Vegas

Las Vegas happens to be a popular vacation destination for many of my colleagues. I haven't been myself, but from the anecdotal evidence there is an event series common to most of these trips. A certain amount of money is allocated as “fun money,” meaning it will be gambled away. At some point the person wins a big gamble at one of the many tables or machines. At that point, the person starts to feel lucky, and decides to continue gambling with the hope of repeating the big win. Over the course of the vacation, the remaining cash is spent, and the person comes home, having spent all of the “fun money,” and sometimes much more.


As any student of decision-making will tell you, the house has the odds in its favor. That means that, over time, the outcome of every game in the casino is favorable to the house. It doesn't matter who is playing the games, as long as the house is on the other side of the transaction. That's what pays for the magnificent fountain displays at the Bellagio, the pool oasis at Caesar's Palace, or the extraordinary shows at Treasure Island.

So if you know you're going to lose over the long term and end up paying for pools and shows, why not change the behavior before spending the money? The short answer is that individuals are willing to take a small risk (assuming they stay in their budgets) in order to have the opportunity for a large gain (the big win). That's the thinking that propels the first bet.

The problem lies in determining which bet is the last, especially with a big win or two under the belt. Individual judgment is clouded by the immediacy of the win. Assume someone starts with $100 and plays five times at a slot machine. At the end of the fifth play, the person wins a jackpot and is now holding $500. While the house odds haven't changed, the perspective of the individual has based on the very recent experience of translating $100 into $500 in only five plays. Using this new anchor, the individual might think that this is repeatable: $100 will turn into $500, or something close, in about five pulls of the handle. In reality the odds have not changed, and the house will earn back the loss (that's what the person's winnings are to the house – a loss) over time as the slot machine continues to be played.

Often, the individual finds that the $500 dwindles to the original $100, then nears zero. Somewhere between $500 and zero, a different psychology kicks in – the need to “earn” back the lost money. Psychology Today calls this out in a 2007 article leading quote: “One more roll, and I'll get it all back.” As the individual continues to play, cash continues to accrue to the house. Some will walk away, finally accepting the loss. Others will continue to play the odds until cash and credit are exhausted, trying to get the big win that will help recoup the losses. To be sure, some will hit that second win, but those are extremely rare, and often the win doesn't replenish the amount of money spent to achieve it.

Final thought on casinos – ever noticed that it's a big deal when people win? Sirens, lights flashing, someone clapping or celebrating at a table, comped rooms, and much more. To be fair, it's not just Vegas where this happens – do you have a lottery in your home state? Everything is designed to highlight the winner. The reason is simple psychology – as humans we have a tendency to focus on shiny objects and pretty things – that is, when we hear a lot about a few people winning, it seems like a lot of people are winning. Our short-term anchors are adjusted, and it seems really easy to join the ranks of the winners – just buy a ticket, roll the dice, scratch the card, pull the handle.So what does any of this have to do with anything?

Every person is always on one side of a transaction. The entity with the best information will, on average, come out ahead (“win”) the transaction by getting more than is given in the most important currency to that entity. The casino will, on average, come out ahead by getting more money than is given. Your employer will, on average, get more in profit than is spent on your paycheck. You will, on average, trade your labor (proxied by dollars you've earned) for things that are more valuable than that labor.

Is it bad to gamble? Before answering that question, it helps to define the verb.  If it's playing for money, then is it different from the securities markets? 2007 was a tough year.  What about opening your own business?  Restaurants have about a 60% failure rate.  If we define it as taking unnecessary risks in hopes of a great reward, then why should anyone reach for greatness, or go "where no man has gone before (and please pardon my sophomoric reference to pop culture)?"

So, it seems, we are back to the value proposition.  We are all going to fail at times - every transaction has an outlier event that could occur, no matter how improbable.  We give in many currencies:  time, energy, money, thoughtfulness, the opportunity cost of the action, etc.  We also get in many currencies:  the promise of a big win, the ability to call ourselves part of a group, a pay check, love, etc.

A popular financial blog, Zero Hedge, has this tag line: “On a long enough timeline, the survival rate for everyone drops to zero."  What are you doing in this largest transaction?  Is the give worth the get?