Are you on a budget or a bankroll? Knowing this is the difference betweeen sanity and insanity if you are investing or gambling. Do you know how to tell the difference?
For most people, the test is easy. If you are taking money out of your income stream to fund your gambling or investment, you are (or at least should be) on a budget. The purpose of such a budget is to ensure that you are not spending money on these activities that you need to pay the rent or eat. If you like to play poker, but lose consistently, you need to be on a budget.
It’s perfectly fine to play poker and lose if you enjoy spending your time that way and can afford it. When you are figuring out whether or not you can afford it, make sure you assess the value of the time spent. For example, if you are a mediocre poker player (as most people are by definition), you can limit you financial budget by playing for lower stakes. Let’s say, five dollars is all you think you could afford to lose every week. If you found tournaments that cost a dime to enter, five dollars would last a whole week even if you never finished in the money.
In fact, there are enough tournaments that are free to get into so that you could easily spend two hundred hours of your time playing in them every week without spending a nickel. The real cost of your activity is the cost of your own time. If you could make as little as fifty cents an hour, you would have effectively spent a hundred dollars on your gambling habit. If you live in the U.S. and get minimum wage, the alternative use cost to you is about fifteen hundred dolalrs for each two hundred hours you spend at the table. If you’ve got a skill that earns you fifty dollars an hour, each one hundred hours you spend on the tables is five grand that you could have had in your pocket. True that time has more value than the money you get for it, but you have to budget your time to make things work in this worl.d.
Very few people, comparatively, are working on a bankroll. A bankroll consists of other people’s money that you have made in this activity. Your investment fund only becomes a bankroll when you take out all of the money you originally put in. Budgeting is still important after you have reached this point, but how much of my bankroll can I afford to bet is a different question than whether this game and these stakes fit within your budget.
If you have a bankroll, you should be guided by past history and Kelly’s Law. Kelly’s Law says that you need some kind of evidence of an edge before you take any bet or make any investment. If it’s a stock, you need a reason to believe that it is going in the idrction you are betting on. If it’s a poker game, that means that you need a past history of making money playing poker.
If your past history says that you lose in poker, playing poker is an amusement decision, not a gambling decision. If it is a gambling decision, the other implications of Kelly’s Law need to be followed as well. One of these is that you should never bet more than half of your money on less than a sure thing. Think of it as a scale where you can bet half of your money on a bet you are 99.99% certain to win, but only one percent of your cash in bets where you have a five percent edge.
It is important to keep in mind as so many people recently have not, that every time you bet all of your money on less than a sure thing, you risk losing all of your money. It doesn’t matter how smart you are or what you think you know. The unknown can strike at anytime.
This of course also implies that you should never use leverage except in the case of a sure thing. Leverage is betting all the money you have and all of the money you can talk your broker into lending to you. This clearly violates the principle of never betting more than half ofd your bankroll on less than a sure thing.
Sure things are incredibly rare, but ninety-nine percent things are available most of the time.
Insurance executives will confirm that these once a hundred year storms come far more often than that. Poker players can tell you how often they get beat by a draw that could only lose to a single card in the deck. If it can go wrong, it will far more often than it looks like it can. Stay within your budget if you are on a budget and inside of Kelly’s guidelines if you have a bankroll, and these events will not wipe you out when they inevitably happen.