Tag: taxes

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A Tax on Ignorance

This article was originally published by me on July 24, 2012. Someone recently commented on it to me and I went back to check it out. I feel the article has stood up well over the past seven years and is worth revisiting, partly because many of my readers today weren’t readers way back then. Plus, I wish to extend the story next week.

I was reading a 2011 interview of Edward Thorp, a mathematical genius who created the first widespread blackjack card-counting system (Beat the Dealer) some fifty years ago, and then published a methodology for investing in various markets (Beat the Market) a short time later. He is widely credited with being the first “quant,” which is someone who uses advanced quantitative models for deciding where to invest.

He was interviewed by a group called “Investment Management Consultants Association” as part of their “Masters Series.” This organization is associated with both the University of Chicago’s Booth School of Business and the Wharton School at the University of Pennsylvania. This is a group of academics with top-notch credentials.  

Most of the interview concerned financial investing, but there were a few gambling questions as well. In particular, Thorp was asked why losers at gambling don’t simply quit.

Thorp said, “It seems to me that people are not just wealth maximizers but seeking to maximize something else, whether they do it accurately or inaccurately, whatever their total satisfaction is from whatever they’re doing. I imagine that’s the explanation for why people will gamble and lose money. They supposedly get an entertainment payout. Part of it, though, is that gambling has a tax on ignorance. People often gamble because they think they can win, they’re lucky, they have hunches, that sort of thing, whereas in fact, they’re going to be remorselessly ground down over time.”

Thorp was not speaking about or to advantage gamblers. Although there are a lot of smart gamblers that read my articles, Thorp was addressing a group of people who were accomplished in financial investing, but likely were not particularly knowledgeable about gambling. These people probably believed the house ALWAYS had the edge. For the vast majority of gamblers, this is a realistic thing to believe.

Although it’s possible that Thorp has never played video poker and almost certainly was not thinking of that game in particular when he addressed these writers, I found myself thinking about how Thorp’s comments applied to recreational video poker players.

There are “smart” recreational gamblers. These players know they are taking the worst of it but enjoy what they are doing and don’t mind paying for it. This is actually a rational way to act for some people. These players believe becoming skillful is too difficult, too time consuming, too boring, or too whatever. These players pay for their gambling excitement. Thorp wasn’t talking about this group of gamblers either because these players are not ignorant about their chances. 

There is a large group of video poker players who simply do not believe that pay schedules matter very much and that strategy is mostly common sense. These people believe they will win if they’re lucky and lose if they’re unlucky.

These players often use systems to limit their losses. Some of them believe that if they refuse to lose more than $100 each time they go gambling — but their potential win is unlimited — that this, then, is a good money management system. Others use variations on the Martingale systems. These systems can usually book a small win, but the occasional big losses wipe out far more than those accumulated small wins.

Still others believe in changing machines if either the machine has just hit a jackpot or has been too stingy in paying out jackpots recently. Both reasons are equally fallacious.

These people are not necessarily stupid (although some are). They have their strategies for playing as they do. They just don’t have the knowledge to realize that their strategies are largely worthless. And they don’t understand that this lack of knowledge dooms them to being a long-term loser.

A lot of these players defend their strategies and will argue with anybody who attempts to explain what modern experts believe is the correct way to think. In the days of Internet forums, everybody has the right to post what they believe. If you’re just beginning, you don’t know who is knowledgeable and who isn’t.

Gambling’s tax on ignorance is quite high. It is especially high for those who don’t believe it exists or think that they are immune to it. Most people who know they aren’t knowledgeable play for small stakes relative to their total wealth. To lose a lot, somebody either really must think that their system works or that they really know the right way to do it. And when the ignorant bet big, the results almost always involve getting into a financial hole that keeps getting bigger and bigger over time.

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Paying to Avoid Royal Flushes

Assume you are a 5-coin dollar player playing 9/6 Jacks or Better and are dealt 3♠ A♥ K♥ T♥ 5♥.  The only two plays to consider are holding three hearts to the royal flush and holding all four hearts.

If we check out EV, we find holding three hearts is worth $6.43 and holding four is worth $6.38. That nickel’s worth of EV has always been too much for me to ignore and I go for the royal every time.

BUT, I file as a professional player and get lots of W-2Gs. Let’s say you don’t get a lot of W-2Gs. In that case, each one that you do get has some serious tax consequences. What if you held the four hearts in order to prevent the W-2G?

Once every 1,081 times on average, AKT turns into a royal flush. If you gave up a nickel each of those 1,081 times and ended up getting one fewer royal flush, it would cost you $55 (rounding slightly).

This is probably not too high a price to pay because a $4,000 royal has far more than $55 worth of tax consequences.

AKT (and AQT and AJT) are the weakest 3-card royal flush draws for two separate reasons. First, the presence of the ace eliminates all straight flush possibilities and reduces straight possibilities. Second, the presence of a ten reduces the chances for a high pair.

If we compared the preceding hand to 3♦ A♣ K♣ J♣ 5♣, holding this 3-card royal flush is better than the 4-card flush by a little more than 17¢ and avoiding the $4,000 royal flush over 1,081 opportunities will cost you $185. That’s quite a bit more than the $55 we were talking about earlier.

Going for the flush from 3♥ K♠ Q♠ T♠ 5♠ costs us $683 over the 1,081 draws, and from 3♣ K♦ Q♦ J♦ 5♦, it sets you back $770. Finally, from 3♠ Q♥ J♥ T♥ 5♥ you’ll lose a whopping $1,095 over the 1,081 hands by going for the flush every time.

So where do you draw the line? I’m not sure. I go for the 3-card royal on all of these hands. You’re going to have to decide for yourself what avoiding a W-2G is worth.

Other factors: If it were a multiple point day and/or there was another juicy promotion which gave me a considerable advantage playing this game, I would be more inclined to go for the flush. After all, time is money and it could easily take 5-20 minutes to be paid.

If I were playing in a state where royals were penalized (say Mississippi which has a 3% non-refundable tax on W-2Gs), that would make going for the flush mandatory in our first example and a closer play in the others.

If I were playing near the limit of my bankroll — either actual or psychological — I would tend to go for the flush, which is a play with a much lower variance.

On the first hand, you get skunked about 70% of the time going for the royal and “only” 68% of the time going for the flush.  If I were someone for whom today’s score mattered, I might go for the flush.   I certainly don’t recommend that you worry about today’s score, but some players just can’t help themselves.

This wouldn’t happen to me because I don’t do this, but if you were picking up someone else’s free-play and a royal flush would be awkward and you insisted on playing dollars anyway because you were in a hurry, I would go for the flush every time on these hands.

There are other hands in this game and every other game where it could make sense to avoid the possibility of a royal flush if it could be done at a low cost. But you should look at them one-at-a-time BEFORE YOU PLAY so you know which “inferior” plays are cost-effective. Trying to figure it out at the machine is very difficult. It’s easy to over-compensate when you’re doing this without study beforehand.

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Too Good to be True?

Casinos are in the business to make money. They don’t intentionally make mistakes. Still, sometimes mistakes happen that smart players can exploit. You don’t need to be a pro. You just have to be alert and savvy — and find one of these mistakes. It also helps if you have the requisite knowledge and bankroll — but that’s not necessary. If someone brought the following to me and nobody else knew about it, I might well have paid a $1,000 finder’s fee. Continue reading Too Good to be True?

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Quitting When I’m Ahead

You’ve heard the expression “Quit when you’re ahead,” applied to gambling. You’ve also heard, “When you’re on a hot streak, keep firing away!” These two bromides give opposite advice on what you should do when you actually hit a big jackpot. The first says go home. The second says stay and keep playing. Continue reading Quitting When I’m Ahead

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A Response to Dennis Krum’s Devolution of Gaming Theory

Not so long ago, a man named Dennis Krum posted an article on vpFREE about video poker and the devolution of gaming. www.gamblingforums.com

After a quick read, I found the premise interesting and invited Krum as a guest on my Gambling with an Edge radio show. Krum accepted. That particular show may be heard at www.slot-machine-resource.com

I am grateful that Dennis Krum came on the radio show. I discovered that I recognized his face but not his name. He reminded me that we were both at the same event about 10 years previously and were both seated at the same table. I remembered the event but not that he was at the table. I do, however, have no reason to doubt him.

I ended up disagreeing with his premise. This comes across slightly on the radio, but I further clarified my thoughts after the show aired.

Krum’s premise is that casinos are middlemen. They offer games, collect from the losers, pay off the winners, and keep the difference as their fee for having the facilities. All they should be concerned with, according to Krum, is maximizing the amount of play. Their profits will come.

This theory works well enough on games of chance — such as craps and roulette (although there are said to be pros at craps and I KNOW there are pros at roulette). If it is strictly chance, there is no reason for casinos to eliminate anybody.

It’s different, in my mind anyway, when you have games of skill. If a casino offered a blackjack game with sufficient rules, bet spread, and penetration so that competent players could earn $500 an hour, every counter in the country would camp out there. There would be a few wannabe counters who lose, but this game would be juicy enough that large numbers of good counters would move into that casino “for the duration.” And even if there were enough seats for all counters and still had some $5 tables for the recreational players, the many tables losing $3000 an hour from the pros would dwarf the few making $100 an hour from the squares.

The casinos have to do something to keep from hemorrhaging money — despite Krum’s thesis that they should always want to maximize the amount played. They can tighten the rules, penetration, bet spread allowed, or eliminate certain players. If they don’t, they will surely go bankrupt for creating a candy store for knowledgeable players.

The same with video poker. Maybe 10 years ago, Caesars Palace, probably by accident, installed a couple of FPDW (100.76%) machines that took $300 a hand to play. While that is beyond the means of most players, there are plenty of players in Vegas (including some who would create temporary teams and pool their money to play) to keep those machines occupied 24/7. (I would have gladly paid $500 to have an 8 hour shift on one of those machines. I could easily have won or lost a sizeable amount of money over those 8 hours, but the odds were definitely in my favor. Assuming I could get 100 hands an hour — you do get a W2G every 12 hands or so and that slows things down— $30,000 coin-in an hour at a 0.76% rate comes out to $228 an hour plus benefits from the Total Rewards system, which was more generous then than now.) Anyway the machines lasted a couple of days and I didn’t find out about them until after the fact.

A dealt $240K royal sealed the deal on the removal of the machines. Caesars over-reacted. It barred from all Harrah’s properties that particular player for having the nerve to get a dealt royal. We can rant and rave all we want on how inappropriate that was, but let’s go on.

To survive, the casinos MUST somehow balance their wins and losses. They can tighten machines, limit points earned on their loosest machines, restrict players, etc. They can lower their slot club rate, the mailers, the amounts of the drawings, their comp rate, whatever.

Several casinos are in considerable financial stress. Krum argues casinos should want more and more business and should never tighten machines or restrict players. He’s entitled to that opinion, but he’s not going to get any casino manager to agree with him. He’ll get players to agree with him because we don’t like the restrictions casinos place on the game.

As players, we always want MORE. You could give us a 105% game with a 2% slot club and a 3% comp rate and we’d still be asking for senior discounts and be REALLY ticked that we have to pay a $12 daily resort fee.

You can argue that there are enough square players and others playing silly money management schemes that casinos can fade a few winning players. And you’d be right. Except if you give the strongest players a very positive high limit game, we can easily wipe out all the profits generated by the lower-limit players.

Running a casino isn’t easy. It’s easy for players to resent casinos tightening up. It’s kind of like an extra tax on players. Nobody likes taxes and everybody wants the OTHER guy to be taxed.

It’s easy for people to argue how casinos SHOULD spend their money. Everybody who has some money is used to fending off “requests for donations” from a wide variety of charities. Well, players following Krum’s thesis are basically requesting “donations to players.” And for some reason, casinos are lending a deaf ear.

As they should.