A few years ago I read Ed Thorp’s book and became fascinated with card counting in blackjack. Unfortunately, I was 20 years too late, as I quickly learned most casinos have protocols in place to stop “advantage players”.
But the experience taught me some interesting lessons, one in particular, regarding edge and bet sizing. Here’s the lesson and how it applies to investing.
Card counting
The basic concept is whether you have an edge over the dealer (or the dealer has an edge over you) depends on the type of cards that are remaining in the deck. The more high cards (10, Jack, Queen, King, Ace) remaining in the deck, the larger your edge. The more low cards (2, 3, 4, 5, 6) remaining in the deck, the larger the dealer’s edge.
You keep a running count which starts at 0 with a fresh deck(s) of play. The higher your count, the larger your edge over the dealer (and vice versa). Each low card that’s dealt increases your count by 1 because that means one less low card remaining in the deck, increasing your edge. Each high card that’s dealt, same logic in reverse, it decreases your count by 1. Keep in mind, it can take hours or even days of continuous play to achieve a high running count and it may only last for a few minutes.
Here’s the lesson: when you do manage to achieve a large edge (high count), you increase your bet size significantly. That’s how you make money in blackjack.
Increasing Bet Size in Investing
This lesson in increasing your bet size when you have an edge applies to investing as well. When I refer to “increasing your bet size” here, I mean investing to buy more of an asset you already own. So why would you want to do this? Let’s take a look at some of the reasons.
Having an edge
In order to generate above-average returns in investing over the long run, you need an edge. One of the simplest ways to do this is to be an owner or investor of a specific business. Time increases the knowledge of the asset you own, giving you an edge over outsiders. Having this knowledge/edge allows you to determine if increasing your stake/bet is the best return on investment (versus pursuing a new opportunity).
Knowing the “running count” of the business you’re invested in is an advantageous position to profitably increase your bet size and returns.
Good opportunities are rare
Good businesses are rare. With the advent of technology, disruptions happen frequently across multiple industries. If you’ve managed to invest in a clear winner, just understand that it’s a rare feat. Even the smartest investors are often wrong with their picks. Good businesses tend to continue to compound and get even better over time. This makes a compelling case for increasing your bet size on high-performing businesses you already own.
Just like in blackjack, achieving a high count at a table can take a long time. Since achieving a high count is relatively rare, when you do manage to obtain it, you’ll want to take advantage.
Easier capital deployment
Seeking new opportunities to invest in requires time, effort, and resources. Not to mention, the level of uncertainty and risk in investing in something that’s completely new.
But with assets you already own, you will have already done the research, analysis and kept up-to-date with the progress. This makes it far less effort to allocate capital to your existing positions over seeking net new opportunities.
Examples of Increasing Bet Size
Let’s walk through some practical examples of increasing bet size.
Real Estate
Unlike the following 2 examples below, it’s hard to deploy more capital to already-stabilized properties. Therefore, increasing your bet size in real estate means adding more properties in a specific geography, category, or some other type of niche you’re already invested in.
Mainstreet Equity is an example of a real estate investor that’s been increasing its bet size for over 20 years, and the results have been phenomenal.
Privately Held Companies
Companies often offer numerous reinvestment opportunities where additional capital can be allocated. Private investors can invest directly onto the company’s balance sheet or buy shares off of other owners/investors.
I recently listened to a podcast with Ho Nam, Managing Director at Altos Ventures, where he discusses his investing style. Ho made some incredible points around investing, but what stood out to me was his ability to increase his bet size in the private companies he owned. Ho mentions that his firm went out of its way to purchase more ownership in their winners. This meant registering as Registered Investment Advisors (necessary to buy a large number of shares from other owners), not being concerned with concentration, and setting up special-purpose vehicles outside of his fund to double down on existing portfolio companies.
Stocks
Publicly traded securities are by far the easiest type of investment to increase your bet size in. All it takes is a click of a button. This is often referred to as “averaging up”.
You can take a full position in a stock to start and study the business closely as it progresses. As time goes on, you should be able to determine whether the business deserves more of your capital or not.
Forces Working Against Increasing Bet Size
Despite the fact that increasing your bet size can be an incredibly profitable strategy, it’s objectively difficult to do. This is why I respect investors who significantly increase bet size over time. It goes against human nature, which is why I refer to it as a superpower.
Here are some of the forces that work against increasing bet size in an existing asset.
New Opportunities Are More Exciting
It’s no secret that it’s far more exciting chasing new ideas, deals, and opportunities to invest in, compared to buying more of the assets you already own. Fund managers are often even incentivized to chase new investments opportunities, instead of allocating money to assets the fund already owns.
The default action to allocate money into new opportunities is like leaving your current blackjack table, where the count may be high, to play at a brand new table where the count is unknown.
Anchoring Bias
Investors mentally anchor an asset’s price to whatever their entry price was. If you invested in a business when it was worth $50m, and today it’s worth $750m, it’s psychologically difficult to invest at the current price. In your mind, $750m seems expensive compared to your $50m entry. This is textbook anchoring bias, and unfortunately, human nature.
The reality is, the company at $750m may actually be a better company than it was at $50m. Even though its price has gone up by 15x, the company’s prospects could have now improved by 30x. This would make the company an even more valuable investment opportunity today than it was when you first invested. And since you’ve owned the business since it was $50m, you should understand this the best and have an edge over outsiders here.
Diversification
Investors often want to diversify to mitigate perceived risk. Increasing your exposure to existing assets would work against diversification. Concentration is a scary thing for most investors, and most prefer to avoid it, even if that means adding worse assets to their portfolio. But, in my opinion, it’s better to be concentrated in assets where you know the “running count” is high, than have a diverse set of assets you know little about.
An outsider, without knowledge of card counting, watching an advantage player would be confused as to why they increased their bet size. The outsider would likely conclude that player is just making a risky bet. But the advantage player will know exactly why they increased their bet size since they’ve been keeping count, quite the opposite of making a risky bet.
Final Thoughts
Blackjack taught me an important lesson around bet size and edge, which has applied to my investing career as well.
If you have surplus cash to allocate to investments before you leave your current table, ask yourself, how high is the count here?
Hi there! I’m Jay Vasantharajah, a Toronto-based entrepreneur and investor.
This is my personal blog where I share my experiences and passion for investing, entrepreneurship, personal financial management, and traveling the world.
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