Charles Ellis has played a few roles in his life: an investment consultant on Wall Street, chairman of the Yale endowment, professor, and author of several books (17? and counting), including the classic Winning the Loser’s Game.
I’ve been reading a lot of Charley Ellis’ articles and interviews the past few days. He has a unique way of framing some of the basic tenets of investing success.
So I’ve pulled some highlights from what I read that help describe what Ellis believes investors need to do in order to “win” at investing.
On what investors should care about.
Back in 1963, I was in a training program at Wertheim & Co. and one day the senior partner, J.K. Klingenstein, was our guest speaker. As he was about to leave, one of the trainees blurted out, “Mr. Klingenstein, you’re rich. How can we become rich like you?”… The room was silent as a tomb, and finally Mr. Klingenstein said firmly, “Don’t lose.” Then he stood up and left. I’ve never forgotten that moment. That’s what investors should really care about: Don’t lose. Don’t make mistakes. They cost too much. Most of the destruction of investment value occurs in small private, anguished experiences, that are never discussed and never recorded, because people were doing things they never should have done.
In investing, losing means taking decisive action at the worst possible times — being driving by your emotions precisely when you need to be the most rational. Trying too hard to win eventually means losing. To win the Indianapolis 500, you first have to finish the Indianapolis 500 — that’s five hundred laps around and around that oval. If you try too hard on just one lap, you won’t live to finish.
While all the chatter and excitement is taking place about big stocks, big gains, and “three-baggers,” long-term investment success really depends on not losing — not taking major losses. We all know that a 50 percent loss requires a double the next time up just to get even, but still we strive for the Big Score, even though we also know full well that accidents happen most often to too — fast drivers; that Icarus got too close to the sun; that Enron Corporation, WorldCom, and many dotcoms had very high “new era” multiples before their obliteration. Large losses are forever — in investing, in teenage driving, and in fidelity. If you avoid large losses with a strong defense, the winnings will have every opportunity to take care of themselves. And large losses are almost always caused by trying to get too much by taking too much risk. If, as investors, we could learn to concentrate on wisely defining our own long-term objectives and learn to focus on not losing as the most important part of each specific decision, we could all be winners over the long term.
On being defensive.
I don’t remember the exact year, maybe 2005 or 2006, David Swenson and I were having lunch. I said, “David, this is going to surprise you but I’m concerned that you may be too careful, too defensive, too protective. I just wonder; should you be a little bit more assertive and take a little more risk?” He said, “Honestly, I don’t know. But I do know one thing. Just about the time you think there’s never going to be a horrific negative surprise, one comes barreling along. I may be too careful. I may be too protective. I may be too defensive. Though knowing history, I think it’s probably a pretty good idea.”
So when the horrible experience came slamming through, it wasn’t that he was really prepared for that specific one, but he was well prepared for real difficulties.
There’s a lot to be careful about. Many see “be careful” as not doing things that are bold or courageous or creative. That’s not the right way to be careful. You should be bold, creative, and courageous, but disciplined and know exactly what you’re doing.
On the best time to be bold.
If you’re buying something, wouldn’t you rather pay less for it than more? When stocks get cheaper, how can that not be good news for long-term invetsors? There are very few times when you should be bold, and history shows that those times are prceisely when it seems you should be most afraid. It’s absolutely cockamamie crazy to sell stocks after they drop. Instead, you should say, “Today, there’s first-rate bargain and I’m buying.”
On avoiding mistakes.
And focus on the non-negative. Really strong defense makes the offense easy. Most of the trouble in investment management is not because you came just a little short of having superb investment results. It’s because you made a mistake. Knowing how to be selective, you avoid the mistakes.
Yes, but also keep the error cost down. As human beings, we’re really good at making mistakes and we need to recognize that and help people understand how to avoid mistakes. That’s why we take driver education — to teach us how to avoid accidents.
On “winning” at investing.
In Munich, Germany, while visiting my son Chad and his wife Trish last summer, we agreed to cheer for their friend who was running in a marathon. Their friend had run several marathons, so she had a realistic plan and knew that at about 11 o’clock, she would pass a particular church. So, we were stationed there, and right on schedule, she came by. We cheered lustily; she waved-and was quickly gone.
We went off to lunch at a Wursthaus and then took the tram out to Munich’s Olympic Park… Sitting in the stadium with a few hundred other fans, we enjoyed watching runners…come through the portal entrance and into the stadium for the final lap to the finish line. The runners were all different in age, dress, and running style, but in one particular way, they were all the same: Runner after runner…reached high overhead with both arms in the traditional triumphal “Y” and held it for at least half a minute as, grinning in victory, they ran out the final lap.
At first, it seemed strange. Didn’t they know the Kenyans had won long ago? As time went by…it might have seemed stranger and stranger to see later runners act like champions, heroes, and winners. Then it hit me: They were winners. They were all winners — because each runner had achieved her or his own realistic objective.
Some finished in less than three hours; some in only three hours; some in “only” three and a half hours. Others beat their prior best times. Some won simply by completing the whole marathon-some for their first time and others for their last time.
The powerful message: Each runner had achieved his or her own realistic goal, so each was a true winner and fully entitled to make the Big Y and run the victory lap.
If, as investors, we each thought and acted the same way — understanding our capacities and our limits — we could plan the race that would be right for us and, with the self-discipline of a long-distance runner, run our own race to achieve our own realistic objectives. In investing, the good news is clear: Everyone can win. Everyone can be a winner.
The secret to winning the Winner’s Game in investing is simple: Plan your play and play your plan to win your game.
Words From the Wise Charles D. Ellis – AQR
Wall Street’s Wisest Man – Money
Investing Success in Two Easy Lessons – C. Ellis