Expected Returns of Lottery

According to this Straits Times article in March this year (non-premium so can click and read), more Singaporeans are gambling, up from 44% of all citizens and PRs (18 years old and above) in 2014 to 52% in 2017. Here are some interesting statistics:

• Most popular game - 4D (42% participation rate) followed by TOTO (36%)
• Among races - Chinese (62% participation rate, up from 53% in 2014) vs Indians (one in three) and Malays (less than one in ten)

•  Median bet per month was $30, up from $20 a month in 2014

As published on the Singapore Pools website, you are more likely to celebrate your 100th birthday (1 in 50) than win top prize at the jackpot machine (1 in 34 million). You are also more likely to be struck by lightning (1 in 240,000) than strike TOTO jackpot (1 in 14 million). If odds of winning a lottery is so low, why are so many people (more than half of the adult population) still throwing away their money?

Most people think that a 4D or TOTO ticket only costs a few bucks but provide the potential for a windfall. If you don't buy, you don't even have a chance or hope. However, more often than not, that hope quickly turns to dashed hope. Even for the serious and long-time punters who think they had devised a system for improving their odds and returns, their optimism is more likely than not misguided. When did you ever see a 4D punter keeping precised track record of all his historical trades and winnings? All will claim to have strike it big one time or another, but who can tell you his exact returns in gambling?

Let's take 4D as an example. 4D is by far the most popular game since it is the easiest game of simply choosing a 4-digit number between 0000 to 9999 and there are 3 draws every week which makes it easy to participate frequently. With a participation rate of 42% vs the total gambling rate of 52%, that means out of every five people who gamble, four will surely be involved in 4D.

The most common bet for 4D is ordinary big or small. Each number gives you exactly 1 in 10,000 probability to win something. The combined probabilities, prize amount and expected return for every $1 wagered are shown in the tables below. For every $1 bet in 4D Game (Big), your expected return is $0.38 or an expected loss of 62%. For every $1 bet in 4D Game (Small), your expected return is slightly better at $0.58 or an expected loss of 42%. The expected return for someone wagering equal amount in big and small would be a loss of 52%. Assuming a median bet per month of $30, your expected loss would be $15.60. Over 10 years, you would have bet a total amount of $3,600 and be left with just $1,728. It is not that bad in the sense that you did not lose all your capital and for the average punter who bets $30 each month, to lose $1,872 over 10 years may be totally acceptable. However, if you simply not bet and instead contribute that $30/month gambling budget at the start of each year into the CPF Special Account earning 4% each year, you would have ended up with almost $4,500 vs only $1,728 if you chose to gamble.

Casual gambling during Chinese New Year or mahjong with friends is perfectly okay as social interaction so I would not group them together with lottery buying. For lottery, the economics is extremely poor hence the only acceptable times where you should wager is either when you buy a new house or car (buying a one-time 4D for your unit number or license plate), or participating in the office pool for the annual Hong Bao TOTO (you do not want to be anti-social, anti-fun). There is no excuse for regular lottery buying with such huge negative expected returns, even with the temptation of a quick windfall.

Stop using Opportunity Cost

Facebook today showed me a two year old article from Dollars & Sense on the costs of running a hawker stall in Singapore. I'm not sure why I'm being shown an ancient article but it could be on the back of the recent saga of hawkers being bullied by private social enterprise hawker centres. You can read about the saga here, here and here. What intrigued me in the article mentioned above is not so much the real costs of being a hawker, but the application of opportunity cost. The article said:

Initial Cost Of Setting Up Roast Paradise

For the initial metalwork and equipment needed to set up Roast Paradise at Old Airport Road, the owners spent about $10,000. This excludes the 2-month rental deposit required.

Aside from that, we must remember that both Randall and Kai incurred an opportunity cost when they spent 6 months on their apprenticeship program in KL. Even if we assume a low opportunity cost of $2,000 per month (remember, they could have been working during that time), this still adds up to $24,000 for both of them.

When we sum up the initial investment and opportunity cost, we are looking at about $40,000.

The writer added in an opportunity cost of supposedly $24,000 into the initial investment costs of starting up a hawker stall. Investopedia defined opportunity cost as the benefits an individual, investor or business misses out on when choosing one alternative over another.

Opportunity cost = return of most lucrative option not chosen - return of chosen option

In the first place, the writer has gotten the concept of opportunity cost calculation very wrong. From an economic viewpoint, the writer only chose to include the economic losses in the first 6 months and exclude the economic returns thereafter. If the two partners had not chosen the hawker path, they would still be earning the assumed $2,000 monthly salary, and not the $4,500 income they are enjoying now as successful hawkers.

Of course, this blog entry is not going to be a boring economics lesson. I just find it absurd that people could be so wrongly fixated on opportunity costs. Anyone who took Economics 101 would learn about the concept of opportunity cost. A mother who chose to gave up her job to become a SAHM (stay-at-home-mum) could incur a huge opportunity cost of her lost annual income x number of years out of the workforce. A house owner who chose to pay off his mortgage early and forfeits the chance to invest the money instead at a higher rate would incur an opportunity cost of earning the spread (investment return - mortgage interest rate). Two guys who flew to KL for a 6-month unpaid apprenticeship incurred opportunity costs of their lost wages.

Why is it that when people talk about opportunity cost, they are mainly interested in the monetary aspect as in how much money is being passed up. The article above did not mention how privileged the two partners are, to be mentored by the KL hawker and to learn all the ropes of cooking and running a roast meat and char siew shop, without paying a single cent of tuition. It is only fixated on the potential loss of income during the 6 months of apprenticeship. And I find that most people think this way as well. How so? It is perfectly okay to weigh decisions using the concept of opportunity cost; after all we can't do everything and we have to plan the most optimal usage of our resources. However, most people think of opportunity costs in only monetary terms, and not other aspects like personal or social costs. Some life decisions are too important to measure in just dollars and cents. What is the impact to the child whose mother chose to gave up her job and become a SAHM? What is the worth of the peace of mind of having no mortgage on your property?

My wife quit her job two years before the birth of our first child. Even though she was earning over $200,000 annually in an European bank, the job was getting stressful and, frankly, possibly affecting our chances at fertility. It wasn't an easy decision to give up an annual cash flow of over $200,000, but it turned out to be one of the best decisions we could have made. She got pregnant the following year after she quit. If she had not resigned back then, we probably wouldn't be blessed with two lovely kids now. We would have more money now, sure, but so what?

Of course, it's easy to use my personal example on hindsight, but as I admitted it wasn't an easy decision back then. We took the plunge and were fortunately rewarded, non-monetary wise. The point is, for major life decisions, do not use opportunity costs to weigh the scenarios, for more often than not, you will place a higher emphasis on economic or monetary value. Instead, use the regret minimization framework to weigh your decisions, for when it comes to regrets, you tend to think more on non-monetary aspects as after all, money’s only something you need in case you don’t die tomorrow.

How much is enough?

Recently caught both the Wall Street films (directed by Oliver Stone) on Netflix. There was a similar scene across both movies with the young protagonist questioning the unscrupulous and greedy old bird about how much is enough for them.

Wall Street

Bud Fox (Charlie Sheen): Tell me, Gordon, when does it all end, huh? How many yachts can you water-ski behind? How much is enough?

Gordon Gekko (Michael Douglas) : It's not a question of enough, pal. It's a zero sum game. Somebody wins, somebody loses.

And in Wall Street: Money Never Sleeps

Jacob Moore (Shia LaBeouf): Your number. The amount of money you would need to just walk away from it and live. See, I find that everybody has a number, and it's usually an exact number. So what is yours?

Bretton James (Josh Brolin): More.

In both cases, the old birds are never satisfied by what they have because they only set out to have "more". And chasing for more is an infinite and tiresome journey. To have more doesn't mean you will be happier. Take it from Warren Buffett, one of the richest in the world, who said, if you think that if you have $100,000 that means that you're an unhappy person and a million dollars is gonna make you happy, it is not gonna happen. Money can solve a lot of problems but it is not the answer to life itself. Jim Carrey, another guy who probably is much richer than you or I, said, I think everybody should get rich and famous and do everything they ever dreamed of so they can see that it's not the answer. So what is the answer to a living a life of happiness? If more money doesn't cut it, then what does?

I have learnt that the simple answer is to know when you have enough and no more. When you acknowledge you have enough, you stop chasing. You stop chasing after all the more expensive products that corporations are always trying to sell you. You stop listening to all the advertisements the media is trying to brainwash you into spending your money. You stop lusting after the latest iPhone, the next fiercer car, the next bigger house... You get out of this infinite cycle of chasing for MORE! To yearn for more is a never ending endeavor and in the end, only makes you unhappy. The thrill of buying a new toy like an iPhone is fleeting and lasts mainly from the purchasing to the unboxing. Even billionaires who seem to have it all will always want more if they are stuck in such a mindset. Why be content with a billion when you can go for two?

When you start living your life from a position of "enough", then you stop going for just more money and start going for fulfillment from non-monetary perspectives. You become contented with your surroundings and possessions. You nourish your soul. You become more honest to living the life you desired, not the life that's imposed on you by the rat race chasing days. You become more socially and environmentally responsible through less wastage and pollution of our planet. You become happier.

Enough = Contentment = Happiness

On a related side note, the familiar scene above in the Wall Street movies happened to me once. It was a few years back and I had the opportunity to sit right beside Steve Cohen in a company dinner. Steve may not be as rich as Warren Buffet but he's still a billionaire many times over and the hedge fund founder off whom the TV show, "Billions", is loosely based on. Despite trying his best to keep a low profile in public view, he has had more than his fair share of troubles with authorities and personal life. I wonder, why keep going so hard when you're already so rich? So I asked him what kept him so motivated despite having amassed a great fortune? He said "Passion". It was a politically correct answer after all. Well, if it is really your passion and can earn billions along the way, then why not keep at it, I guess?

Paying off mortgage vs investing the money?

A couple of years ago, I was deliberating between paying off the mortgage of the property I was residing in, vs refinancing the mortgage and investing the money in higher yielding assets.

I shared my intention to pay off the mortgage completely with a few of my friends and they were all wondering am I crazy to even consider the idea of repaying the mortgage early. Isn't it better to hold the mortgage at its current low interest rate of ~2% and invest the cash instead? Surely it's not that difficult to find yields higher than 2%?

Coming from a finance background, I totally understood their rationale. Treating it as a pure academic exercise, there is no single reason to pay down the mortgage early. Assuming a $1 million outstanding mortgage with 20 years tenure remaining and a 2% mortgage rate, and simply investing the cash in a 20-year bond of 4% yield, I would be able to pay off the mortgage at the end of 20 years and an additional $367,450 sitting in the bank!

However, the exercise above factors in a few assumptions:

1. The mortgage rate doesn't fluctuate and move up above the investment yield
2. The investment yield has no risks
3. The investment yield is fixed

The only way the above scenario can pan out in a perfectly hedged manner is if I invest in the Singapore government treasuries and I'm able to fix my mortgage at a constant rate for 20 years.

In Singapore, we don't have a long-term fixed rate mortgage plan. The closest to it is probably a mortgage loan from HDB which is pegged at 0.1% above the prevailing CPF Ordinary Account (OA) interest rate which has been kept constant at 2.5% since July 1999. Hence the best fixed-rate mortgage one could possible get is the HDB loan at 2.6%. The current Singapore 20-year government bond yield is around 2.9%, hence we get a positive spread of 0.3%. However, keep in mind that the 20-year yield has been hovering between 2% to 3% for the past few years so there's no guarantee of a positive spread! In addition, if the CPF OA interest rate (being the higher of the current legislated minimum interest rate of 2.5% of the 3-month average of major local banks' deposit interest rates) was to rise, that could possibly shrink the arbitrage spread as well.

As shown, there is no perfect hedge of keeping the mortgage and investing the cash and earning the assumed positive spread. No matter how unlikely or how low the risk is, there is still risk ultimately.

On the other hand, paying off the mortgage early completely eliminates this risk, and reduces stress. Being completely debt-free means a lot to a retired guy. It means that there will never be creditors showing up at my doorstep, trying to repossess my house. Trying to service a mortgage and investing the money instead is a different ball game which could bring about more stress.You have to strive to beat your cost of the mortgage, even if you may think the benchmark is not set high. Paying down the mortgage early comes at the expense of having less capital to invest and hence lower investment gains, but it gives me financial peace of mind, which I think is a priceless asset in itself.

In the end, I repaid the mortgage and became completely debt-free. I did give up the opportunity to utilize the cash for a potential return, but that is probably a small price to pay for complete peace of mind. Especially now that global interest rates are rising, I do not have to fret. Of course, this doesn't mean that you should be left with no savings or investments after paying off the mortgage!

Risk Management & Regret Minimization

The best portfolio managers are not the ones with the best ideas or the highest hit rate, but the ones who excelled in managing their risk. The key in assessing risk/reward is not the reward, but rather the risk. What is your worst case scenario? Is it a potential career ender? As the chinese saying goes, 留得青山在，不怕没柴烧。As long as you stay afloat, you can always mount a comeback. The worst mistake in the hedge fund business is not making monetary losses, but rather a regulatory censorship of any kind. Once your integrity is tainted, it's all game over.

Risk management is not just crucial in the portfolio management business, but also in other industries. Amazon's Jeff Bezos uses a structure he called the "regret minimization framework" to make major business and life decisions. As the name suggests, he seeks to minimize the number of regrets one can have. Here is a much younger looking Bezos explaining his thesis:

The framework I found, which made the decision incredibly easy, was what I called — which only a nerd would call — a “regret minimization framework.” So I wanted to project myself forward to age 80 and say, “Okay, now I’m looking back on my life. I want to have minimized the number of regrets I have.” I knew that when I was 80 I was not going to regret having tried this. I was not going to regret trying to participate in this thing called the Internet that I thought was going to be a really big deal. I knew that if I failed I wouldn’t regret that, but I knew the one thing I might regret is not ever having tried. I knew that that would haunt me every day, and so, when I thought about it that way it was an incredibly easy decision.

It is truly better to have tried and failed than not try at all. How likely is one at their deathbed looking back at his or her life and laments the number of things that they wish they had the guts to do when they were younger? Perhaps if we know the most common regrets those dying have, then maybe we can take precautions early in our lives to minimize the regrets that we will have when we are 80.

Bronnie Ware was a palliative nurse who cared for those dying and in their last few weeks of their lives. When the patients were asked about any regrets they had or anything they would do differently, she found a few common themes and shared her findings in an article which was subsequently turned into a book, The Top Five Regrets of the Dying: A Life Transformed by the Dearly Departing.

Regret 1: I wish I'd had the courage to live a life true to myself, not the life others expected of me

Regret 2: I wish I didn't work so hard

Regret 3: I wish I'd had the courage to express my feelings

Regret 4: I wish I had stayed in touch with my friends

Regret 5: I wish I had let myself be happier

This is a book which I actually enjoyed despite the morbid nature and it helped me in some major decisions in my life, such as whether to quit my job and retire. I will elaborate further in future blog posts as the whole topic of regret minimization coupled with the top regrets of the dying is simply too huge for just one blog post. This is akin to explaining a framework on how to lead your life.

To sum up this post, risk management is the most important portion in portfolio management and possibly life itself. To minimize the risks in your life is to minimize the potential regrets. Whether is it a lifelong regret or a short-term regret like buying that expensive apartment at the peak of the property market. As long as you're aware of the worst case scenario and consequences that could arise as a result of your decision, and how to deal with it when it really comes, your risk/regret can be minimized.

Why I blog

I've actually been struggling whether to write a blog or not to. A blog seems passe in 2018 and I'm not blessed with the art of writing which would garner me a miserable readership, if any at all. But I figured I would express my views here anyway, for myself to consolidate and document my ideas and more importantly, maybe write long enough to have a trove of personal thoughts so that one day, I can tell my kids about this blog and they can learn more about me, my take on life and its lessons, even long after I'm gone.

This blog will cover topics like:

* Finance industry, in particular hedge funds (natural since it's been my entire career so far)

* Personal finance (FIRE movement)

* Minimalism (key to saving the world and making yourself richer and happier)

* Musings on life and the important things in it (in my own personal view)

* My experiences and background (how I rose from a heartland boy to work in some of the largest hedge funds in the world)

* Random stuff

Go-Away Money

*** I replaced F-You Money with Go-Away (G-A) Money to make my blog a family-friendly place.

I stumbled upon the concept of G-A Money accidentally in the movie, The Gambler, starring Mark Wahlberg and John Goodman. Jim Bennett (Mark Wahlberg) was a literature professor and a gambler who doesn't know when to stop and whose debt causes him to borrow money from the loan shark, Frank (John Goodman). I was kinda blown away by the simple and profane explanation of the position of Go-Away money by Frank. Here's the transcript:

Frank: I need to know if you got the *peep* brains to walk when it's time to walk. People don't, you know. Ballplayers who can't play anymore. *Idiots* trying to maintain a standard of living not possible anymore... A lot of those around. I've seen you be half a million dollars up.

Jim Bennett: I’ve been up two and a half million dollars.
 
Frank: What do you got on you?
 
Jim Bennett: Nothing.
 
Frank: What did you put away?
 
Jim Bennett: Nothing.
 
Frank: You get up two and a half million dollars, any *idiot* in the world knows what to do. You get a house with a 25-year roof, an indestructible Jap economy shitbox, you put the rest into the system at three to five percent to pay your taxes and that’s your base, get me? That’s your fortress of *peep* solitude. That puts you, for the rest of your life, at a level of "Go-Away". Somebody wants you to do something, go away. Boss pisses you off, go away! Own your house. Have a couple bucks in the bank. Don’t drink. That’s all I have to say to anybody on any social level. Did your grandfather take risks?
 
Jim Bennett: Yes.
 
Frank: I guarantee he did it from a position of go-away. A wise man’s life is based around go-away. The United States of America is based on go-away. You're a king? You have an army? Greatest navy in the history of mankind? Go away, blow me. We’ll *mess* it up ourselves. Which we have done. Beautiful "go-away" position lost forever.

Of course, it's not the first time G-A money is ever discussed. Time magazine has an article on this in 2016. Heck, if you googled G-A money (the uncensored version), you get more than 200m hits! Basically, G-A money is the amount of money you need to not be compelled by anyone to do anything you don't like. It's having the freedom to choose what you want without being constrained by money. Whether you want to do this job or that or retire or follow your passion, instead of the money.

Growing up, I always knew I want to be in such control that any problem that can be solved by money is not a problem. I just didn't know there's already a phrase for it, which is G-A money. And ironically, when I watched Frank deliver his vulgar yet seemingly logical philosophy, I knew that's a position that I had already achieved. Having accumulated a decent amount of wealth from my years in the hedge funds industry, I was cautiously confident of not working ever again and maintaining the current level of living standards for my wife and two young kids. At the same time, my job wasn't giving me great satisfaction or happiness, so I was thinking about quitting, but I wasn't sure how my wife would take it.

And this is what she told me.

If you're not happy, just go. Not worth it. We can and will afford. Don't worry.

You're more important to me and the kids than any amount of money.

Yea I think we have G-A money. Lol

And that's how it all ended... or began?