Thursday, April 2, 2009

Gamblers’ Folly: Double or Nothing

When gamblers are losing money, they often start increasing the size of their bets to try to get even. A familiar example of this is the double or nothing bet.

It’s not just Blackjack players who do this. When stock prices drop delaying retirement dreams, some investors suddenly switch to low-return conservative investments, but others start making reckless investments in an attempt to make back losses quickly.

Billionaire investor George Soros takes neither approach. In his book Soros: The World’s Most Influential Investor, Robert Slater quotes Soros’s thoughts on downside risk:

“If you’re doing poorly, the first move is to retrench. Don’t try to recoup. And when you start again, start small.”

Soros is clearly advising investors to avoid the double-or-nothing mentality by saying not to try to recoup. Superficially, it may seem that he advocates a switch to conservative investments, but this isn’t really what he is saying either.

Soros routinely used leverage (borrowed money) and his talk of retrenching and starting small at least partially means to reduce the amount of leverage. Having reduced your bet size (starting small), Soros is advocating continuing your investment approach on a smaller scale.

One interpretation of Soros’s remarks is when things go south, don’t give up and switch to low-return conservative investments, and don’t take wild chances trying to recoup losses; stick to your investment plan with your smaller portfolio.

Whether you’re a passive index investor or an active trader like Soros, it makes sense to avoid overreacting to losses.

1 comment:

  1. I like your interpretation of his retrenchment. If you are making huge leveraged bets, retrenchment is relative. Sounds like an interesting book, for sure.