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What are the odds that Tom Waterhouse makes a great investor?

racing, horse racing, melbourne cup, winning

Did you see the news?

Apparently Tom Waterhouse – yes, that Tom Waterhouse – has gone from bookie, to racing tipster and now wants to start a funds management business.

Cue much guffawing.

What does Tom Waterhouse know about stocks?

How could he possibly be a fund manager?

Hahahaha!

And yet…

I’m no fan of bookies.

Or racing tipsters.

Gambing on horse races is a zero-sum game.

If I win, you lose.

Actually, it’s worse than that.

If I win, you lose more, because the house takes its cut, too.

And unfortunately, there are more than a few people addicted to the punt, and for whom gambling is the cause of much unhappiness, poverty and breakdown.

And yet…

The simplistic ‘What would an ex-bookie know about stocks’ is, well, simplistic.

I have no idea what Tom Waterhouse knows – or doesn’t know – about investing.

Maybe he’s just looking to parlay his name recognition into a new field.

Maybe he’ll be terrible at it.

Maybe he’ll employ others to do the hard work.

Or maybe he’ll be great.

Time will tell (and, based on what he was quoted as saying in The Australian yesterday, he’s going to give himself time to earn a track record before putting out his shingle, so he should get credit for that).

Now, here’s what’s supposed to come next.

As someone in the investment community, I’m supposed to point out the difference between investing and gambling.

I’m supposed to say ‘gambling’ with a sneer, clearly letting you know that as an investor, I’m superior in almost every way.

See, I’m not one of them. I’m one of the good guys.

But man, there are few things I dislike more than arrogance and smug superiority.

Especially when it’s not warranted!

Let me introduce you to one of the best investors in the last half-century.

His name is Charlie Munger, and he’s Warren Buffett’s right hand man.

Not only is he a billionaire and a polymath, he’s about as close as it gets to investing royalty.

Tell ’em what you said, Charlie:

“We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is.”

Well, that’s inconvenient for the ‘investing isn’t gambling’ crowd, huh?

To be clear, though, what those sneering investors are doing is playing on our preconceptions of those words.

If someone says “taking a gamble”, we assume they mean “doing something that probably won’t work”.

When they say “that’s gambling”, they mean “good luck, loser!”

And maybe that’s fair enough.

To be sure, the outcomes from – and let’s put those terms aside for a minute – buying and holding shares in quality companies are likely to be better than trying to earn a positive return from a horse race where the outcome is less than zero-sum, after allowing for the house’s take.

Or, put more simply: History suggests that owning shares is more profitable than playing roulette, blackjack or trying to pick a winner in the 6th at Moonee Valley.

So, yes, I’d rather people invest in shares than get on the punt.

But that’s not to say they’re mutually exclusive pastimes.

Indeed, as Munger points out, both are an exercise in probability.

More specifically, in risk and return.

That ‘sure thing’ that got beaten on the weekend? It’s the equivalent of the ‘can’t lose’ blue chip stock your broker recommended that, well, lost.

The rank outsider that paid 30-to-1? Meet Afterpay, whose shares went up 10-fold after the market lows of late March, and that were up 30-fold in three short years.

And yes, the 100-to-1 long shot shares more than a little in common with that biotech hopeful or luckless gold explorer that never seems to deliver.

But good investing shares a lot in common with professional gambling.

Both require a thorough understanding and assessment of the odds: the risk and potential return.

Both require a diversified portfolio – of companies or bets – in the full knowledge that some of them will go badly.

Frankly, the professional gambler is more an investor than the novice day-trader who believes they can beat the market.

The professional gambler is more an investor than the bloke who buys stuff because their mate suggested it, because it’s going up, or because everyone is talking about it on some free internet forum.

I hope that makes you uncomfortable. Not because I’m telling you that you’re wrong, per se, but because I hope it leads you to reassess how you invest.

The aim of investing isn’t to find ‘sure things’.

No, not because that’d be bad, but rather because it isn’t possible.

There are no ‘sure things’ – in investing or anywhere else (setting aside death and taxes, that is!).

But rather because the investor’s job is to try to get a handle on the risk they’re taking, as well as the return they’re being offered.

If you were offered a 1% return, you’d better hope the investment is about as risk free as they come!

If you were offered 80%, you should assume there is a very, very high chance of doing your dough.

But if you were offered, as Charlie Munger suggests, a 50% chance of a 3-to-1 payout, you should take it.

But first, remember that a horse with a one-in-two chance of winning will actually lose half the time! 

Munger would be the first to say you shouldn’t put all of your eggs in that one basket.

What he didn’t say – but those who know Munger’s work would safely suggest he meant – was that he wouldn’t want just one horse, nor a single bet. 

Munger would want a heap of those mispriced bets. Because he knows that as long as he’s calculated the odds successfully, the average return from a collection of similar bets will be very, very good.

I have no idea whether or not Tom Waterhouse will be a good investor.

But what I expect is that years of working as a bookie, and being part of a racing family, should have endowed him with a very good understanding of risk and return.

There are worse ways to learn something that many ‘investors’ take many years to learn, or never learn at all.

Fool on.

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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