Red 23 - The Power of Knowing When to Walk Away.
“Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort.”
– morgan housel
By Shawn Perkins | Behavioral Finance
4 minute read
A few years ago, some friends and I took a weekend trip to Harpers Ferry, West Virginia to get out of town during the dreary Richmond winter. After we settled in, the idea of going to the casino outside of town was thrown around, and of course, we went.
Being the responsible finance guy in the group, I promised myself (and my wife) that I would only use $100 to enjoy losing. After wandering the floor, I got my bearings of the casino and settled down at a roulette table. This is out of the norm for me, because generally am a Blackjack kind of loser. But why not give it shot.
So, taking the conservative approach, I put $5 on black to kick things off.
Lost.
Another $5 on black.
Lost.
Alright. How about we put $5 on Even to try to recoup some of my $10. Sounds reasonable, right?
Lost.
This went on for a few more rounds. Different optimistic strategies with the same disappointing outcome.
Last one. I’m down $30 and I would like to have some money left to enjoy losing a few hands of Blackjack. So, opting to go big or go home, I put $5 on Red 23.
Winner!
A $175 payout on a $5 bet! 35-1 odds and I came out a winner. The euphoria was intoxicating. I didn’t have much time to celebrate as the next round was about to begin. I had a decision to make. Should I keep playing? I had just won back my losses and then some, so why not take a chance to ride the momentum? Or should I pocket my winnings and walk away?
I have worked with clients who have been in a similar position. The only difference is that their fortune didn’t come from a roulette table. It came from putting a significant amount of their money on one single stock that exponentially increased in value.
If you win in roulette, and you’re a reasonable person, you will acknowledge that you made an arbitrary decision on where to place your bet and that you had no idea where the ball would end up.
Would you feel the same about an investment that you made? Probably not. You’ve done your research. You knew that the stock was undervalued for this or that reason. You knew that others didn’t appreciate the technology that could change the world. It was inevitable that the stock was going to go up! In fact, It has more room to run!
They were wrong and you were right. That feeling has staying power.
Having a concentrated position on a single stocks is dangerous on so many levels. You’re exposing the value of your hard-earned money to the risks associated with one company stock instead of diversifying across many different stocks. Or better yet, just buying the index and forgetting about it.
But the biggest risk, particularly after experiencing a significant gain, is no longer a risk associated with the company or the market.
It is the irrational biases that prevent you from knowing when to cash out and walk away. You have become the biggest risk to yourself.
Luckily, there are ways to solve this. In some cases, if my clients have a strong conviction on holding a concentrated position, I often suggest adding a stop-loss. This allows them to continue to hold on to the stock if it goes up but establishes a floor so that if the price begins to fall, it automatically triggers a sell order at an established price to protect from further loss. But the most common advice is to regularly rebalance the portfolio to shave the gains right off the top and diversify among the rest of the investments.
So, if you find yourself on the positive end of an investment, or you made a bet that landed your way, do yourself a favor. Pat yourself on the back for taking a risk, find the humility to admit that luck had some part in your success, and realize that becoming a winner and staying a winner require incredibly different decisions and emotional control.
As for my roulette winnings, I pocketed what I won and bought the next round of drinks.
Spread the wealth!