Posted on by CTKS

Three Lessons From A Singaporean Favourite Game

Apart from red packets and delicious snacks, there is one other thing that everyone look forward to during the Lunar New Year. It’s Mahjong! On top of being a good game to stimulate your brain and catch up with your relatives and friends, this household favourite game yields many lessons about investing and life.

Lesson 1: You can’t win it all

The first lesson is a tough pill to swallow. No matter how skilled you are at reading the cards of others or how disciplined you are at playing defence, you cannot always win in Mahjong. Sometimes, people just keep winning from 自摸 (drawing the tile themselves). Disgusting! Trust me, I understand how frustrating this is (been on the receiving end of that multiple times). Unfortunately, this is something that is completely out of our control. You win some, lose some. Sometimes you are lucky, and sometimes you are not.

Thankfully, doing nothing is perfectly fine! Luck comes and goes, but in the long run, over many repetitions, what gives one an edge is skill and the right mentality. Thus, by directing our efforts to the things we can control, we can poise ourselves to seize opportunity when the tides turn.

This is very applicable to investing and anything that involves a mixture on luck and skill, even life. Given the infinite number of factors affecting the outcome, there is a infinite possibilities that could occur. Even if we have done everything we can to the best of our ability, some things are just out of our hands. In investing, we should expect a third of our decisions to not work out. With that in mind, we should have a sound plan and take precaution to ensure that we can remain financially resilient. Eventually, lady luck will once again shine on us.

Lesson 2: Take calculated risk

Mahjong also teaches us a thing or two about risk, something that is hard to understand simply by reading or listening. This makes it challenging to learn anything much about risk from our formal education. Yet, risk is pervasive in life. At every step of the way since birth, luck and risk is at play regardless of whether we are aware of it, and arguably much more so in investing. In my opinion, the best way to learn about risk is to learn from experience, and playing Mahjong is an excellent opportunity to do that.

Take for example a situation where someone is calling (waiting to win) a 满台 (the maximum “points”, usually 5 in Singapore) and the best you can do with your hand is 三台 (three “points”). In this case, the downside if you throw the winning tile is huge while the potential gain of winning a 三台 is relatively small. So, what would you do in that situation? As rational players we should play defence when we draw a tile that we think may be the winning piece for the other player. While doing so may mean that we submit to fate that we won’t win this round, we do not risk losing more. We much rather wait for another round where the reverse is true, when we are calling a 满台 and others are calling only two or three 台. These situations where the payoff is skewed in our favour present excellent opportunities to play aggressively.

In investing, we want to “bet” big on situations which has a huge upside and minimal downside. Or in the words of Monish Pabrai, “heads I win, tails I don’t lose much”. The converse is also true. We should ignore investments that have small upside but could potentially lead to large permanent losses. We much rather wait for the low risk high reward opportunity. Following this logic, I never short a stock. This is because the upside is at most a 100% while the downside is unlimited. When we invest in a company, the upside is unlimited. Why would I take the first bet? When we make rational decisions based on this sound principle, they cease to be bets. Instead, they are strategic moves involving calculated risks. Such opportunities are few and far between so when we are lucky to find one, make sure to capitalise on it.

In both Mahjong and investing, there are many nuances that writing cannot encapsulate. However, the idea of looking for “bets” with huge upside and minimal downside remains the core of a winning strategy. As mentioned above, the best way to learn about risk is by experiencing it. In order to truly appreciate how luck and risk come into play, one has to put themselves through those situations, and one of the best ways to do so is playing Mahjong.

Lesson 3: You can’t know everything

Building on the concept of risk, the next lesson drawn from Mahjong applies to investing and life as well. Picture this:

You are calling a 满台 and it is your turn to draw. You look at the tiles on the table and know that another player is gunning for a 清一色 (full suit) 索子 (bamboo). You pray to god to draw anything but a 索子. As you draw your tile and slide your thumb across the face of the tile, you feel sticks… and you heart drops. You know that he wants 索子 but you are not sure which exact piece he needs (unless you have a PhD in mahjong like the Aunties and Uncles). At this point in time you face a major dilemma. Do you throw the 索子 and risk losing a lot of money? Or do you play defence and miss out on the potential of winning a lot of money? In such situations, there is no easy way out. Neither is there a correct answer. It all depends on you.

Similarly in investing, you cannot pinpoint what the future beholds. The best you can do is assess all available information and make a decision that you are comfortable with based on your current financial situation, risk appetite and goals. If you think that the risk-reward ratio is attractive after thorough assessment of the available information, you just have to take the leap of faith. As such, we can expect that unknown unknowns may occasionally derail some of our theses. This makes the case for a certain degree of diversification, never put all your eggs in one basket.

That being said, I am not promoting gambling. We all have to take responsibility of our actions and know our limits. Sometimes before making a big decision, a certain friend of mine will look in his drawer to count his chips. In both investing and Mahjong, we only risk what is reasonable. And what is reasonable, depends on a variety of factors such as our risk tolerance and financial resilience. I simply hope to share that there is value we can gain from playing intricate games such as Mahjong that formal education cannot offer us. So, the next time you play Mahjong, pay attention to the life lessons that this Singaporean favourite game has to offer.

Posted on by CTKS · 4 Comments

Change And Uncertainty

“The only constant in life is change.” – Heraclitus, Greek philosopher

The everchanging and unpredictable nature of markets is a going concern that stresses many investors out. Perhaps we have an innate desire for order and predictability, which explains why uncertainty and change make us uneasy. Whatever the reason, given that change and uncertainty is inextricably tied to investing, we investors can do better if we face the truth. In this article, I will share three main ideas pertaining to change and uncertainty.

1. Everything changes, embrace the idea of impermanence

For how much the world changes, it is unexpectedly difficult to visualise how quickly the world changes. A simple experiment borrowed from Warren Buffet illustrates this perfectly. Below is a list of the top 20 companies by market cap as of March 21st, how many companies do you think will remain in this list 30 years from now?

Surely Apple, Alphabet (Google) and Facebook will still be here, there is no other company like them!

Now, let’s take a look at the same list in 1989, 30 years ago…

You will see many familiar names on this list in 1989. However, what is striking is that none of these companies remain in today’s list. Zero. This goes to show how hard it is to predict the trajectory of businesses. This is not to say that it is impossible for the 20 largest companies today to remain on that list in 30 years time but whatever number we think it will be, chances are it is less. It is thus foolish to believe that certain things will NEVER change.

As investors, we need to be realistic and doing so will involve admitting that we cannot predict or be certain about the future. Instead, we should view the world through a probabilistic lens. Some companies have a higher probability of doing well and becoming successful, while others have a higher chance of failing. There is no such thing as a sure win. In fact, if anyone tells you that a company is sure to return you many times your money, take your money and walk away.

Looking at investing in terms of probability can help us make better decisions. As uncertainty cannot be completely eliminated, we should accept that there will always be a certain degree of risk in investing (i.e. there will always be a chance of failure). The goal is to find investments that has a high probability of working out and even if it does fail, the loss is marginal. In other words, a huge upside and limited downside. Therein lies the argument for having a certain degree of diversification. By having our eggs in different baskets, we significantly decrease the probability that our entire portfolio will go to zero. Even if the worst happens (the business fails due to low cost competitors or lawsuits or another recession hits), and it will, we can avoid crippling losses.

2. Even in an unpredictable world, certain things are surprisingly predictable

The future may be extremely unpredictable but history repeats itself. In the markets, cycles are surprisingly predictable. In the business and credit cycles, period of expansions are followed by periods of contraction. Likewise, in the stock market cycle, periods of euphoria are followed by periods of depression, which are then followed by periods of optimism again.

Thus, it is possible to study patterns in the past and use them as a rough guide for what could happen next. One such example is the stock market cycle.

As seen in the S&P500 chart above, a period of euphoria (from 1997 to 2000) is followed by one of despondency (2000 to 2002), which is then followed by another cycle of extreme optimism and greed (2002 to 2007) which is followed by severe pessimism (2008-2009). More recently, the Covid-19 pandemic resulted in a huge market sell off in March of 2020. Soon after, the markets rebounded to all time highs. Thus, it is inevitable that cycles will reverse and reckless excess will be punished, and vice versa. Therein lies a possibility of turning cyclicality to our advantage by behaving countercyclically.

However, this is not to say that we should start timing the market and enter at the bottom to sell at the top. After all, it will be foolish to think that we can predict when the tides will turn.

Since we cannot change the environment or predict it, we have to adapt to the prevailing climate by being more aggressive or defensive. Instead of thinking of whether to invest or not as a binary decision, we should see it in terms of a spectrum. When the market crashed in March of 2020, wise investors would have acted counter cyclically by deploying their cash reserves and picking up more shares in great businesses. At times like today when the markets seem to be approaching dangerous levels, we can perhaps hold back a little and start to accumulate some cash, waiting for opportunity to present itself. Some may even consider trimming their positions. However, I personally would never completely sell out of my holdings in expectation of profiting from a market crash. The expectation of successfully doing so is simply unrealistic in my opinion. As Warren Buffet puts it, “be fearful when others are greedy and greedy when others are fearful.”

3. First be lucky, then be humble

In being honest with ourselves about our limitations and vulnerabilities, we will come to appreciate the role of luck and risk in our lives and investing. Regardless of whether we like it or not, the two cousins play a role in every part of our lives and even more so when the markets are concerned. Where there is luck, there is also risk. From the lottery of birth to the successes in life, luck plays an elusive yet decisive role.

Thus, we should always remain humble and never get ahead of ourselves. We may make a series of successful investments/bets, but never take it for granted that our future endeavours will see the same success. As quickly as luck can bestow us with an obscene fortune, risk can take it all away.

It also follows that we should be grateful and contented with what we have. Do not succumb to greed and take riskier bets or taking on too much leverage such that when the unexpected happens, we will be in financial ruin and unable to climb back.

Exercise adequate scepticism and prudence in this uncertain world. Do not take anything for granted, be it that Apple will continue its dominance or that a company will continue its growth trajectory linearly. Yes, this may mean that we will miss out on some of the explosive returns we are witnessing in meme stocks today. However, it also means we are protecting ourselves from financial ruin and remaining in the game, making sure that we always have another chance for luck to be on our side. This is perhaps the only way to deal with luck and risk.