Why Fancy Oxbridge Bankers Got Outmatched by Your Shady Uncle's Bookies
The only person in my family who’s ever been good with money was my grandfather Fred. He was a real card shark, too, and would disappear for days at a time to go play poker. Once, he came home with a car. He taught me how to play cards, naturally, one time emptying his pill case so we’d have something to bet with (“I’ll raise you a Lipitor and two Vitamin C.”). He died before I starting learning about money and investing and stuff, but he taught me enough about cards for me to apply lessons retroactively. Splitting aces in a hand of blackjack, after all, is a kind of diversification.
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Learning more about money, however, did surprisingly little to elucidate any real, meaningful difference between gambling and finance. If puts, options, short-sales, and the many other fancy trades bankers have come up with over the years were really so brilliant, then why, for example, did the best bankers in the world recently get outsmarted by a bunch of bookies?
Try This Tactic
One thing that’s true in life and in cards? The importance of being able to bluff. A study of 35,000 high-stakes poker players — some of them novices, some of them experts — from researchers at the University of California, Davis found that the main thing the winners had in common was their ability to bluff. The reason is that poker is all about managing the uncertainty that comes from not being able to see your opponent’s cards. Good bluffers are better at strategically misinforming their opponents, which also means they are improving the relative quality of their information. Better information, better decisions.
The Bookies Called It
When I first started working full time in journalism, the big financial story of the year was Brexit. This was before the presidential election of 2016, and, if you’ll remember, no one really thought the UK would actually leave the European Union. On the night of the vote, odds were going 10-1 against. Cool heads, young people, and immigrants would win the day. Of course, that’s not what happened. A lot of people were also making bets that night, too, from well-connected currency traders who went to Cambridge to random Joes making bets on gambling sites.
Over the course of the night, people slowly started to realize they called it wrong. The bookies started adjusting their odds, and the traders started making bets that Brexit would happen by selling pounds. But here’s where it gets really wild: The currency markets adjusted to the reality of Brexit at around 4 a.m. the night of the election, according to a new study from a group of Cambridge economists. The bookies adjusted their odds to reflect the likeliness of Brexit at 3 a.m. The inefficiency was wide enough that you could have made nine cents on the dollar by selling a pound (a bet Brexit would happen), and then making a corresponding hedge in the gambling markets (taking a bet at really good odds that Brexit wouldn’t happen.) In other words, you could make millions of dollars by betting on both teams to win (at least in theory).
So why’d the gamblers call it first?
Like those winning poker players, lead researcher Dr. Tom Auld tells Inverse there are two possibilities. Unlike a poll or an expert, prediction markets are based on people who are willing to put their money where their mouth is, he explains.
“That provides what we call incentive compatibility,” he says. “You can say whatever you want in a polling organization, but actually, talk is cheap.”
The other main reason that the bookies called it? Like those exceptional bluffers, he thinks they may have had access to slightly better information. In other words, those fancy bankers were part of the global financial elite, who could never have anticipated Brits would vote against the interests of their stock portfolio. The people making the bets on gambling sites, he reasons, may have had an earlier inclination of where the vote was actually going.
“It really was very apparent early on that we voted to leave. It just wasn’t the narrative in the press,” Auld goes on to say. “I expect in this case, around these kinds of popular votes, it won’t happen again because everyone has adapted. But biases are really rife. Bubbles are human nature. And there was kind of a ‘remain’ bubble.”
Pour One Out for a Legend
Speaking of the blurred line between investing and gambling, I would be remiss if I didn’t take a moment to pour one out for John C. Bogle, a legend in finance who died yesterday at 89. Bogle is the mind behind what could be the most important financial innovation of the 20th century: the index fund. In 2005, Paul A. Samuelson, the first American to win the honorary Nobel in Economics, said the index fund ranked alongside “the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese.” Even Massachusetts Sen. Elizabeth Warren — not known for her coziness with financial services CEOs! — paid tribute.
Bogle figured out that while most professional stock pickers are basically gambling, everyday stock pickers are pretty much gambling against opponents with X-ray vision who can see all their cards. (Whether Microsoft goes up or down, the dude who sold you his stock is getting his commission.) To get around fees, he developed a simpler philosophy for how everyday people should invest their money that didn’t involve trying to play the market, and he developed a company to serve those needs. Vanguard remains the industry standard for being among the cheapest places you can invest your money in stocks.
Here are his eight rules, pulled from the 1999 book Common Sense on Mutual Funds.
1. Select low-cost funds
2. Consider carefully the added costs of advice
3. Do not overrate past fund performance
4. Use past performance to determine consistency and risk
5. Beware of stars (as in, star mutual fund managers)
6. Beware of asset size
7. Don’t own too many funds
8. Buy your fund portfolio and hold it
It’s a pretty simple set of ideas that, in a lot of ways, really boil down to “don’t overpay some Wall Street asshole for shitty advice.” Bogle will be missed.