In Poker and Personal Finance, Here’s How a Small Sample Can Ruin You

By Dan Kadlec

December 7, 2017

Don't let a small sample sway your money decisions

Long-time readers know that I enjoy poker and value its many embedded money lessons. I have been part of a home game for years, and I have taken my shot in the big dance in Las Vegas—the World Series of Poker’s Main Event.

The game has taught me many useful money lessons. With caveats, I recommend it for youngsters. A few years ago, for Time magazine I chronicled fundamental changes in the way Texas Hold ‘Em is being played at the highest levels.

What does this have to do with financial literacy? Plenty. But I want to focus here on a simple lesson we often talk about in our home game: Don’t be fooled by a small sample.

Our game consists of 12 tournaments a year to determine a league winner. In tournament poker, a dozen is a super small sample size. Winning the league one year doesn’t necessarily validate your strategy. The cards may simply have fallen right. Likewise, failing to win the league does not mean you are an inferior player. These things can only be determined after your play has been tested over hundreds of tournaments.

Young savers and investors would do well to understand the pitfalls of small sample size. Inexperienced people are especially prone to interpreting a successful outcome as validation of a particular decision or strategy—even though the outcome may have occurred against long odds.

For example, a young investor may think stock picking is easy if the first stock she buys jumps 10% in a week. Yippee! Let’s buy more! But that pattern won’t persist. Eventually she will begin to understand how much she does not know about picking stocks—too often after loading her portfolio with terrible investments.

David Dunning, a psychologist at the University of Michigan, calls this “the beginner’s bubble” where individuals are ignorant of their own ignorance. This can be a costly state of mind, and yet it is all too common. This is one of the primary goals of financial education—to communicate to individuals that knowing what they do not know about money is perhaps the most valuable knowledge of all.

By the way, this is a central tenet of Warren Buffett’s. He calls it the circle of competence and argues that how much you know about anything is less important than…

• • •

…knowing when you have stepped outside your circle. Those who do not recognize when they have strayed too far from what they know may act from a sense of false confidence and make poor decisions. But if you can identify when you have crossed the line, you will seek answers first.

Over confidence in the money sphere is abundant. Writing in the Wall Street Journal, Jason Zweig notes a survey where 68% of people saving for retirement claimed they were familiar with their plan’s fees but only 25% had ever read the fee disclosures. What was the source of their confidence? Many don’t know what they don’t know.

Only 38% of individuals can answer five simple money questions correctly, according to another survey. And we are talking really basic questions. Take the quiz yourself. Something close to this abysmal success rate applies even among CEOs and other top corporate managers.

Yet when asked how they felt they performed on the five-question quiz, the average respondent overestimated their score. They did not know what they did not know.

Financial Confidence Not What You Think  

Confidence about money is a tricky issue, not unlike Goldilocks and her porridge. Too much confidence leads to poor decisions. Too little confidence leads to inaction. But just the right amount of confidence—the perfect temperature, if you will—leads individuals to ask questions and with the answers take important actions on things like 401(k) contributions and paying down debt.

Courage with money is as important as knowledge

Financial confidence underpins “financial courage,” which is an important key to overall financial wellness, Mercer found. Only through financial courage does one confront their knowledge gaps and ultimately make wiser personal money management decisions, Mercer concluded.

This finding is changing the financial education landscape at many companies. If financial confidence, or courage, correlates with financial well-being—and it does—what employees may need more than any textbook knowledge of money is an easy and timely way to get the answers that they have the courage to seek.

Teachers, employers and policymakers might keep this in mind as they set a course to help individuals better manage their money. Classic financial education will always have its place. Indeed, it is one source of financial confidence. But what may be more important are tools that quickly steer an individual looking for answers. Such tools might include online resources like mymoney.gov and AskCFPB. They might include hotlines or one-on-one counseling.

For those who lack financial confidence, improvement is most likely to occur through baby steps—by making small financial decisions and building courage gradually. Individuals will not gain confidence if they feel overwhelmed. Coaching and accessible tools help them get past feeling lost, and small wins keep them interested in learning.

Can You Ace This Money Quiz (Most Cannot)?

In a study, just 38% of individuals—including roughly a third of financial executives—answered all five questions correctly. These are staple questions that have been widely incorporated into financial literacy assessments, including the 2004 Health and Retirement Study and the 2009 and 2012 National Financial Capability Survey. See how you do.

Testing money skill is tougher than testing wine

Compounding Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

More than $102

Exactly $102

Less than $102

Inflation Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account?

More than today

Exactly the same as today

Less than today

Diversification Buying a single company’s stock usually provides a safer return than a stock mutual fund.

True

False

Mortgages A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.

True

False

Bond Pricing If interest rates fall, what should happen to bond prices?

They will rise

They will fall

They will stay the same

There is no relationship between bond prices and interest rates

How did you do? Answers: 1) More than; 2) Less than; 3) False; 4) True; 5) They will rise.

For more on financial courage and well-being:

How Financial Courage Leads to Financial Wellness

How Money Stress Costs Employers $250 Billion a Year

Why Your Company Must Offer A Financial Wellness Program

 

Posted in Latest Research on December, 2017