Investing and Gambling: Lessons Learned the Hard Way

Meeting Your Retirement Needs When You’re Short and Growing Desperate

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Even before he entered college, Alex Kearns discovered the new trading platform, Robinhood. On June 11, 2020 that discovery ended tragically for Alex and his family when Robinhood restricted his account because the popular brokerage asserted that he was $730,000 in the hole. Imagine that you’re a college student, your parents don’t know what you’ve been up to, and now you’ve racked up a debt of three quarters of a million dollars. Alex must have felt mortified.

Later that night, at 3:26 a.m., the company sent an automated email demanding that Alex take “immediate action,” calling for a payment of more than $170,000 in just a few days. Alex was not only stricken, but he was confused. He thought he had covered his trades so he wrote the company, “I was incorrectly assigned more money than I should have, my bought puts should have covered the puts I sold. Could someone please look into this?”

The response showed that no one could answer Alex’s request. The automated response read: “Thanks for reaching out to our support team! We wanted to let you know that we’re working to get back to you as soon as possible, but that our response time to you may be delayed.” The company assigned him a case number.

Alex couldn’t live with the disaster he had brought on his family without his parents’ knowledge. He took his life. The very next day Robinhood sent a follow up automated email. “Great news!” The email read, “We’re reaching out to confirm that you’ve met your margin call and we’ve lifted your trade restrictions. If you have any questions about your margin call, please feel free to reach out. We’re happy to help!”

It was too late.

Another recent investment had a happier outcome. In January 2021, an investor in Michigan invested $2.00 in a ticket in the Mega Millions lottery and earned a cash out return of $776.6 Million, assuming that’s the exit strategy that this successful investor chooses. You may be thinking that that is gambling and not investing. That raises a pertinent question.

When to Gamble; When to not.

Is investing the same as gambling? Is spending a form of investing? In this article we look at these often-confused concepts to discover what makes sense and what doesn’t. What is the difference between investing and gambling? The answers to those questions can be confounding. All we can share is our personal experience.

You may be thinking that investing involves a lower risk of loss. After all, our fortunate lottery investor benefitted at the expense of millions and millions of others who lost their entire $2.00 or more investment. The same is true whenever an investment pays off beyond what we might consider a fair return.

No one can escape investing. When we take a job, we are investing our time to gain our livelihood. If we have savings, we have to harbor them somewhere. Holding cash is risky since currency deflation erodes our purchasing power. If we give the money to a bank, we are subject to whatever fees or policies that the bank may adopt from time to time.

Most people soon reach the point at which they open a brokerage account as did young Alex Kearns. The sad truth is that he was ready intellectually for investing, but he didn’t yet have the maturity that differentiates investing from sheer gambling. He thought he was investing but, when he got that middle of the night email, he suddenly changed his thinking to believe that he had gambled with his family’s fortunes and lost.

It’s that maturity of insight that separates investors from speculators and gamblers. Investors are looking for something more than just a quick buck at the expense of other players. Investors seek to build fresh value as the basis for their returns. But, even so, that element of betting and gambling cannot be totally eliminated. That’s what calls for maturity and wisdom.

Wise Investors.

Many years ago, as my wife and I were approaching retirement, we were struggling with how safely to invest the savings that we needed for the years when we would no longer be earning. We attended an enormous conference for investors held at the Los Angeles Convention Center and featuring Vanguard’s Jack Bogle, the eponymous Charles Schwab, and Marie Bartiromo, who was then with CNBC. We got there early and we sat in the front row at the feet of these sages of wise investing. The learning was worth every minute of our time there, and it changed our strategies forever.

Jack Bogle was particularly illuminating. He taught us that unless you have a particular connection with an investment, it’s best not to try to outsmart the market. If diversification is a good risk management approach, then investing in an indexed fund is ideal. He began with the alternative. If a good return, say, is 5%, and you hire an investment manager at a fee of 1%, then you have immediately cut your return to 4%. That’s a 20% value haircut.

Moreover, what is certain is that the manager gets the 1%. There’s no assurance you’ll get the 4%. It may be more; it may be less. You may even lose, but win or lose the manager gets 1%. Bogle pointed out that’s not a good deal. The manager’s interest is not aligned with yours.

Not surprisingly, Bogle was good friends with Burton Malkiel, the author of “A Random Walk Down Wall Street,” the book that exploded the myth that it takes an expert to invest wisely. Bogle’s Vanguard funds gave practical life to Malkiel’s thesis by introducing indexed investing. The mechanical nature of indexed investments forces the discipline of selling high and buying low. No human has the emotional maturity to match that mechanical approach. It also cuts the cost of investment management from the 1% range to a tenth of that. My wife and I have followed that strategy ever since with great peace of mind and satisfying results.

Our Retirement Challenge.

It wasn’t always that way for us, however. There was a time as I neared 60 years old when I realized that I didn’t have enough saved for retirement and that I wasn’t likely to have enough productive years remaining to make up the deficit. As an actuary, I was able to calculate that we would need roughly triple our savings to that point to fund our retirement. The only way to make up the deficit was to take risk. That can be scary. It was scary.

As I thought about risk, I realized that the riskiest investment one can make is to take a job. There is said to have been a time when loyalty between employer and employee resulted in career employment with a pension to live on thereafter. At least that’s the nostalgic belief incorporated in the notion of a career crowned with a gold watch and a retirement sendoff. The reality is different.

The truth of the matter is that employees are laid off when a business shrinks. The owners may lose some of their investment, but the laid off employee has lost everything and may be bereft. Usually, though not always, it works out and a new job is found. As we thought about our own retirement exposure, we realized that we were not of the gold watch generation. We had to look to our own resources.

What’s more, as I thought about the job analogy, I realized that one could scrutinize the soundness of a potential financial investment the same way one considers a prospective job opportunity. Both are risky. Both can involve concentrated risk betting on a single company. And, there’s that gambling word, “betting,” because taking a risky job or making a risky investment is akin to gambling. A shrewd person will assess the “gamble” and place that bet — job or investment — wisely after much thought.

Learning from Buffett.

For openers I studied Warren Buffett whom I knew was not a lucky entrepreneur who got rich by executing on a new idea. Buffett was an investor just like we were with those inadequate savings of ours. Buffett wanted to get rich from an early age. That was never my goal. I just wanted to have enough money so money wasn’t important. Now, as I neared retirement age, I still had not achieved that goal, but Buffett had.

Buffett learned value investing while a graduate student in business at Columbia University where he studied with Benjamin Graham, a proponent of the idea that investment values will over time follow the fundamental financials of a business and not the vagaries of the capital markets. That led Buffett to defy the mutual fund convention of diversification and to concentrate his investments in enterprises that he would be willing to own as sole owner. Eventually, he did become owner of several businesses. He did well with that.

With respect to the gambling question, Buffett distinguishes sharply between thoughtful, considered investing and the gambler’s fascination with speculation. It was with this thinking in mind that my wife and I approached our own financial quandary. We were well behind Warren Buffett in taking up active management of our investing. Buffett started as a teenager and we were moving beyond middle age. But start we did.

Our Own Principles.

We began by developing a set of principles. Our crowning principle was that the CEO have a moral compass above greed and self-aggrandizement. That immediately eliminated most publicly traded enterprises. Beyond that we wanted a CEO who had an eye for talent and who advanced talented people to senior positions bypassing mediocrities and functionaries. We wanted an enterprise with a vision to change the world, a practical vision and one that was likely to succeed. We saw the emerging potential of the internet, so our quest narrowed early on to ventures in that space.

To summarize, we were looking for a publicly traded, investable company with great upside potential and one that we would be delighted to be working for. With time we found one on which we were willing to place our chips. Yes, it was gambling. We knew we had to take risk to win. But we also thought that the enterprise we chose had great growth potential and was led by a CEO whose values we respected.

Without disclosing what enterprise that was, I can share that the CEO’s appealing visionary statement was a belief that bringing the world together in a global network of connectivity could be a compelling force for world peace. I grew up during World War II. World peace matters. Peace is the antidote to mass killing and mechanized destruction.

We took half of our savings, and placed that huge concentrated bet on that single company. This story has a happy ending. The enterprise in which we invested rose in value to 80 times what we paid to buy in. We began to average out of it before it peaked. As it neared its peak it was taken over by an established corporate entity which followed conventional principles of business administration. The notion of shareholder value took precedence over mission, and today that enterprise is studied in business schools as a failure.

Still, it worked for us and our concentrated investment paid off big time. I should quickly share with you that those several years with that concentrated risk were years of high anxiety. I studied all sorts of defenses, puts and calls and more. My experience was that options prices were disproportionate to the insurance protection they provided. They primarily benefitted the originating traders just as life annuity contracts usually benefit the salespeople more than the annuitants.

Who Can You Trust?

After a time, we had reached our goal which was to have sufficient wealth for retirement so that money would no longer matter. It’s a truism that if you have double what you need, watching the market fluctuate up and down becomes more amusement than gut wrenching. We knew that we had little interest in investing per se, so we began to look for someone else to manage our funds.

First, we talked with a boutique investment management firm. They proposed to sell out our holdings, triggering massive capital gains taxes, and to invest in a concentrated portfolio of their choosing. Not only that but they were going to charge us that famous 1% of assets for their services. That didn’t seem positive, so we quickly dropped that idea. Subsequently, that firm turned out to have gambled a bit too aggressively and they went out of business. RIP.

Next, we got in touch with the Private Banking Division of a major national bank. They promised us a dedicated portfolio manager who would follow our instructions. We trusted the bank, which will remain unnamed here, though it was and remains a top five big bank. That proved disastrous, and our consequent loss was more than what our starting retirement goal had been, though by then our holdings had risen enough that we were able to absorb that hit.

We had agreed with the private bank that our funds would be segregated and invested in a portfolio of ten stocks in which we instructed the bank to invest, with the understanding that they would rebalance the holdings monthly following the same kind of sell high, buy low discipline that makes index investing successful. The bank charged handsomely for this service. Private banking is a very lucrative undertaking.

As it turned out, our assigned portfolio manager left the bank for a new opportunity. The bank then ignored our instructions and invested our funds into a standardized portfolio with over a hundred companies which the bank used for its computerized trading, saving the bank money. By the time we found out, the result of our portfolio at the bank, compared with what it would have been if our instructions had been followed, as mentioned earlier, had cost us more than our original retirement goal.

To add insult to injury, when we went to transfer the portfolio back to our control, the bank charged us a termination fee for every one of those hundred plus positions they had erroneously imposed on us. That cost, too, was huge, and we thought of suing, but we’re not litigators, so we simply took it as an expensive lesson in corporate greed and malfeasance and left it at that without redress.

Back to Those Wise Investors.

It was during this period that we attended that investor conference with Jack Bogle, Charles Schwab, and Marie Bartiromo. It became clear that both Bogle and Schwab were exceptional for their integrity as trustworthy stewards for other people’s money. After our experience with the private bank, we were ready for trustworthy.

Simple takeaways: Invest prudently and with full awareness of the risks. Don’t trust anyone who says they can give you a performance boost of more than what they charge. Remember money is a temptation for many people who may not share your values and your sense of integrity. Especially, be cautious of mega-corporations. In big corporations, like that big bank, there are so many people in charge that no one’s in charge, and responsibility is not anything that a rising executive would dare to accept.

Again, this story has a happy ending. We decided that we’d had enough, so we invested fully in low-expense exchange-traded indexed funds. That has worked well for us ever since, and at long last after many trials, we reached that coveted goal of having enough so that money is not important. If you’re not there yet, we can assure you that is a goal worth striving toward. We live simply, and we are very content.




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Jack Cumming

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