Thinking in Bets – Lessons for Investors

I know what you may be thinking. “A book about poker? I thought this blog was for investors in equity crowdfunding?”

The subtitle of the book hints at the real value that it offers, though: “Thinking in Bets: Making smarter decisions when you don’t have all the facts.”

Annie Duke defines a bet as “...a decision about an uncertain future.” And that’s exactly what investing is. Investors must decide whether to invest capital based on incomplete information and an unpredictable future.

Being successful in investing doesn't always mean having more financial acumen or industry knowledge than other investors. Sometimes, the greatest advantage an investor can have over other investors is a thorough understanding of human biases and psychology.

In the words of one of the world's greatest investors:

We don’t have to be smarter than the rest. We have to be more disciplined than the rest." - Warren Buffett

Annie presents concrete examples of and techniques for how to be more disciplined in any uncertain environment, whether that's in a game of poker, in making an investment, or in choosing a new career.

I would honestly rate this as one of the best investing books that I’ve read, even though it isn’t technically about investing. It focuses on the psychological and human side of investing, which all investors can fall victim to from time to time.

Head over to our books page now and do yourself (and your investment portfolio) a favor by picking up a copy of Thinking in Bets by Annie Duke.

Top Four Takeaways from Thinking in Bets

Annie was a professional poker player, winning a World Series of Poker (WSOP) gold bracelet in 2004, winning numerous high-profile poker championships, and was previously the leading WSOP money winner among women. She has earned her stripes in making decisions in uncertain environments, so it would be wise to reflect on the lessons that she shares in this book.

While Thinking in Bets presents many lessons that can be applied to countless areas of life, here are our top four takeaways for private market investors:

  1. Understand that outcomes depend on two factors - skill and luck
  2. Understand how recent events impact your decision-making and can cause tilt
  3. Use Ulysses contracts to prevent your future self from making emotional and irrational decisions
  4. Use mental time-travel to improve the quality of your decisions

1 - Understand that outcomes depend on two factors - skill and luck

Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about." -Annie Duke

To illustrate this point, Annie claims that “Life is like poker, not chess”.

In chess, while the number of possible moves is enormous, there is no element of chance or uncertainty involved. Theoretically, you can re-trace any of your moves in any game and find out exactly where you went wrong. Furthermore, all the information required to make a decision is available on the board the entire game.

In contrast, in poker, your opponent’s cards are hidden, so you must learn to make decisions without having a complete picture of the situation. In addition, there is always an element of luck in the cards that are flipped from the deck. Due to this element of chance, you can calculate the probability of outcomes in each hand, but it is impossible to know with certainty how each hand will play out, even when you know exactly which cards each player holds.

When assessing outcomes, such as with investments, you need to recognize that both of these factors - skill and luck - will influence your results.

Even if you make the right decision, you may get a bad outcome due to luck.

On the contrary, it is possible to make a bad decision but get a good outcome.

To improve your decision-making process, it is imperative to create two distinct buckets - one for luck and one for skill - and then assess how much of each outcome is attributed to each bucket.

You can only improve that which you can control, so don't waste time stressing about factors that were due to luck. Focus your energy on the factors that you can control.

2 - Understand how recent events impact your decision-making and can cause tilt

First, let’s define what tilt is in poker. According to Wikipedia, tilt is “a state of mental or emotional confusion or frustration in which a player adopts a less than optimal strategy.”

For example, a poker player may “go on tilt” after catching a couple of bad breaks in a row (i.e. hands that they statistically had better odds of winning, but end up losing due to chance when the cards are flipped). Despite making the correct decision, the player gets an unfavorable outcome due to luck. This can then cloud their judgment, causing them to play over-aggressive in subsequent hands by trying to make up for their losses. It can also manifest in many other ways that are detrimental to their long-term strategy.

We can easily see how the concept of tilt applies to investing. For example, perhaps an investor decided to sell all their private shares and realize gains during an Initial Public Offering (IPO), only to see the stock gain massively on the first day of public trading. This would leave an investor with a feeling of remorse for having sold their shares prematurely. In an emotional state, and without reflecting on their initial decision to sell, the investor may decide to buy the stock back the next day, only to find the stock now heading in the opposite direction.

Every investor - myself included - is susceptible to clouded judgement and emotional swings from time to time. To counteract those emotions, investors must put systems and rules in place that protect themselves from making irrational decisions when under the influence of emotion.

In poker, that may be walking away from the table for a break, or not using any additional money to buy-in again after going broke.

With stocks, that may be a predetermined stop-loss order that automatically sells your stock at a certain price threshold if things don't go your way.

In startup investing, due to the illiquidity of private market securities, investors fortunately have a sort of built-in protection from themselves, since you cannot buy or sell your private shares at will.

However, investors will still have important decisions to make along the way, so it is important to reflect on these options before they occur to remain as objective as possible when they do occur.

Some decisions in equity crowdfunding investments could include:

  • Do you sell all of, just a portion of, or none of your shares during the company's initial public offering (IPO)?
  • Do you make a follow-on investment in a later funding round for a startup that you previously invested in?
  • Do you break your standard investment amount (e.g. $100) and invest twice as much as you normally would because you really like a given business?
  • Do you deviate from the industry that you usually invest in because an exciting company in another industry has caught your attention?

All of these are examples of decisions that are better planned out in advance and documented in some form, rather than being handled on a case-by-case basis. You can and will change your strategy over time, but having an investment thesis documented and that you can reference will help improve the quality of your decisions.

Path-dependence of outcomes: (A + B) = (B + A) in mathematics, but not always in life

We can intuitively understand that a string of bad or good outcomes can impact our decision-making in the near-term, and use planning to put systems and triggers in place to protect ourselves from these biases. However, Annie demonstrates that the order in which events occur can also influence how we field outcomes.

Imagine going out gambling one night with your friends. In the first hour, you are up $1,000! But over the next few hours you slowly lose it all back to the house, erasing all your gains and ending up right where you started.

In a second instance, imagine that same gambling night out, only you hit a streak of terrible luck to start and lose $1,000 in the first hour. You decide to stick around because your friends are still there. Then, over the next few hours, you slowly win it all back, ending up exactly with zero in gains.

Annie asks - how would you feel in each situation?

Likely, you would feel sad and upset at having lost all your early gains in the first situation. But in the second situation, you would probably be relieved, happy to have broken even, and might even buy the next round of drinks in celebration!

While you ended up with the same outcome in both situations, the order in which the events occurred had an impact on how you viewed that outcome.

While Annie presents this example through gambling, it is easy to imagine the same thing happening with your investment decisions. That is, an investment either goes up at first, only to come crashing back down, or vice versa.

The takeaway from this section is:

What has happened in the recent past drives our emotional response much more than how we are doing overall.” - Annie Duke

Knowing this fact, how can we improve our decision-making? One way to combat human emotions is called a Ulysses contract.

3 - Use a Ulysses Contract to protect your future self from emotional responses

In Homer’s Odyssey, there is a part of the journey where the hero, Odysseus (Ulysses is the Latin name), sails past the island of singing Sirens. The Sirens are beautiful women whose captivating voices lure nearby sailors so close that their ships capsize off the rocky coast. No man had the willpower to withstand their enchanting songs.

Odysseus longed to hear the songs, but didn't want to put his crew's lives at risk. To prevent himself from falling for the trap, but to still hear the songs, Odysseus devised a plan. He had his crew tie him up to the mast before approaching the treacherous waters so that he could not move, and then had them stuff their own ears with wax so that they wouldn’t be driven to madness by the songs.

Odysseus made a decision and took action in his present, controlled, emotional state, to prevent his future, emotional and uncontrollable self from doing something that would be harmful. This is called a Ulysses contract.

In a similar way, investors can set up rules and thresholds to protect their vulnerable, emotional future selves from acting in ways that sabotage their long-term investment objectives.

In the book, Annie talks about Ulysses contracts in the form of setting up automatic investments. Another example would be creating investment plans with your investment advisor prior to investing, which documents your target goals, allocations, and strategies.

Investment decision logs are another tool that can improve future decision-making

A common theme among the books that we have reviewed thus far (Angel and Principles) is that they all recommend some form of an investment “decision log”. A decision log helps to document decisions in an objective manner when you make them, as well as outline expectations and conditions for when the investment position should be reevaluated or changed.

Investors should write down their investment goals, criteria, and predictions before making any investments. This helps us to remain more level-headed and focused when it comes time to make an unemotional decision in the future, and prevents some of the biases that humans are susceptible to when reflecting on past events.

Do you see this startup having a $50 million or $1 billion exit? Do you see any obstacles and roadblocks that the founders will have to overcome? What are the biggest risks? What are the biggest opportunities?

Reflecting on potential outcomes and assigning probabilities in advance (and then writing them down!) will allow you to revisit these predictions and improve your decision-making in the future.

While Annie never explicitly recommends keeping a decision log, it is not hard to see how the following quote supports doing just that:

If we don’t try to hold all the potential futures in mind before one of them happens, it becomes almost impossible to realistically evaluate decisions or probabilities after.” -Annie Duke

In addition to Ulysses contracts and investment decision logs, there is another mental trick that we can use to improve our decision-making.

4 - Use mental time-travel to improve the quality of our decisions

When we make in-the-moment decisions (and don’t ponder the past or future), we are more likely to be irrational and impulsive.” -Annie Duke

Examples of making irrational, in-the-moment decisions are ubiquitous. For example, employees often prefer to take retirement lump-sum distributions and get paid immediately, even though the deferred reward could potentially be much larger.

Or have you ever been asked to do something several months out by a friend, only to regret having agreed to it when the time finally comes? Or have you ever had that one extra drink while out with friends, only to regret having it the next morning?

These are all examples of temporal discounting. Temporal discounting is when you value your present self at the expense of your future self.

For investors, this can manifest in numerous ways. Perhaps you decide that you’d rather buy that new smartphone you’ve been wanting, rather than investing the money to let it grow. Or perhaps you cash in on winning investments too soon, wanting to enjoy the fruits of your gains now, rather than letting the investment continue to compound and grow even larger in the future.

How can we combat this human tendency of over-valuing the present self over the future self?

There is one technique that Annie calls the 10-10-10 rule. Ask yourself, “[W]hat are the consequences of each of my options in ten minutes? In ten months? In ten years?

When evaluating early-stage companies or making any decision, reflecting on the 10-10-10 question has the ability to remove you from your present, biased circumstances, to reflect what your future self may think when looking back at this decision.

That "Airbnb for women's handbags" app may have sounded like the next big thing when listening to the founder's pitch, but thinking about what your future self would say about that investment can often help to be the voice of reason in otherwise emotional circumstances (and no, that is not a real product - yet).

Removing yourself from the present moment can help you to make better decisions that align with long-term objectives, not only in investing, but in careers, relationships, health, and other areas of life.

No one can predict the future

We are going to do better, and be happier, if we start by recognizing that we’ll never be sure of the future. That changes our task from trying to be right every time, an impossible job, to navigating our way through the uncertainty by calibrating our beliefs to move toward, little by little, a more accurate and objective representation of the world.” - Annie Duke

Life is random. The future is unpredictable. There is no way of getting around that.

No matter how likely anything seems, nothing in life is a sure bet.

Some people may believe that - given enough information, resources, and thought - we can develop extremely complex models based on historical data to predict what successful investments look like.

The uncomfortable truth is, whether you are a quant on Wall Street or a Venture Capital firm in the private markets, all those models are based on history. No one has a crystal ball of what the future holds. And any model that tries to predict future events is an educated guess at best, and pure speculation at worst.

A metaphor that I often remind myself of when thinking about historical performance is that relying on historical data to make decisions about the future is like driving your car while only looking in the rear-view mirror. While it can inform you about where you have been and perhaps improve your performance if more of the same keeps coming, it cannot predict the unknown that lies ahead, especially when the road changes unexpectedly.

Do you think that you, or even the company's founders, have a definite idea about what the future holds? What if a massive volcano erupts or an asteroid hits the Earth? What if a giant solar flare like that in 1859 occurs (estimates are that a similar solar flare today could cost the US infrastructure trillions of dollars)? What if an alien civilization pulls up to visit Earth tomorrow? What if we stumble upon a cure for cancer?

While these events are extremely unlikely and may even sound crazy, the fact is that much of Earth's history has been shaped by these black swan-type events as discussed by Nassim Nicholas Taleb (maybe except for the alien visit - as far as we know). Only they don't look so crazy in hindsight.

Thus, even if we think we can predict the future, we are only projecting an image of what we think today’s world will look like tomorrow. From historical precedent, the future will be completely unlike the present-day.

How does one succeed in a world where the future cannot be known?

The answer lies in applying principles to optimize our performance in the unknown, such as those found in Thinking in Bets, as well as in other books, such as Antifragile by Taleb and Principles by Ray Dalio.

By realizing that we cannot know the future with certainty and by taking actions to improve our decision-making in uncertain environments, we can continually improve our outcomes, decision-making processes, and lives.

If you find some of these points insightful, be sure to head over to our books page and pick up a copy of the book for yourself so that you can get all the other wisdom that Annie shares.

>