The Arithmetic of Life and Death (16 page)

Reginald’s accountant replied that a 30 percent return in two or three years, although a very high return and a success rate of 67 percent, would always underperform a consistent return of only 7 percent per year, as follows:

In fact, because of the single year loss, the last two years of Reginald’s investment strategy had produced a total return of -9 percent. That is because 130 percent times 70 percent is not 100 percent; it is only 91 percent. The accountant then made Reginald a chart that showed how much an investment of $2,000 would be worth in the long run, assuming that a 67 percent speculative success rate was sustainable:

Long-Term Return

Finally, the accountant suggested to Reginald that he simply invest in stocks, which, according to all the advertisements, had averaged a 10 percent return over the very long run and which, therefore, would produce a sum of $19,700 in only 24 years for each $2,000 invested. Frustrated with his inability to sustain high rates of return, Reginald was more than happy to agree.

The accountant, who must have been distracted by the preparation of his résumé at the time, unfortunately forgot to tell Reginald that most stock return calculations depended upon an unprecedented bull run between 1982 and 1997. During that period, the stock market went up fourteen out of sixteen years and the average annual return was almost 15 percent.

From 1967 to 1982, however, the value of the annual Dow Jones average dropped seven out of fifteen years. Over the entire period, the average increased by a total of only five points, from 879 to 884. That equates to an average increase of about .35 points per year and an average annual return of approximately 0.04 percent.

Two thousand dollars invested in the Dow Jones in mid-1967 would have been worth about $2,012 by mid-1982. If the same $2,000 had been invested in a bond fund with an average return of 7 percent, it would have been worth approximately $5,415 in 1982.

Over the entire thirty-year period between 1967 and 1997, the Dow Jones composite went up by an average of about 8 percent per year. In its worst year, from the last trading day in December 1973 to the last trading day in December 1974, the Dow Jones average actually dropped from 824 to 596, a loss of a bit more than 27 percent. Fifteen years later, the Dow Jones went up by 27 percent. If
those had been consecutive years, however, the result would have been a net loss, and a clear lesson on the cost of volatility. That is because 1.27 times .73 is only .93.

Over the same thirty years, Moody’s Aaa bonds yielded from 5.51 percent to 14.17 percent, an average return of more than 9 percent with much lower volatility than stocks. But the last sixteen years still heavily favored stocks, despite three years of negative returns.

No one knows what will happen in the next thirty years, but regardless of the relative performance of stocks and bonds, saving and investing will be manifestly superior to doing neither.

However, if you start late, you have little chance of winning, and, if you gamble to catch up, then you risk losing more ground than you may gain. Eventually, either error could deposit your “Golden Years” in a tin can.

W
hether it is the thrill of victory, the prospect of instant wealth, or just the fun of it, millions gamble, gamble frequently, and gamble big. One would presume, therefore, that most of them win. They don’t. The entire gaming industry—the big casinos, the thousands of employees, the tens of thousands of machines, the glitzy advertisements, and the vast neon signs—is built on their losses.

In fact, the gambling industry exists on a singular premise: You probably lose. Every single game is constructed to ensure it over the long run. If you bet on a professional football game, for instance, you must bet $11 to win $10. The bookmaker has no interest in whether you win or lose the bet, he just wants to ensure that the same amount of money is bet on each team. So he manages the point spread to ensure equality of “action.” Thus, by game day, if
1,000 gamblers have bet on one team, then 1,000 have bet the other way. The next day, there will be 1001 winners: the 1,000 gamblers who were lucky enough to bet on the winning team, each of whom will have won $10, and the bookmaker, who will have “won” $1,000.

If you bet on sixteen football games over the course of the season, and if you are smart enough to “beat the spread” nine times, then you will win $13, a 7 percent return on your investment. If you lose nine of sixteen, then you will lose $29, or more than 16 percent. Either way, the bookmaker will get $16.

Casino poker works in a similar fashion. In return for providing a fair deal, the dealer keeps, or “drags,” a small percentage of each pot. After a while, this adds up. If the average pot is $50 and the average drag is 2 percent, then after 100 hands the dealer will have dragged $100. In other words, he will have “won” the equivalent of two pots—and he will have lost zero pots. If you and your opponents play long enough, the dealer will eventually get all of the money on the table. For the players, the only evidence of superior skill will be the order of insolvency.

Slot machines can be faster. The house “edge” on them can exceed 10 percent, but even at a house edge of 5 percent, death can be swift. Suppose you sit down to a new-age, dollar slot machine with $100 worth of $1 casino coins. Since the latest machines are fully electronic, it is easy to play at least six times per minute. And you can play up to three dollars at a time, an opportunity you cannot pass up. After ten minutes, you should be down by about $9. After an hour, you should have about $46 left. You will probably not make it to the end of the second hour unless you replenish your stake, which is what most tourists do.

Roulette, craps, twenty-one, baccarat, the racetrack, the lottery, and all other forms of gambling have the same thing in common. Each and every one of them is set up to ensure that the game provider wins. If you have ever seen the casinos in Las Vegas, all of which have been built on the losses of people who gamble there, then you know that the people who provide the games have gotten pretty good at it.

Still, it is okay to gamble—as long as you do not harbor the delusion that you are likely to win. Once you can accept the likelihood of loss, then you can treat gambling as a form of entertainment (or as an atypically entertaining form of taxation, since all states that permit gambling also tax it).

Almost all forms of entertainment cost money. Readers pay for books. Bird-watchers pay for binoculars and cameras. Even hikers pay for boots. In all cases, the cost is absolute. Whatever the entertainee pays is gone for good.

Gambling is the exception, because gamblers will often get back some portion of the money that they originally wagered. They may also get the same amount back or even, in rare instances, more than they wagered. Thus, gambling is the only form of entertainment that offers its participating audience the opportunity, however remote, of finishing the evening with more money than they had at its beginning.

Gambling is, in fact, a form of entertainment. It is not a road to big money. Only a few players win; the majority lose. The business of gambling, which is very big money, has been statistically structured to guarantee it.

If you decide to gamble, do it for fun. You may defeat the house advantage in the short run with a streak of good luck, but you should expect to lose in the long run. It’s the safest bet you can make.

S
treaks occur when the same unlikely event happens over and over, or much more often than logic would seem to tolerate. Over the long run, however, good streaks and bad streaks tend to balance each other out. The sum of these streaks, both good and bad, is called the Law of Averages.

Most of us have experienced many streaks firsthand, although we seem to dwell on the bad ones: the week that both the washing machine and the furnace went out, the two flat tires on the same day-trip to the theme park, the season when our favorite baseball player went hitless in twenty consecutive at bats, the police fund-raiser where we lost ten consecutive hands of blackjack.

As illogical as they may seem, though, streaks are fundamental to the disorder of Nature. That’s because the opposite
of streaks, which is perfect order, is usually contrary to the nature of Nature.

Shuffle ten red cards and ten blue cards together at least ten times. The total number of cards in the randomly combined deck is twenty. If they are in perfect order, then the cards will alternate in color: red, blue, red, blue, red, blue, et cetera. But this isn’t what happens. That is because the odds of a perfect, alternating sequence of color are less than one in 92,000 (1 × 10/19 × 9/18 × 9/17 × 8/16 …).

Of course, any sequence of same-colored cards might be more than just two in a row. For instance, the odds that the first five cards in the twenty-card deck will all be the same color, which would be quite a streak, are approximately 1 in 31 (the chances that the second card will be the same color as the first are 9 in 19, the odds of the third card being the same color as the first two are 8 in 18, the fourth card’s odds are 7 in 17, and the fifth card’s odds are 6 in 16). Therefore, a five-card streak of either color at the beginning of the deck, which is a streak, turns out to be about three thousand times more likely than a “normal” alternating sequence of twenty cards.

In general, streaks are more likely than order. A baseball player who bats .250 will not get a hit every fourth trip to the plate. (If this were always true, then the batter would be walked intentionally every fourth at bat.) Instead, his or her hits will tend to come in bunches. Sometimes the bunches will extend into streaks. On other occasions, the lack of hits will become a streak. The chances that a .250 hitter will go hitless in twenty consecutive trips to the plate, for instance, are only about 3 in 1,000. That is a nasty streak. But if the batter has six hundred at bats per year, then
he is likely to endure just such a streak almost twice per season.

The same thing can happen to you. If you have a 49 percent chance of winning any hand of blackjack at the local police fund-raiser, then you would not expect to lose ten hands in a row—a horrible streak of bad luck. In fact, the odds are about 1 in 840. But if 250 people play fifty hands of blackjack at the police fund-raiser every year, then, on average, fifteen of them will lose ten consecutive hands. One unlucky player may lose fourteen in a row.

In the natural disorder of Nature, events tend to occur in bunches. Streaks, therefore, are fundamental to life. If you must choose between a streak or order in the short run, always pick the streak. But be careful. It is often easy to determine which streak has just occurred, but you can never be certain how long any streak will last.