Charley Ellis recognized that there were two different games being played in the stock market. The game the experts play differs from the game the amateurs play.
When the amateurs try to play the experts’ game they frequently make mistakes and lose money. That’s not to say the experts are fantastic at making money. A few are but experts, on average, fail to beat the market too. So the majority of experts fall short of the market and the amateurs, emulating experts, do worse.
Ellis’s solution is to play a different game entirely. The game amateurs should play, and many experts too, is built on a foundation of avoiding errors. Essentially, not losing. Fewer errors lead to better results.
Ellis wrote this in his 1975 classic The Loser’s Game. In it, he used an analogy between tennis and investing. It turns out there are two different games in tennis too. The game the professionals play is not the same game as the one the amateurs play.
The pros can be aggressive. They have the skill, precision, and experience to place shots just outside their opponent’s reach. They play a winner’s game. The match goes to the player who earns the most wins.
Amateurs, however, often lose by trying to play like the pros, because it leads to unforced errors. It’s a loser’s game. Amateurs win in tennis by volleying until their opponent hits it into the net or out of bounds. They win by not losing.
Of course, the concept of loss avoidance has been around forever but Ellis’s analogy delivers a strong message. It’s a piece every investor should read every few years.
And many of Ellis’s teachings since then follow the concept of winning by not losing.
On the Best Investment Policy
Know your own financial situation. Know your long-term goals. Know what your limits are. But be careful. Most people approach investments as if the right “solution” were mathematical, and their investment objectives rational. The objective factors are usually not the most important parts of the “best” investment policy. Experience teaches that the subjective and emotional factors are usually more important because the emotional errors — buying too high because of excessive confidence or selling too low because of excessive anxiety — do more harm than rational errors. So you need to know as well what is your emotional situation and what are your emotional constraints. What riskiness can you live with and live through? Can you hang on when the pressure is most intense and the data most compelling that you are clearly wrong? If not, recognize your own emotional realities and learn to live well within them.
If you are not able to sit down and write out in an hour’s time what you are trying to do with your portfolio and how you intend to do it…you should at least consider making a serious study of your objectives, your risk aversion, the nature of the capital markets, your cash inflow and outflows, and the design of an investment policy that is truly right for the long term, for you.
The reality is that “roughly right” is all we can ever hope for on long-term asset mix, because even the most sophisticated investors must make their judgments on the basis not of facts, but on probabilistic estimates of two great uncertainties, markets and human reactions to markets, and without knowing the consequential leads and lags that will surely be part of the real world.
The really hard part about investment policy is not figuring out the best feasible combination. While it takes some time and analytical discipline, this part of the problem-solving is far from advanced science. The really hard part is managing ourselves: our expectations and our interim behavior. Walt Kelly’s Pogo puts it as “we have met the enemy and he is us.” Most investors are too optimistic about the long run and much too optimistic about how well they will do compared to the averages, so they set themselves up for disappointment.
Every investor should recognize the powerful potential impact of luck — not good luck, but bad luck. We can all live through good luck. But bad luck — the apparently random occurrence of adversity — is equally prevalent, and its consequences can be far greater.
On Getting Excitement Out of the Market
Go to a continuous-process factory sometime — a chemical plant, a cookie manufacturer, a place that makes toothpaste. Everything is perfectly repetitive, automated, exactly in place. If you find anything interesting, you’ve found something wrong.
Investing is a continuous process too; it isn’t supposed to be interesting. It’s a responsibility. If you go to the stock market because you want excitement, then sooner or later you will lose. Everyone who thinks the stock market is a game loses — everyone, to the last man, woman, and child. So, the purpose of an investment policy is simply to ensure that your continuous process never breaks down.
On Not Losing
In investing, losing means taking decisive action at the worst possible times — being driven by your emotions precisely when you need to be the most rational.
All investors of course will experience uncomfortable fluctuations in the market. That’s reality — and not a major concern. The real concern is with irreversible losses caused by overreaching for speculative possibilities; by taking market risks greater than our capacity to endure turbulence and maintain consistent rationality; by reaching for managers whose best performance is behind them and who are destined or doomed to underperform — with your money; and by going into debt.
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.
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.
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.
In a rapidly rising market, the faster you trade, the better you’ll do — and that makes you forget that those whom the gods would destroy, they first make confident. The more you know, the higher the odds that you’ll make a serious mistake. That’s why it’s not the beginners who tend to die at skydiving and why most car accidents happen within a few miles of home. There’s a saying in the British Royal Air Force that investors need to remember: “There are old pilots, and there are bold pilots, but there are no old, bold pilots.”
As human beings, particularly if we are successful in other parts of our lives, we are notoriously unable to accept the obvious reality that, on average, we are average, and that our normal experiences will usually be about average because we are, as a group, captives of the normal distribution of the bell curve. It amuses us that Lake Wobegon’s children are all above average, yet studies all the time show we think we are above-average drivers, above-average parents — and above-average investors. And we do tend to take it personally when our stocks go way up or go way down, even though, as Adam Smith admonishes, “The stock doesn’t know you own it.”
- Reality Catches Up – M. Housel
- What’s The Bull Case? – Irrelevant Investor
- Betting Against Expensive Junk – Verdad
- Is Value Just an Interest Rate Bet? – AQR
- The Role of Concentration in Fund Performance – Evidence Investor
- Why Your House Was So Expensive – D. Thompson
- No Great Stagnation in Guinness – Fitzwilliam
- Mosquitoes at Disney World: Why Do You (Almost) Never See Them? – Mousetrack
- When Newsletters Were Printed – Tedium
- The Road Ahead for Webb – Supercluster