How is investing like backgammon?
Photo: Katana. Source: Morguefile
Both involve uncertainty. Both are highly quantitative. And both combine skill, strategy, and a bit of luck.
I loved backgammon growing up. I could play for hours with family and friends. I read books and studied different board combinations. I even organized a couple of tournaments in college. I loved the fast pace and exciting finishes, and learned a lot. I think the most important skills I gained were knowing how to work with uncertainty and using probabilities to gain an advantage.
The main factor in backgammon, of course, is the element of chance. You can’t know what the dice will do each time you roll. No matter how careful or calculating you are, if you roll a 2-1 and your opponent rolls double-sixes three times in a row after you’ve broken contact—unlikely as that might be—you’re going to lose some ground. In the same way, there’s a lot of chance and random events in the stock market. Companies get taken over; firms miss their earnings expectations; regulators change the rules; courts award billion-dollar verdicts. No one knows what the market will do from one day do the next.
But there are ways to improve your chances. In backgammon, if you need to leave a piece exposes, leave it far enough away so your opponent can only hit it with a combination of both dice, rather than with just one die. As the board develops, certain strategies will do better—a back-game, a blocking game, reading your opponent’s tendencies. Being flexible is important.
But the most important skill in backgammon is being able to read the board and calculate your odds of success at any particular time. If you can calculate your chance of winning, you will be able to use the doubling cube effectively. The rules and strategies for doubling and redoubling have a lot of nuance, but using the doubling cube allows you to play the probabilities and manage the stakes of the game.
Photo: Takasaki. Source: Wikipedia
Reading the board and managing your stake are a lot like reading the market and managing a portfolio. There are times when valuations, momentum, and fundamentals are in your favor, and when they’re running against you. There are times when one approach performs better than another, based on how the market is playing out. But risk and uncertainty are always part of the equation.
Many people are obsessed with finding the optimal portfolio—looking for certainty in their investments. But nothing is certain. Instead, we need to embrace the uncertainty of the markets. Only then can we make the odds work for us.
Douglas R. Tengdin, CFA
Chief Investment Officer