Depending on where you’re from, gambling is either the most fun thing ever, or a horrible taboo. In either case, there’s a lot of misinformation around the activity.
I love gambling and used to play tons of poker and backgammon, as well as making various sports bets.
While I haven’t bet on anything in years, there are many gambling lessons that have carried over from cards and football into finance. And here are three concepts that can help make you a better investor.
Make Smart(er) Decisions By Applying Expectation Value
Expectation value is the mathematical formula for determining how much money you’ll make our lose from a particular action. In gambling, casino games all have a negative expectation value.
The house always wins.
Other games, like poker or Chess, have positive expectation values — if you know what you’re doing.
With investing, there’s a common fallacy where people pile into a falling stock, under the assumption they’re getting in at a great price.
3M Company is a good example of this, with a lot of investment articles and videos highlighting the stock’s historically low price and high dividend yield.
What these pundits forget is that 3M is facing enormous lawsuits that could bankrupt the business.
To simplify the expectation value, you’re risking $100+ per share to maybe earn $5.96/year in dividends plus capital gains — if the company doesn’t go bust and send your holdings to zero.
At the moment, it’s a dangerous bet.
In contrast, there are other beatdown stocks (and this is in no way financial advice) like T. Rowe Price or Realty Income that are also trading at multi-year lows — without the bankruptcy risk.
T. Rowe Price, for example, has zero long-term debt. A factor that makes it virtually impossible for the company to implode.
Understanding expectation value helps you avoid costly mistakes.
It saves you from being suckered in by fallacies like cheap share prices or high dividend yields.