part i

WHY CURRENT METHODS DONT WORK

The Sure Thing Almost Nobody Plays

Imagine you are entering a deluxe, well-appointed casino. Off the lavish entry foyer, there are two ample gambling wings, one hued in reds, the other in muted greens. The red wing looks enticing, but if I may insist, lets first enter the less crowded green rooms to watch the action.

The atmosphere is unhurried, the blackjack tables are sparsely attended, and every player sits behind a mound of green and black chips. You think at first youve come to the wrong place. You see the ordinary table limits, the ordinary clothes, the ordinary games. But then how did these ordinary people get such piles of money?

Then it comes to you. Theyre all winning. In fact, as you walk around the green wing, you hardly can find a losing player. You know, of course, that the average house take on table games is 5%, but as you count winning and losing hands, you realize these players are getting a better break. They seem to be gaining at a rate of 60% to 40%. You start fresh and take another count. The results are the same.

A pit boss appears at your shoulder.

"Excuse me," you say, "but can this be right? The odds favor the players?"

"Yes, indeed. The odds in the green room usually run 60 to 40. Its been that way since we opened."

"But... most of the players must go away winners."

"They sure do. At those odds, we calculate that 9,999 out of 10,000 make money. At our high-stakes tables in the back, they do even better, with winners running about 20,000 to 1. Its a good thing we get so few players, or theyd break the house."

On Markets and Odds

Sounds Uke a pleasant dream rapidly degenerating into nightmare. Yet it happens daily in the market. Moreover, the odds in the green and red rooms are notjust attention grabbers. Theyre very real. In the marketplace, in fact, some investments steadily make money, while others lose consistently at these identical odds. Like the casino, most people want investments that have a good chance of beating the market. Yet, despite considerable time and effort devoted to the mission, they gravitate toward investments where swarms of enthusiastic players are endangering their savings at odds similar to those in the red room.

It seems surrealistic, but it isnt. Generations of investors have passed up sure things to buy losing investments. We all know, for instance, that for safety we should invest in treasury bills and govemment bonds. The investment environment has changed radicaUy in the postwar period, however, as well see in detail in chapter 13. Treasury bills and govemment bonds, gilt-edged securities for centuries, are now surefire ways to

Somewhat amazed, you thank him and shake your head. Theres no time to lose, you decide, but youll need more than the few dollars you have in your pocket. You hatch a plan to gather your Ufe savings, come back to the casino, and win the bundle youve been dreaming of.

On your way out, you glance into the red wing. The action level is much, much higher. The room is crowded and fairly roars with excitement. Can it be even better here, you wonder? Curious, you go in. Players bet multiple table positions, wave frantically for change, entreat the gods for luck. You see few green and black chips, fewer winning players. The piles of chips in front of them are dwindUng with each hand. In fact, the odds are worse than normal. Again, you start to count. Although the players continue to excitedly toss in their chips, the odds appear to be maybe 60 to 40 in favor of the house. Once more, your curiosity whetted, you walk over to a pit boss and ask her the odds at these tables.

She tells you what you suspected. They are 60 to 40 in favor of the casino. Warming up to the subject, she chuckles and says, "This room coins gold for the casino, the chances are 9,999 in 10,000 rounds that we wind up winners." You dont have to be a genius to see that this is obviously not the place you want to be.

You go home and get your stash. You retum to the casino with your fistful of money, excited, eager for action, all the time figuring how youll do even better at the game. But then a strange thing happens. You walk into the red wing and start to play.