Texas Hold’em poker has exploded in popularity over the past 20 years. Annie Duke, a renowned poker player, was synonymous with its rise on TV.  She penned an excellent book that stands out as one of my all-time favorites, and it’s about…investing. 

In her book, Duke highlights a common mistake amateur poker players and investors alike make: equating the quality of a decision with the quality of its outcome. This error is particularly costly and problematic for investors. 

For instance, if you invest in the stock market and it goes up, you might think it was a brilliant decision. Conversely, if you buy stock and it goes down, you might feel like an idiot! However, it’s not that simple, even though our brains naturally want to make it so. Here are three lessons Duke shares from poker that investors should take to heart:

Decision Quality vs. Outcome Quality

1. The quality of a decision cannot be solely judged based on its outcome. Successful people often attribute their success to the quality of their decisions, while those who fail tend to voice this point.

Investment Application: Buying a stock or investment that decreases in value doesn’t mean the decision to buy it was bad because the outcome was undesirable. Consider driving home after drinking too much and arriving safely. It’s irrational to think the positive outcome means you made a good decision and should repeat it. Similarly, if you didn’t drink at the party (good process) but still got in an accident on the way home (bad outcome), it would be completely irrational to think drinking would have kept you safe. 

This analogy helps investors understand the difference between process and outcome and the inherent logical flaws we often make. The same applies to driving without a seatbelt or walking blindfolded across a busy intersection: a good outcome does NOT make a good process.

Playing the Odds

2. Just like in poker, investing doesn’t come with guarantees or crystal balls. The best we can do is put the odds in our favor and invest accordingly. 

Duke recounts playing a hand where her chances of winning were 70%, but she lost. Someone in the crowd suggested she should have folded, but she disagreed. If the odds are in your favor, you play the hand every time because you’ll win more often than you lose, despite occasional losses.

Investment Application: Buying undervalued stocks or selling overpriced ones puts the odds in your favor, but it doesn’t guarantee a positive outcome. Just as selling company stock for an employee to reduce their risk of mixing their financial and work capital doesn’t become a bad decision if the stock goes up after they sell it.

Consistently making decisions based on favorable odds should lead to success over the long term, even if short-term outcomes are unfavorable.

Staying Disciplined

3. Duke emphasizes the difficulty of staying disciplined when a strategy yields poor results. Success requires accepting that even the right strategy will sometimes lead to poor outcomes. However, if we followed that right strategy each time we faced favorable odds, over the long term we should expect to come out way ahead.

Investment Application: In poker and investing, we want to make these decisions while keeping in mind the keywords “long term” and that over the short term, non-desirable outcomes may occur. The chart below reminds us that when it comes to investing, anything can and does happen in the short run. But as you extend your time horizon, a good process lends itself to a much tighter range of outcomes, and almost all of them are good.

Duke shares in her book that one of the hardest things for investors to do is to stay disciplined when their strategy delivers poor results. To be successful, you must accept the fact there will be periods, even very long ones, when the right strategy leads to poor outcomes. It’s why Warren Buffett has said investing is simple, but not easy.  Like the advice of the best time to buy an umbrella, whether we heed this advice could be the difference in achieving our financial goals or not.

Castle Quotes: What makes a great decision is not that it has a great outcome. A great decision is the result of a good process, and that process must include an attempt to accurately represent our own state of knowledge. That state of knowledge, in turn, is some variation of “I’m not sure”. – Annie Duke

It turns out the better you are with numbers, the better you are at spinning those numbers to conform to and support your beliefs. – Annie Duke