From Poker to Investing: 10 Tips From the MCU

I just picked up my copy of poker legend Doyle Brunson's Super/System 2, a modern-day version of the book deemed "poker's bible," which was published back in 1978. The original Super/System featured contributions from experts on several of the most popular poker games, including Bobby Baldwin's section on Limit Hold'em, Mike Caro's course in draw poker, and of course Doyle's legendary gospel on No Limit Hold'em. Super/System 2 does much of the same, while introducing new material on such things as online poker and WPT Enterprises' (Nasdaq: WPTE) World Poker Tour.

But flipping through the new book, the one section that really caught my eye was "43 Exclusive Super/System 2 Tips From Mike Caro University (the MCU)."

As the title of the chapter suggests, Mike Caro -- a leading poker teacher, a theoretician, and the "Mad Genius of Poker" -- offers 43 tips and concepts to playing profitable poker. Most of the tips are poker-specific, but many are concepts that also apply wonderfully to investing. Below and in Parts 2 and 3, we'll discuss how 10 of these tips -- taken from the "Insight and Attitude" section of the chapter -- can enhance your chances of successful investing over the long term.

MCU Tip No. 2: Money you don't lose buys just as many things as money you win.
The lesson: Save money by lowering risk and avoiding overpriced stocks.

The first and most profitable lesson I learned as a poker player was how to save money. When I first started playing Hold'em, I had a tendency to overbet. Sometimes I would bet a marginal hand on the end -- hoping my opponent would fold -- when the correct play would be to check and showdown. Basically, I would unnecessarily risk more of my money than either the cards or the money in the pot warranted.

In poker, most of the money you win is money that is given to you by bad players, rather than money that you earn. And similarly, one of the keys to increasing your profit is reducing the amount of money that you give away.

Investing in stocks is no different.

While we aim to beat the market, a Foolish investor's No. 1 priority is the preservation of capital. After all, it doesn't do much good to beat a market average if it means we lost money.

Save money and protect the downside in your investments by reducing the risk in your portfolio, and avoid overpaying for stocks. Better yet -- as I wrote last month in "Rule Breaking With Less Risk" -- focus on high-quality businesses with strong brands such as Coke (NYSE: KO), Starbucks (Nasdaq: SBUX), or McDonald's (NYSE: MCD), seek undervalued stocks, and buy with a margin of safety.

MCU Tip No. 7: If one pro plays twice as many hands as another, both might earn the same profit.
The lesson: It's better to have a few superior stocks in your portfolio than to diversify by adding marginal companies.

It's generally wise for investors to have some level of diversification in their portfolios, but one common error is over-diversification. Concentrate your portfolio on the stock ideas that best fit your criteria: Great businesses at good-to-great prices. Don't add stocks simply for the sake of diversification -- every stock you buy that doesn't fit the bill necessarily reduces the quality of your portfolio.

If your top stocks make up such a great percentage of your portfolio that you are uncomfortable, consider an index fund or index-tracking exchange traded fund such as S&P Depositary Receipts, or check out Shannon Zimmerman's Motley Fool Champion Funds for mutual fund ideas.

MCU Tip No. 4: You don't get paid to win pots; you get paid to make the right decisions.
The lesson: Ignore short-term results, and focus on how you played the game.

The game of blackjack is my favorite proxy for this one.

Blackjack is a game of decisions, yet there is no thinking. A perfect basic strategy player knows the best long-term play for every situation he is dealt, and he can know to the hundredth of a percent the house advantage against him just by looking at a chart. In a theoretical game, even a card counter playing with an edge over the house does no thinking; he already knows what his advantage/disadvantage is at any point in time, the size of his bets are predetermined by the size of his advantage and the size of his bankroll, and his playing decisions are also predetermined by the counting method he is using.

With that in mind, a blackjack player knows exactly what he expects to win or lose over the long run. Yet over the short term, results vary wildly.

For example, anybody who's ever seen the movie Swingers with Jon Favreau and Vince Vaughn knows that you "always" double down on 11 (taking exactly one more card while doubling your bet). That's not entirely true, but it's close enough. The point I will make is that it is always correct to double down on 11 when the dealer is showing 10 or less (unless you are counting cards), and a player should always double down in those situations because it is the best play and the right decision.

But even though doubling on 11 vs. a dealer's 10 or less is by far the best play over the long run, a player could conceivably do so and lose 10 or 15 times in a row!

A gambler might experience this, panic, and refuse to double in the same situation in the future. But an investor knows that doubling is the best play, and he knows that he will profit far more over the long run by continuing to double down rather than the alternative (which in this case is merely drawing another card). That said, investors should ignore short-term fluctuations in stock price and focus on making the right decisions. Doing so will pay off greatly in the long run.

On to "Part 2: Always Look Ahead" and "Part 3: Don't Chase Losers."

Fool contributor Jeff Hwang owns shares of Starbucks.