Posts tagged ‘Winning the Loser’s Game’

Winning the Loser’s Game

During periods of heightened volatility like those recently experienced, it’s easy to get caught up in the emotional heat of the moment. I find time is better spent returning to essential investing fundamentals, like the ones I read in the investment classic by Charles Ellis, Winning the Loser’s Game“WTLG”.  To put my enthusiasm in perspective, WTLG has even achieved the elite and privileged distinction of making the distinguished “Recommended Reading” list of Investing Caffeine (located along the right-side of the page). Wow…now I know you are really impressed.

The Man, The Myth, the Ellis

For those not familiar with Charley Ellis, he has a long, storied investment career. Not only has he authored 12 books, including compilations on Goldman Sachs (GS) and Capital Group, but his professional career dates back prior to 1972, when he founded institutional consulting firm Greenwich Associates. Besides earning a college degree from Yale University, and an MBA from Harvard Business School, he also garnered a PhD from New York University. Ellis also is a director at the Vanguard Group and served as Investment Committee chair at Yale University along investment great David Swensen (read also Super Swensen) from 1992 – 2008.

With this tremendous investment experience come tremendous insights. The original book, which was published in 1998, is already worth its weight in gold (even at $1,384 per ounce), but the fifth edition of WTLG is even more valuable because it has been updated with Ellis’s perspectives on the 2008-2009 financial crisis.

Because the breadth of topics covered is so vast and indispensable, I will break the WTLG review into a few parts for digestibility. I will start off with the these hand-picked nuggets:

Defining the “Loser’s Game”

Here is how Charles Ellis describes the investment “loser’s game”:

“For professional investors,  “the ‘money game’ we call investment management evolved in recent decades from a winner’s game to a loser’s game because a basic change has occurred in the investment environment: The market came to be dominated in the 1970s and 1980s by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with cautious custodians or amateurs who are out of touch with the market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to winning is to lose less than others lose.”

 

Underperformance by Active Managers

Readers that have followed Investing Caffeine for a while understand how I feel about passive (low-cost do-nothing strategy) and active management (portfolio managers constantly buying and selling) – read Darts, Monkeys & Pros.  Ellis’s views are not a whole lot different than mine – here is what he has to say while not holding back any punches:

“The basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management – fees, commissions, market impact of big transactions, and so forth-85 percent of investment managers have and will continue over the long term to underperform the overall market.”

He goes on to say individuals do even worse, especially those that day trade, which he calls a “sucker’s game.”

Exceptions to the Rule

Ellis’s bias towards passive management is clear because “over the long term 85 percent of active managers fall short of the market. And it’s nearly impossible to figure out ahead of time which managers will make it into the top 15 percent.” He does, however, acknowledge there is a minority of professionals that can beat the market by making fewer mistakes or taking advantage of others’ mistakes. Ellis advocates a slow approach to investing, which bases “decisions on research with a long-term focus that will catch other investors obsessing about the short term and cavitating – producing bubbles.” This is the strategy and approach I aim to achieve.

Gaining an Unfair Competitive Advantage

According to Ellis, there are four ways to gain an unfair competitive advantage in the investment world:

1)      Physical Approach: Beat others by carrying heavier brief cases and working longer hours.

2)      Intellectual Approach: Outperform by thinking more deeply and further out in the future.

3)      Calm-Rational Approach: Ellis describes this path to success as “benign neglect” – a method that beats the others by ignoring both favorable and adverse market conditions, which may lead to suboptimal decisions.

4)      Join ‘em Approach: The easiest way to beat active managers is to invest through index funds. If you can’t beat index funds, then join ‘em.

The Case for Stocks

Investor time horizon plays a large role on asset allocation, but time is on investors’ side for long-term equity investors:

“That’s why in the long term, the risks are clearly lowest for stocks, but in the short term, the risks are just as clearly highest for stocks.”

Expanding on that point, Ellis points out the following:

“Any funds that will stay invested for 10 years or longer should be in stocks. Any funds that will be invested for less than two to three years should be in “cash” or money market instruments.”

While many people may feel stock investing is dead, but Ellis points out that equities should return more in the long-run:

“There must be a higher rate of return on stocks to persuade investors to accept risks of equity investing.”

 

The Power of Regression to the Mean

Investors do more damage to performance by chasing winners and punishing losers because they lose the powerful benefits of “regression to the mean.” Ellis describes this tendency for behavior to move toward an average as “a persistently powerful phenomenon in physics and sociology – and in investing.” He goes on to add, good investors know “that the farther current events are away from the mean at the center of the bell curve, the stronger the forces of reversion, or regression, to the mean, are pulling the current data toward the center.”

The Power of Compounding

For a 75 year period (roughly 1925 – 2000) analyzed by Ellis, he determines $1 invested in stocks would have grown to $105.96, if dividends were not reinvested. If, however, dividends are reinvested, the power of compounding kicks in significantly. For the same 75 year period, the equivalent $1 would have grown to $2,591.79 – almost 25x’s more than the other method (see also Penny Saved is Billion Earned).

Ellis throws in another compounding example:

“Remember that if investments increase by 7 percent per annum after income tax, they will double every 10 years, so $1 million can become $1 billion in 100 years (before adjusting for inflation).”

 

The Lessons of History

As philosopher George Santayana stated – “Those who cannot remember the past are condemned to repeat it.” Details of every market are different, but as Ellis notes, “The major characteristics of markets are remarkably similar over time.”

Ellis appreciates the importance of history plays in analyzing the markets:

“The more you study market history, the better; the more you know about how securities markets have behaved in the past, the more you’ll understand their true nature and how they probably will behave in the future. Such an understanding enables us to live rationally with markets that would otherwise seem wholly irrational.”

 

Home Sweet International Home

Although Ellis’s recommendation to diversify internationally is not controversial, his allocation recommendation regarding “full diversification” is a bit more provocative:

“For Americans, this would mean about half our portfolios would be invested outside the United States.”

This seems high by traditional standards, but considering our country’s shrinking share of global GDP (Gross Domestic Product), along with our relatively small share of the globe’s population (about 5% of the world’s total), the 50% percentage doesn’t seem as high at first blush.

Beware the Broker

This is not new territory for me (see Financial Sharks, Fees/Exploitation, and Credential Shell Game), and Ellis warns investors on industry sales practices:

“Those oh so caring and helpful salespeople make their money by convincing you to change funds. Friendly as they may be, they may be no friend to your long-term investment success.”

Unlike a lot of other investing books, which cover a few aspects to investing, Winning the Loser’s Game covers a gamut of crucial investment lessons in a straightforward, understandable fashion. A lot of people play the investing game, but as Charles Ellis details, many more investors and speculators lose than win. For any investor, from amateur to professional, reading Ellis’s Winning the Loser’s Game and following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours.

investment-questions-border

http://www.Sidoxia.com

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 16, 2016 at 3:15 am 1 comment

The 10 Investment Commandments

Moses ascended Mount Sinai to receive the powerful spiritual words of the Ten Commandments from God on two stone tablets and then went on to share the all-important, moral imperatives with his people. If Moses was alive today and was a professional investor, I’m sure he would have downloaded the “10 Investment Commandments” from Charles Ellis’s Winning the Loser’s Game on his e-reader, and then share the knowledge with all investors. I’m the furthest thing from Moses, but in his absence, I will be happy to share Ellis’s valuable and useful 10 Investment Commandments for individual investors:

1)      “Save. Invest your savings in your future happiness and security and education for your kids.”

2)      “Don’t speculate. If you must ‘play the market’ to satisfy an emotional itch, recognize that you are gambling on your ability to beat the pros so limit the amounts you play with to the same amounts you would gamble with the pros at Las Vegas.”

3)      “Don’t do anything in investing primarily for tax reasons.”

4)      “Don’t think of your home as an investment. Think of it as a place to live with your family-period.”

5)      “Never do commodities….Dealing in commodities is really only price speculation. It’s not investing because there’s no economic productivity or value added.”

6)      “Don’t be confused about stockbrokers and mutual fund salespeople. They are usually very nice people, but their job is not to make money for you. Their job is to make money from you.”

7)      “Don’t invest in new or ‘interesting’ investments. They are all too often designed to be sold to investors, not to be owned by investors.”

8)      “Don’t invest in bonds just because you’ve heard that bonds are conservative or for safety of either income or capital. Bond prices can fluctuate nearly as much as stock prices do, and bonds are a poor defense against the major risk of long-term investing – inflation.”

9)      “Write out your long-term goals, your long-term investing program, and your estate plan – and stay with them.”

10)   “Distrust your feelings. When you feel euphoric, you’re probably in for a bruising.”

We all commit sins, some more than others, and investors are no different. A simple periodic review of Charles Ellis’s “10 Investing Commandments” will spiritually align your portfolios and prevent the number of investment sins you make.

Read More about Charles Ellis (article #1 and article #2)

investment-questions-border

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

November 21, 2015 at 9:34 am 6 comments

Ellis on Battling Demons and Mr. Market

A lot of ground was covered in the first cut of my review on Charles Ellis’s book, Winning the Loser’s Game (“WTLG”). His book covers a broad spectrum of issues and reasons that help explain why so many amateurs and professional investors dramatically underperform broad market indexes and other forms of passive investing (such as index funds).

A major component of investor underperformance is tied to the internal or emotional aspects to investing. As I have written in the past, successful investing requires as much emotional art as it does mathematical science. Investing solely based on numbers is like a tennis player only able to compete with a backhand – you may hit a few good shots, but will end up losing in the long-run to the well-rounded players.

Ellis recognizes these core internal shortcomings and makes insightful observations throughout his book on how emotions can lead investors to lose. As George J.W. Goodman noted, “If you don’t know who you are, the stock market is an expensive place to find out.” Hopefully by examining more of Ellis’s investment nuggets, we can all become better investors, so let’s take a deeper dive.

Mischievous Mr. Market

Why is winning in the financial markets so difficult? Ellis devotes a considerable amount of time in WTLG talking about the crafty guy called “Mr. Market.” Here’s how Ellis describes the unique individual:

“Mr. Market is a mischievous but captivating fellow who persistently teases investors with gimmicks and tricks such as surprising earnings reports, startling dividend announcements, sudden surges of inflation, inspiring presidential announcements, grim reports of commodities prices, announcements of amazing new technologies, ugly bankruptcies, and even threats of war.”

           

Investors can easily get distracted by Mr. Market, and Ellis makes the point of why we are simple targets:

“Our internal demons and enemies are pride, fear, greed, exuberance, and anxiety. These are the buttons that Mr. Market most likes to push. If you have them, that rascal will find them. No wonder we are such easy prey for Mr. Market with all his attention-getting tricks.”

 

The market also has a way of lulling investors into complacency. Somehow, bull markets manage to make geniuses not only out of professionals and amateur investors, but also cab drivers and hair-dressers. Here is Ellis’s observation of how we tend to look at ourselves:

“We also think we are ‘above average’ as car drivers, as dancers, at telling jokes, at evaluating other people, as friends, as parents, and as investors. On average, we also believe our children are above average.”

 

This overconfidence and elevated self-assessment generally leads to excessive risk-taking and eventually hits arrogant investors over the head like a sledgehammer. Michael Mauboussin, Legg Mason Chief Investment Strategist and author of Think Twice, is a current thought leader in the field of behavioral finance that tackles many of these behavioral finance issues (read my earlier piece).

The Collateral Damage

As mentioned by Ellis in the previous WTLG article I wrote, “Eighty-five percent of investment managers have and will continue over the long term to underperform the overall market.” When emotions take over our actions, Mr. Market has a way of making investors make the worst decisions at the worst times. Ellis describes this phenomenon in more detail:   

“The great risk to individual investors is not that the market can plummet, but that the investor may be frightened into liquidating his or her investments at or near the bottom and miss all the recovery, making the loss permanent. This happens to all too many investors in every terrible market drop.”

 

With the market about doubling from the early 2009 equity market lows, this devastating problem has become more evident. With volatility rearing its ugly head throughout 2008 and early 2009, investors bailed into low-yielding cash and Treasuries at the nastiest time. Now the stock market has catapulted upwards and those same investors now face significant interest rate risk and still are experiencing meager yields.

The Winning Formula

Ellis acknowledges the difficulty of winning at the investing game, but experience has shown him ways to combat the emotional demons. Number one…know thyself.

“’Know thyself’ is the cardinal rule in investing. The hardest work in investing is not intellectual; it’s emotional.”

 

Knowing thyself is easier said than done, but experience and mistakes are tremendous aids in becoming a better investor – especially if you are an investor who spends time studying the missteps and learns from them.

From a practical portfolio construction standpoint, how can investors combat their pesky emotions? Probably the best idea is to follow Ellis’s sage advice, which is to “sell down to the sleeping point. Don’t go outside your zone of competence because outside that zone you may get emotional, and being emotional is never good for your investing.”

Finding good investment ideas is just half the battle – fending off the demons and Mr. Market can be just as, if not more, challenging. Fortunately, Mr. Ellis has been kind enough to share his insights, allowing investors of all types to take this valuable investment advice to help win at a losing game.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 10, 2011 at 1:51 am Leave a comment

Winning the Loser’s Game

Besides hanging out with family and friends, and stuffing my face with endless amounts of food, the other benefit of the holidays is the quality time I’m afforded to dive into a few books. While sinking into the couch in my bloated state, I had the pleasure of reading an incredible, investment classic by Charles Ellis, Winning the Loser’s Game“WTLG”  (click here to view other remarkable book I read [non-investment related]).  To put my enthusiasm in perspective, WTLG has even achieved the elite and privileged distinction of making the distinguished “Recommended Reading” list of Investing Caffeine (located along the right-side of the page). Wow…now I know you must be really impressed.

The Man, The Myth, the Ellis

For those not familiar with Charley Ellis, he has a long, storied investment career. Not only has he authored 12 books, including compilations on Goldman Sachs (GS) and Capital Group, but his professional career dates back prior to 1972, when he founded institutional consulting firm Greenwich Associates. Besides earning a college degree from Yale University, and an MBA from Harvard Business School, he also garnered a PhD from New York University. Ellis also is a director at the Vanguard Group and served as Investment Committee chair at Yale University along investment great David Swensen (read also Super Swensen) from 1992 – 2008.

With this tremendous investment experience come tremendous insights. The original book, which was published in 1998, is already worth its weight in gold (even at $1,384 per ounce), but the fifth edition of WTLG is even more valuable because it has been updated with Ellis’s perspectives on the 2008-2009 financial crisis.

Because the breadth of topics covered is so vast and indispensable, I will break the WTLG review into a few parts for digestibility. I will start off with the these hand-picked nuggets: 

Defining the “Loser’s Game”

Here is how Charles Ellis describes the investment “loser’s game”:

“For professional investors,  “the ‘money game’ we call investment management evolved in recent decades from a winner’s game to a loser’s game because a basic change has occurred in the investment environment: The market came to be dominated in the 1970s and 1980s by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with cautious custodians or amateurs who are out of touch with the market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to winning is to lose less than others lose.”

 

Underperformance by Active Managers

Readers that have followed Investing Caffeine for a while understand how I feel about passive (low-cost do-nothing strategy) and active management (portfolio managers constantly buying and selling) – read Darts, Monkeys & Pros.  Ellis’s views are not a whole lot different than mine – here is what he has to say while not holding back any punches:

“The basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management – fees, commissions, market impact of big transactions, and so forth-85 percent of investment managers have and will continue over the long term to underperform the overall market.”

 

He goes on to say individuals do even worse, especially those that day trade, which he calls a “sucker’s game.”

Exceptions to the Rule

Ellis’s bias towards passive management is clear because “over the long term 85 percent of active managers fall short of the market. And it’s nearly impossible to figure out ahead of time which managers will make it into the top 15 percent.” He does, however, acknowledge there is a minority of professionals that can beat the market by making fewer mistakes or taking advantage of others’ mistakes. Ellis advocates a slow approach to investing, which bases “decisions on research with a long-term focus that will catch other investors obsessing about the short term and cavitating – producing bubbles.” This is the strategy and approach I aim to achieve.

Gaining an Unfair Competitive Advantage

According to Ellis, there are four ways to gain an unfair competitive advantage in the investment world:

1)      Physical Approach: Beat others by carrying heavier brief cases and working longer hours.

2)      Intellectual Approach: Outperform by thinking more deeply and further out in the future.

3)      Calm-Rational Approach: Ellis describes this path to success as “benign neglect” – a method that beats the others by ignoring both favorable and adverse market conditions, which may lead to suboptimal decisions.

4)      Join ‘em Approach: The easiest way to beat active managers is to invest through index funds. If you can’t beat index funds, then join ‘em.

The Case for Stocks

Investor time horizon plays a large role on asset allocation, but time is on investors’ side for long-term equity investors:

“That’s why in the long term, the risks are clearly lowest for stocks, but in the short term, the risks are just as clearly highest for stocks.”

 

Expanding on that point, Ellis points out the following:

“Any funds that will stay invested for 10 years or longer should be in stocks. Any funds that will be invested for less than two to three years should be in “cash” or money market instruments.”

 

While many people may feel stock investing is dead, but Ellis points out that equities should return more in the long-run:

“There must be a higher rate of return on stocks to persuade investors to accept risks of equity investing.”

 

The Power of Regression to the Mean

Investors do more damage to performance by chasing winners and punishing losers because they lose the powerful benefits of “regression to the mean.” Ellis describes this tendency for behavior to move toward an average as “a persistently powerful phenomenon in physics and sociology – and in investing.” He goes on to add, good investors know “that the farther current events are away from the mean at the center of the bell curve, the stronger the forces of reversion, or regression, to the mean, are pulling the current data toward the center.”

The Power of Compounding

For a 75 year period (roughly 1925 – 2000) analyzed by Ellis, he determines $1 invested in stocks would have grown to $105.96, if dividends were not reinvested. If, however, dividends are reinvested, the power of compounding kicks in significantly. For the same 75 year period, the equivalent $1 would have grown to $2,591.79 – almost 25x’s more than the other method (see also Penny Saved is Billion Earned).

Ellis throws in another compounding example:

“Remember that if investments increase by 7 percent per annum after income tax, they will double every 10 years, so $1 million can become $1 billion in 100 years (before adjusting for inflation).”

 

The Lessons of History

As philosopher George Santayana stated – “Those who cannot remember the past are condemned to repeat it.” Details of every market are different, but as Ellis notes, “The major characteristics of markets are remarkably similar over time.”

Ellis appreciates the importance of history plays in analyzing the markets: 

“The more you study market history, the better; the more you know about how securities markets have behaved in the past, the more you’ll understand their true nature and how they probably will behave in the future. Such an understanding enables us to live rationally with markets that would otherwise seem wholly irrational.”

 

Home Sweet International Home

Although Ellis’s recommendation to diversify internationally is not controversial, his allocation recommendation regarding “full diversification” is a bit more provocative:

“For Americans, this would mean about half our portfolios would be invested outside the United States.”

 

This seems high by traditional standards, but considering our country’s shrinking share of global GDP (Gross Domestic Product), along with our relatively small share of the globe’s population (about 5% of the world’s total), the 50% percentage doesn’t seem as high at first blush.

Beware the Broker

This is not new territory for me (see Financial Sharks, Fees/Exploitation, and Credential Shell Game), and Ellis warns investors on industry sales practices:

“Those oh so caring and helpful salespeople make their money by convincing you to change funds. Friendly as they may be, they may be no friend to your long-term investment success.”

 

Unlike a lot of other investing books, which cover a few aspects to investing, Winning the Loser’s Game covers a gamut of crucial investment lessons in a straightforward, understandable fashion. A lot of people play the investing game, but as Charles Ellis details, many more investors and speculators lose than win. For any investor, from amateur to professional, reading Ellis’s Winning the Loser’s Game and following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

January 5, 2011 at 1:23 am 2 comments


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