Gambling and Risk Aversion

Money was on the line, and I had a call to make. After sixteen weeks, I found myself in our league's fantasy football championship. (Yes, it is a dorky hobby, but it is mine. I like football, I like winning money, and now I had a chance to enjoy both.) But I am also risk averse. I, as most humans, feel losses more acutely, and for much longer, than I feel gains. Victory is fleeting. Regret lasts. So like I said, I had a call to make.

Here are the details...

The winner of the championship game would win $650. The loser of that game would still win $300 for second place. So, either way, I was going home with something better than a kick in the groin. And my team was the favorite: throughout the entire year, my team had scored the most points by a good margin. Still, being the risk averse person that I am, I wanted a guarantee. I made the other owner an offer: I'll take home $550, win or lose, and you get $400, no matter what happens.

I figured I was buying some insurance: for the cost of $100 I was locking in a $550 pot. The other guy, who probably had a less than 50% chance of winning, was now guaranteed $400 either way. The rub was that he could win the game and still end up taking home less money than me. Ultimately, he didn't want to give up the chance of winning for just $100 more, and refused the offer. So whoever won would take home $650, and the loser would get $300. So, what happened?

I won the game: by a lot, too. In the end, my offer would have been bad for me. I should have simply played to win from the beginning. And this makes sense: being risk averse carries opportunity costs. I was trying to buy insurance: and insurance, in the aggregate, costs us more than it pays out. Looking only at the numbers, we should aim to be risk neutral.

But that sort of analysis ignores our emotions. Winning $650 feels good, of course. But losing, even a smaller amount like $350, somehow has a bigger impact on me. And I am not alone. Losing hurts more than winning feels good...if that makes sense. In some ways, the smartest thing I could do is to simply not gamble. Only one player out of twelve can be the winner each year. What I'm doing by wagering, on most years, is ensuring that I'll feel disappointed and have a slightly lighter wallet.

But small time gambling is probably not a big deal, either for my money or for my emotions. I am a big boy, and one who can lose a hundred dollars without crying into my big boy handkerchief. But risk appetite is a more serious issue when it comes to something like retirement investments, or paying off a mortgage. Being risk neutral can help avoid overly conservative approaches: like aggressively paying off a 4% mortgage, or carrying too much money in bonds or, baby Jesus forbid, cash.

On the other hand, maximizing gains is probably not the only thing one should consider. If you are naturally risk averse, you might not have a very good 2015 should your investments lose $100,000 in value over the next twelve months. Your spouse may not be very happy, either. And while your mood does not show up on a net worth calculation, it is a lot more important. A little risk aversion might make for a happier new year.

Which all goes to say: get to know yourself. Observe the way you react to financial gains and losses: ideally, with some small coin first. For those looking to dip their toes in the water, may I recommend fantasy football?


*Photo is from gchampeau at Flickr Creative Commons.