The Gambler’s Conundrum

You are sitting at the table with a pile of chips in front of you. Airfare is already covered as is your room and a few meals. The excitement of Vegas, Macau or whatever the venue is reverberating through your body and your momentum is unmistakable. You have finally figured out how to crack their system. Too bad the other gamblers don’t see what you see. In a few more hours, your pile of chips will be much larger and your financial status greatly enhanced. You will also know the perfect time to leave, your level of peak earnings with the house only receiving your generous tips. The downside risk feels minimal.

Such is the gambler’s conundrum. This is the first half of a story that usually ends without chips, without the free room and without airfare. Hopefully, you at least picked up a free buffet. The momentum expressed earlier and the system you artfully employed was an illusion of randomness, a proverbial flip of the coin. You guessed heads several times and for a while you were right. However, the law of odds caught up with you over time. Your skills were not greater than those of the other gamblers. The timing of your winning cycle was just different.

As a financial planner, I hate to say that there are many analogies between investing and gambling, but there are. There is that unmistakable positive momentum in markets now and it is stopping some investors from making necessary long-term moves in their portfolios.

Rebalancing their asset allocation and reducing individual position concentrations has taken a back seat to inaction and to riding the current wave. In some cases, portfolio risk is well in excess of both an investor’s risk tolerance and their risk capacity. However, the gambler’s conundrum helps to rationalize this inaction. It is that feeling that you can ride the wave higher, but will be able to anticipate and to thus sidestep any declines.

You are the gambler and the market is the house. You believe that other investors are not seeing what you see and if a stampede to the exits occurs, you will be the first stampeder to reach the door.

I would argue that this too is an illusion of randomness. Nobody can consistently guess when markets will turn as large declines are only realized in retrospect. When investors attempt to and fail to guess the market’s pivot points, their portfolios can get violently whipsawed and experience permanent losses.

My advice to investors would be to stay disciplined, to periodically rebalance their portfolios and to avoid concentrations in individual positions. Keep a consistent and balanced allocation of different asset classes. Also ensure that the risk of your portfolio meets both your tolerance for this risk and your investment horizon.

A very protracted bull market is causing some investors to fall into the gambler’s conundrum. My hope is that they end up with a lot more than a just free buffet.

* Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.