As I’ve written in past memos, I have an indelible recollection of the first book I read as a Wharton freshman in 1963. The book was Decisions Under Uncertainty: Drilling Decisions by Oil and Gas Operators by C. Jackson Grayson, Jr. (who in 1971 would take on the role of “price czar” in the Nixon administration’s efforts to get inflation under control).

The best and most lasting thing I took away from Grayson’s book – and the first thing I remember learning in college – was the observation that you can’t tell the quality of a decision from the outcome. This revelation had a profound influence on me as a 17-year-old and represented the first critical building block in my understanding of how the world works.

As Grayson explained, you make the best decision you can based on what you know, but the success of your decision will be heavily influenced by (a) relevant information you may lack and (b) luck or randomness. Because of these two factors, well-thought-out decisions may fail, and poor decisions may succeed. While it might seem counterintuitive, the best decision-maker isn’t necessarily the person with the most successes, but rather the one with the best process and judgment. The two can be far from the same, and especially over a small number of trials, it can be impossible to know who’s who.

By my stage in life – if not well before – one should have figured out his strengths and weaknesses and tilted his activities toward the former. I’ve concluded that my strengths include the ability to:

  • frame questions,
  • logically organize data and weigh pros and cons,
  • know what I don’t know,
  • accept that future outcomes aren’t predictable,
  • think about the future probabilistically, and
  • make decisions incorporating all of the above (although far from always correctly).

Also very important has been the ability to internalize Grayson’s point about decision quality (and thus live with my unsuccessful decisions from time to time). This set of attributes equipped me for a career in investing . . . and for finding enjoyment in games of chance.

My Life as a Gambler

Although I’ve made reference to them in some past memos, games have played a bigger part in my life than you probably know. Because of the many connections between investing and gambling, many of the investors I respect play blackjack, poker or backgammon. You might enjoy learning about my past in this regard.

Like most people my age, I spent time as a child playing card games like “War” and “Old Maid” (there were no videos to watch or video games to play, and my parents considered television a pernicious influence that had to be strictly rationed). My first brush with “grown-up” games and betting involved gin rummy starting around age 12. Hours spent playing with my three closest buddies established a pattern for life.

When I was a sophomore in college (1964-65), card games at the fraternity house took up an embarrassingly large fraction of my time. A different game occupied our afternoons each semester, including gin, pinochle, cribbage, hearts, casino, bid whist, spades and tonk (many of these have since been relegated to the dustbin of leisure-time history). Most evenings were devoted to poker. (You’re right to wonder when I studied. I actually can’t remember doing much of it that year.) And when I eventually got serious about my studies as an upper-classman, I took up the commensurately serious game of bridge.

The next big step came in 1970-72, when I began to ski and was introduced to backgammon back at the lodge. Although probably dismissed by non-game players as trivial, backgammon, like bridge, is a game that requires a great deal of thought and one where study and practice can lead to a very high level of skill. More on it later.

As you may know, I got Citibank to move me to Los Angeles in 1980. One of the big ways this changed my life was that it led me to meet my great friend Bruce Newberg, whose mind is perfect for handling the odds and strategies involved in games (as it is for investing). Bruce and I have had thousands of hours of enjoyment playing backgammon and gin over the last 40 years. We’re probably about even financially after all that time, and if not, the winner’s hourly rate of pay is in pennies. All we get out of it is fun. Our motto is, “The only thing worse than losing is not playing.”

I also enjoy visiting a casino once in a while, and the opportunity to play blackjack. In blackjack, you and the dealer are each dealt two cards. You can “hit” or “stay” as you choose – take additional cards from the deck or decline to do so. The dealer has no choice; he’s required to hit (or forced to stay) depending on his card total. In the end, whoever’s total is closer to 21 without going over is the winner.

Lots of people go to casinos every year and lose money at blackjack without knowing the first thing about how to play successfully. Instead, they count on luck and hunches and say they “just play to have fun.” But there are actions you can learn to take in blackjack – mostly regarding when to hit or stay – that will improve your results. These have been codified into what’s called “basic strategy.”

Beyond that, the key to further improving your probability of winning lies in the fact that, unlike most games of chance, in blackjack the outcomes of future hands aren’t independent of the outcomes of past hands. This is so because in blackjack the dealer deals several hands in succession without returning the cards that have been played to the “shoe” from which he deals. Thus, which cards have already been dealt directly determines which cards remain to be dealt. If you can track the former through “card-counting,” you can have an idea about the latter. But since the dealer’s shoe can contain six or eight 52-card decks, keeping track of the cards played in itself requires exceptional skill.

Edward Thorp wrote the definitive book on this, called Beat the Dealer. When he won too much money, Ed was banned from the casinos and had to turn to “straight” pursuits. As a result, he studied warrants on Japanese stocks and developed the art of arbitrage. When I last saw Ed he was living an idyllic life in Newport Beach, prospering even in the absence of suits, ties or regular office hours.

But let’s return to backgammon. In this game, two opponents – one moving clockwise and the other counter-clockwise – try to bring their pieces around the board while simultaneously preventing the other from doing so, and then be the first to take them off the board. Each player’s ability to move forward is determined by rolling a pair of dice. It’s a total disaster if you’re ignorant of the probabilities governing rolls of the dice and instead rely on luck, gut instinct or what you think is your innate skill. (In fact, the most important skill in backgammon consists of knowing these probabilities and thus what actions to take given your position.)

More recently, through study Bruce has gotten too good for me at backgammon, so now we’re mostly down to gin. In gin, each player is dealt 10 cards, and by alternatingly picking from the deck and discarding, you try to form them into “melds” of three or four cards of the same kind (such as 9-9-9) or in a run of the same suit (such as 4-5-6-7 of spades). As the hand goes on, you can opt to “knock” (if your un-melded cards add up to less than a certain number) or try to get “gin” (all 10 cards melded), which pays off in more points – unless your opponent knocks or gets gin first.

An aside: when I speak to students, I often say, “For me, the thing that makes investing fascinating is the fact that there’s no action you can take that is sure to work, no strategy that’s always a winner.” To illustrate, I go on: “It’s like gin. Sometimes knocking is the best thing to do, and sometimes you should play for gin.” And all I get are blank stares. Few young people play cards anymore, and even fewer have ever heard of gin.

Another aside. While I don’t think they’re the result of conscious decisions, my life as a gambler has always exhibited two characteristics:

  • First, I haven’t made a serious study of the games I play. I feel if I want to work, I can go to the office.
  • And second, I only play for small stakes. Some people dream of big killings, and some like the frisson attached to risking large sums. I’ve never felt that my enjoyment increased with the amount of money on the table. I play for fun and to test my decision-making, not to win big money. (Point of reference: back around 1990, I was visiting Ric Kayne at Lake Tahoe and he said, “Tonight I’m going to take you to the casino and make a man of you. We’re going to play until you win or lose real money!” So he called the casino host and asked him to arrange a $25,000 line of credit for me. The host called back a few minutes later and said, “Sorry, Ric, I can’t justify a $25,000 line for someone whose average bet is $11.”)

What about coming full circle? One of the best things I ever did was to teach my son Andrew to be a game player at an early age. I now have a built-in opponent for gin and backgammon. There can be few sweeter memories than sitting on a log with him at Big Bear State Park playing War in 1992, when he was five. And it continues; my five-year-old granddaughter, Rosie, is my new opponent at War. There’s nothing better!