Why Do We Play Unbeatable Games?

The game seemed easy, and I was excited to wager next...

I had just watched a man win 10,000 Spanish pesetas on the streets of Madrid. The game seemed easy, and I was excited to wager next.

I was 16, and on a summer abroad trip to Spain. I had brought most of my savings with me, a few hundred dollars, to buy antique silver coins. And just my luck – I ran into this game on the way to the coin store that was going to help double my money.

The game was simple. The man running it had set up three upside-down plastic cups on top of a cardboard box. There was a little black ball, which the man deftly shuffled between the different cups. All you had to do to win was correctly guess which cup the ball was under at the end of the shuffle.

All I had to do was not take my eye off the ball as it was being shuffled. I could do that, no problem. And having just watched the guy before me win big, I was ready to claim my spoils.

I bet, and intently tracked the ball with my eyes. Clearly seeing it under the middle cup, I pointed to it. The game operator nodded, lifted the cup and… there was nothing!

I couldn’t believe it – I was sure the ball was there. I played three more times, each time being 100% convinced the ball was under the cup that I was pointing to, only to lose yet again. As it started to dawn on me that something might be amiss, I saw the police approaching from far away.

As if by magic, the game operator packed up the boxes and evaporated seemingly into thin air. The crowd dispersed almost as quickly. And I was left standing there, having lost all the money I had brought with me and wondering how I could have missed where the ball was four times in a row.

Later, I found out that the game wasn’t simple at all. As you might have guessed – the ball was never going to be under any cup that I pointed to. It was made of a dense sponge that the conman would pinch between his fingers at the end of the shuffle, so no matter which cup I chose, I was going to lose. If asked to show where the ball was, he would deftly place it under some other cup and demonstrate it to anyone doubting his honesty. That’s why there was a towel on top of the cardboard box – so that the sponge ball wouldn’t roll as the operator flicked it after the fact under some other cup.

What about the big winner before me? My 16 year-old self didn’t realize it, but later I understood that it was just an accomplice making it look like the game was beatable to suckers like me.

Last weekend, I thought back to that experience almost 30 years ago when I took my kids to a state fair in New Hampshire. They were far less interested in the giant vegetables and animals than they were in rides and games. This was fine with me – they are kids and I wanted them to have fun.

The rides were fine, but there was one game that they were really drawn to. They would pay $5 of my money for the privilege of getting a bucket of small thick rings. The goal was to toss those rings on to soda bottles arranged in a dense square. If any ring landed on top of a bottle, they would get a giant stuffed animal.

Having my doubts, I nevertheless let them play. Of course, they missed all their shots.

Not only that, but so did the numerous adults playing alongside them. Clearly it wasn’t the tossing – it was the game! Yet everyone was so close to the bottles that it seemed unlikely that they couldn’t land even 1 in a 100 rings. And yet that was exactly the outcome I observed.

Not only did this remind me of my lesson at the school of hard knocks on the streets of Madrid, but also of certain approaches to investing. Specifically, investing in large, well-followed companies in very efficient capital markets.

Having spent 15 years at large investing firms prior to starting Silver Ring Value Partners, I have plenty of first-hand experience helping manage large mutual funds focused on large capitalization companies. Let me tell you – it’s a tough game!

Yet, the clients love it and keep shoveling money into large-cap funds. They are seduced by well-dressed and well-educated professionals who have very clever reasons for why the stocks of their 30-100 large companies chosen out of 500 are going to do much better than the rest.

For a taxable client to come out ahead after fees, expenses and taxes vs. a low-cost index, the manager needs to beat the index by about 2% per year. That seems easy. Just as easy as tossing rings while standing mere feet away from the target. However, in practice it is just as hard.

The next day we came back to the fair, and of course the kids wanted to buy more buckets of rings for the game. It tried to explain to them that they can’t win at this game. That probably nobody could, and that they were better off spending the money on a ride.

The reply came and it was crystal clear: “We don’t care. It’s fun.”

As I shrugged and watched the kids literally throw our money away, I noticed that the operator was proudly displaying 7 soda bottles with rings on top.

“What are those” I asked him.

“Oh, those are yesterday’s winners” he replied.

“What about today’s?” I asked.

“Nobody has won yet.”

As we walked away after the kids ran out of rings, I smiled to myself. 7 was probably about the same number as the number of large-cap mutual funds that will meaningfully beat the market over the next 20 years after taxes, expenses and fees. But it’s not like it’s going to stop the clients and the professionals from playing. It’s fun for the former and very profitable for the latter.

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About the author

Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners, an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.