roulette is the key to riches. You don't see the nineteen losers this way.

So how to tease out the true traits that lead to higher expected wealth? Visit both clubs: the winners' club and the losers' club; see which traits that the winners have that the losers do not have. These are the traits to emulate.

This idea reminds me of the distinction made between value transference and value creation by Half Sigma.

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