By: Douglas J Utberg

In the game of blackjack, you can ‘double down’ on a hand by doubling your bet for one more card from the dealer.  (When playing blackjack, your goal is to create a hand that is as close as possible to 21 without going over)  This action allows you to take additional risk for an immediate payoff.  Within the community of people who enjoy the game of blackjack, most will tell you that it is advantageous to double down on an eleven, or possibly a ten.  The principal reason for this is because cards with a value of ten have a higher concentration than other cards.  Because of this, it is advantageous for players to increase their risk in certain situations because of an increased probability for a higher payoff.

In the world of investing, there are both times to increase your exposure to risk for a higher payoff, and appropriate situations.  The problem which arises is that many people end up taking excessive risk to chase returns.  In this situation, it is rarely the optimal time to take more risk in the hopes of earning a higher return.

Currently, there are many people from the baby boom generation who are currently ‘doubling down’ with their retirement accounts by over-weighting their portfolios in high-risk ventures such as emerging market stocks and speculative real-estate in an attempt to pump-up the value of their nest egg before retirement.  The risk of this strategy is that your nest egg could crack just before it hatches.

The hidden danger of highly volatile investments is that the risk of loss generally stays hidden until market disruptions push the value of multiple asset classes down simultaneously.  In this case, there is not enough time to adjust your portfolio before it has been significantly burned.  These types of situations are especially dangerous, because the market tends to change very abruptly as relevant news and information develop.  For people who are approaching retirement, volatility can be especially dangerous.

This is not to say that investors shouldn’t take risks . . . it is very difficult to generate returns in excess of bond or money market yields without taking risks.  The caution is that you should be aware of the risks that you are taking, and not allow yourself to fall into a false sense of security because the market hasn’t had a significant downward movement lately.  Large returns generally require that you take large risks.  If you are currently earning large returns, chances are that you are at risk for a large adjustment.  It is very important to make sure that a significant downward adjustment in value of your risky investments will not place you in a situation that you can’t recover from.

Thus, when deciding whether to ‘double down’ on your investment strategy, it is critically important to understand whether you are in a situation where such a decision is optimal.  Are your personal emotions constructed in such a way that a dramatic shift in market valuation will cause excessive nervous tension?  In most cases, investors are their own worst enemy … we allow our emotions over the movements of our portfolio value to influence our actions in a way that frequently moves contrary to our rational thoughts.

Thus, investing becomes a battle of reason vs. emotion.  Our reason frequently tells us to make decisions that would appear to be quite smart by most objective standards.  Reason typically evaluates decisions based on their inherent merits.  However, not all of our decisions are made rationally.  Instead of making our investing decisions based simply on the merits of a particular investment, we allow ourselves to be influenced by the other people we have seen being successful in making money.  When the market is going up, our emotions want to double-down on what we have seen as being successful.  When the market is going down, our emotions want to run for the hills and retreat from the perceived danger of the investing world.

As it turns out, the movement in market perception of a particular investment does not necessarily change the underlying fundamentals.  Many investments that are fundamentally sound experience negative market news, and other investments that lack solid fundamentals will experience upward escalations in market valuation that defy reason.  In the former case, it is important to avoid the emotional pull to bail-out on an otherwise solid investment strategy.  In the latter example, it is important to avoid the temptation to increase our investment, simply because the price has gone up and we hope that it will go up some more.

In the end, it is important for each of us to understand the extent to which our emotions compel us to ‘double down’ on what may turn out to be a highly risky strategy.  All of our decision should be made because of what we judge to be best for our well-being.  Achieving our desires will require that we take risks of some manner along the way.  However, it is important to ensure that all of our decisions are being made consciously instead of re-actively … rationally instead of emotionally.  This will help us to make sure that we don’t double-down on risky situations that we are not emotionally prepared to deal with.