Despite the fact that you might hear investors say that they're making a "bet" on a stock or that they "doubled down" on an investment, a battle rages about how similar investing and gambling really are. Some argue that there's little difference between, say, handicapping horses and investing in equities, while others bristle at the idea, and say that when you treat investing as buying a piece of a business there's no comparison.
I hate to disappoint, but I'm not going to stick my neck in the middle of that debate.
But whether we agree that investing and gambling are similar, there are some general ideas from the game of poker that can be adapted quite well for investing. And, heck, if there's the possibility that it'll make you a better investor, is it worth fretting about the source?
Lesson 1: You don't have to play every hand
One of the quickest ways to make your chip stack disappear in poker is to blindly play every hand dealt to you. In a 10-player Texas Hold 'em game, you're only forced to bet 20% of the time, and even then they're only small bets. You can throw away every other hand that's dealt to you if you want, and it won't cost you a dime.
But why would you throw away any cards? Well, a two of diamonds and a six of clubs can theoretically become a full house, but you start out with the odds stacked heavily against you when you play a hand like that. Waiting for something like a pair of kings or a queen and jack of spades gives you a much better chance of seeing a return on the money that you're wagering.
The same holds true for investing. There's a possibility that CIT Group (NYSE: CIT ) could magically avoid bankruptcy and return a bonanza for shareholders. Or Sirius XM Radio (Nasdaq: SIRI ) could finally prove the critics wrong, start posting huge profits, and watch its stock fly. But let's face it, both are long shots, and if you're looking for solid, predictable returns to build a retirement nest egg, throwing piles of money at either stock is probably not the best idea.
On the flip side, companies like Pfizer (NYSE: PFE ) and Honeywell (NYSE: HON ) positively ooze predictability and solid returns over the long run. Investing in companies like these -- assuming you're paying a fair price -- simply gives shareholders a much higher probability of seeing returns from their investment. And, heck, investors don't even have to wait for rewards since both currently pay dividends that exceed the yield on 10-year U.S. Treasuries.
Lesson 2: Play your cards right
Kenny Rogers immortalized yet another lesson that we can take from poker when he sang: "You got to know when to hold 'em / know when to fold 'em / know when to walk away / and know when to run."
In both poker and investing, you're faced with continually changing information. The best poker players and investors are those who not only make the most accurate analysis of the available information, but use that analysis to drive good decision making, whether that's -- in investing -- buying, selling, or just sitting tight.
IBM (NYSE: IBM ) is a great example of the constantly changing tides that investors can take advantage of. The company had one of the truly great growth stocks in its early years and delivered impressive gains. But not all that long ago it faced some major challenges as the PC market commoditized and its bread-and-butter mainframe market turned into a sleepy niche.
More recently, IBM has found a new life in transitioning to offering higher-margin software and services. Just like recognizing when you have a possible straight flush developing and betting accordingly, investors who figured out what was going on at IBM and invested accordingly have been handsomely rewarded. Over the past five years, its stock has substantially outperformed the S&P index.
Lesson 3: Be choosy with your "all-in" moments
It's certainly exciting to watch a poker pro push all of his chips into the middle of the table and call "all in." But it's important to remember that top-notch players have run through a bunch of mental math to determine that the odds are heavily in their favor when they make a call like that.
Having all of your money invested at all times can be one of the easiest ways to go about investing, but it can also put you at a disadvantage. Not only will you absorb the full brunt of declines such as the one we've been living through, but it also leaves you with very little dry powder to invest when stocks do fall. However, with just a little more activity and attention, investors can keep an eye on stock valuations and adjust how much they have invested based on how pricey the market is.
If your all-in moments are restricted to times when the market is trading near or below its long-term average valuation, then you can shift the odds of market-beating returns further in your favor. Fortunately, there are many great tools available for tracking the overall market's valuation, including my favorite, professor Robert Shiller's 10-year average P/E spreadsheet.
When it comes to individual stocks, though, the picture is a little bit different. Although elite investors like Berkshire Hathaway's (NYSE: BRK-A ) Warren Buffett can make comments about being willing to go all in on Wells Fargo (NYSE: WFC ) , most mere mortals are best served by avoiding an all-in call -- having their entire portfolio -- on a single stock.
Putting away the cards
While having a working knowledge of poker might help bring some of the lessons above to life, you don't have to ever play a single hand to put them to work. To review, here are three of the investing lessons that we can take from the poker table:
- Wait for the best investment opportunities -- there's no harm in passing on a stock if you aren't convinced that it's a worthwhile investment.
- Always be on top of new information and be willing to take action when necessary.
- Going "all in" in your portfolio should be reserved for when market factors are highly attractive.
You can take these three lessons and start putting them to use right now. However, if you want to see how seasoned investors use these principles to create investing success, then you may want to check out the Motley Fool Inside Value newsletter. The advisors at Inside Value may not be poker pros, but they are valuation experts, and I see them using the lessons above in their stock-picking decisions. You can try out Inside Value absolutely free for 30 days.
Berkshire Hathaway is a Motley Fool Stock Advisor selection. Berkshire Hathaway and Pfizer are Motley Fool Inside Value picks. The Fool owns shares of Berkshire Hathaway.
Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not own shares of any of the other companies mentioned in this article. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy knows that pocket aces are great, but still only give a 31% win rate in a 10-handed game.
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