Charles Ellis

Winning the Loser's Game: Timeless Strategies for Successful Investing

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Charles Ellis

Now in its sixth edition, this book by Charles D. Ellis is undoubtedly one of the true classics in the genre of sensible investing. It is right up there with Burton Malkiel’s A Random Walk Down Wall Street and William Bernstein’s The Four Pillars of Investing.

The author of 14 books and a PhD. Graduate of New York University, Ellis was a managing partner of Greenwich Associates for thirty years, the international strategy consulting firm he founded that serves virtually all the leading financial service organizations around the world. He is a past trustee of Yale University and Chair of its investment committee. He was also a director of The Vanguard Group, and he currently is the Chairman of the Board of the Whitehead Institute for Biomedical Research, a leading institution in the field of genomic research. Dr. Ellis is frequently called up to consult on investing issues with major institutions around the world. In other words, when Charley Ellis talks, people listen.

The title of this book refers to a famous article that Ellis wrote in 1975 titled “The Loser’s Game” which states that investing is like amateur tennis. It is a loser’s game, whereby a player loses the game based on how many mistakes he makes relative to his opponents.  Investing is a loser’s game, and he who makes the fewest mistakes will win over the long run.

His innovative book was a solution to the loser’s game—shifting away from “working ever harder in a futile effort to beat the market” to a winner’s game of “concentrating on the big picture of long term asset mix and investment policy.”

This is especially applicable to the nearly 50 million individual investors in America. First, these individuals are on their own in designing long term investment policies. Second, few experts can afford to allocate time to provide the counseling individuals needed at a reasonable fee. Finally, the industry thrives and sells on the false promise that the typical investor can beat the professionals, the market return notwithstanding.

His conclusion is startling: successful investing does not depend on beating the market. The simple and more productive task is to design a long-term program that can succeed at providing the best feasible results in the long run.

Investing in a perfect world is a zero sum game. On average, all investors make the market return before costs. Therefore, the assumption that most institutional investors can outperform the market is demonstrably false. It is impossible for them to outperform themselves.

It turns out that investing with and like the “professionals” is a loser’s game. Trying to beat the market generates frictions and costs. Once you subtract the cost of active management, such as fees and commissions, they no longer even match the market, but the market is beating them. The outcome is determined by the actions of the loser, who defeats himself! The key point is that the professionals are competing in a highly efficient market where the current price reflects all available information. 

Regarding the individual retail investor, he has no basis to believe that he can beat the professionals at their own game, particularly when they themselves are getting beaten by the market? If all investors could play and win the loser’s game by themselves, then there would be no demand for professional money managers. Somehow, that just doesn’t seem very likely, or else those “professionals” would have gone out of business by now. If you – like Walter Mitty – still fantasize that you can and will beat the pros, you’ll need both luck and prayer.

The solution is to play the winner’s game instead of the loser’s game. Playing the winner’s game ensures that you can make smart decisions. The winner aims to capture his fair share of the readily-available returns offered by the American (and global) capitalism pie via index funds which minimize frictions and costs that take bites out of the pie.

Like all the wise people of investing, Ellis reminds us that risk and return are not just simply related but they are joined at the hip. Demanding a higher expected return requires that you take on higher risk. One of our favorite quotes from Ellis is: “There are three kinds of investment risk. Two can be virtually eliminated. The third, market risk, must be managed.” A good advisor will add value by determining the level of risk an investor can assume in order to achieve the returns that are available to her. This is accomplished via the investment policy statement which spells out the risk and return objectives, providing a road map to reach a destination such as retirement or funding education expenses. Ellis refers to the investment policy statement as “the most effective antidote to panic” which is a destroyer of future returns.

Ellis uses the coin-tossing analogy to explain why so many investors get hoodwinked into paying high fees for active management. In the long run, coin tossers average 50% heads and 50% tails. In the short run, some will appear to be much better than average at tossing heads. The short term results may appear to skill on the part of the coin tosser, but it would take many years of measurement to determine if the portfolio manager’s superior results were luck or skill. Unfortunately, there are many studies such as the Standard and Poors Persistence Scorecard which show that managers’ past returns are terrible predictors of future performance.

Although individuals should not play the loser’s game by hiring active managers or trying to be active managers themselves, they still ought to learn how to live with losses. Short term losses are an unavoidable reality on the path to long term gains. In order to reap the rewards of investing in capitalism, investors must be willing to endure losses from time to time.

Ellis warns us about another unavoidable pie-destroying monster, inflation. The only way to grow our pie is to invest in assets which produce a sufficiently high rate of return which can outpace inflation. This usually means equities and real estate investment trusts.

Finally, Ellis admonishes investors to beware of their own worst enemy—themselves. Individual investors possess behavioral tendencies which lead them to buy when prices are high and sell after they have declined. As Ellis explains, the problem is not in the market but in ourselves. From 1982 to 1997, mutual funds averaged approximately 15% in annual returns, but mutual fund investors captured only 10%. Other studies that we have reviewed such as the Dalbar study suggest that the returns received by investors are actually a great deal lower.

As with the movie War Games, the only winning move for the loser’s game is not to play. Instead, play the winner’s game of buying, holding, and rebalancing a risk-appropriate portfolio of globally diversified index funds. If you need assistance in finding the right portfolio for you, please take our Risk Capacity Survey or call us at 888-643-3133.