Better Investing — A Book Review of “Winning the Loser’s Game”
Doing Less is (Often) Doing More
Many beginner tennis players learn a surprising lesson: forget strategy and just get the ball over the net. Only the top tennis players actually win through skillful shots; the rest of us win…by not losing first. For most of us, patience and a soft touch are the keys to survival on the tennis court.
Charles Ellis, the author of “Winning the Loser’s Game,” has a similar message for investors. Short, while packed with wisdom, Ellis’ book has become a favorite over the past few decades, alongside Burton Malkiel’s “A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing” and David Swenson’s “Pioneering Portfolio Management: An Unconventional Approach to Institutional Management.” A sign of the times, select any one and the Amazon algorithm will often suggest the other two.
What does Ellis want us to know? To begin with, old habits die-hard. Today’s investing market is based upon the successful strategies of the 1950’s and 60’s. Too many of us cling to the belief the market can be beaten. While industry incentives and compensation structures may promote this thinking, Ellis also hints customers want to believe this as well. In the same way we are all “above average” drivers, we too can be superior investors, and certainly better than average.
Ellis describes the environment half a century ago, when individual investors, the “little guy,” bought and sold stocks in one-off trades. With so many of these little guys, then 90% of the market, a small group of professional traders could count on enough amateur “mistakes” to do much better than the overall market.
But as they say, nature abhors a vacuum. After a few decades of easy wins and an explosion of funds under professional management, the dynamic changed. Success led to success until, by the 1970’s, the “market came to be dominated by the very institutions that were striving to win by outperforming the market.”
Quantitatively, individual investors soon fell from 90% of market participants to 10%. Professional investors, those who once counted on a large number of mistakes, grew to become the new 90%. This reversal “made all the difference.”
Professional investment managers were no longer competing against amateurs — they were competing with each other. The business paradigm evolved — “lose less than the others lose.” Benchmark hugging entered Wall Street’s lexicon, namely to stay in the game you shouldn’t take too many risks.
What does this mean for the individual investor?
In a frictionless, cost free environment, pitting two chess masters against one another may make for an interesting match. However, investors pay a huge price for this highbrow entertainment. Ellis and his colleagues, backed up by academia and other researchers, have a prescription for individual investors: trade less and reduce your fees.
Active trading, the buying and selling of stock and bonds, costs money. Further, we are notoriously bad at timing our entry and exit into securities. Add to that the salaries, overhead and compliance costs of firms who direct and execute these trades, among a variety of expenses, and these charges begin to add up, costing investors much of their annual return.
According to Ellis’ rough calculation, investors in active management should expect to pay a bit less than 3% a year for this stock picking service. While this may strike some as a small amount, Ellis is quick to point out “recovering these costs is surprisingly difficult in a market dominated by professional investors.”
Being rational…is not easy.
Even still, Ellis writes, that isn’t the hardest part to investing. An investor’s biggest challenge is simply bad behavior. This is no longer a provocative view. A cottage industry of behavior economics has grown to prominence in the last decade.
What does Ellis suggest? Sound investment policy. A defined plan can re-assure us during periods of market volatility. As Kahneman, Thaler and others have become famous for pointing out, “being rational…is not easy.”
The reasons Ellis gives are many, though they can be boiled down to this — we buy and sell for reasons unrelated to the market. Home purchases, college tuitions, vacations and all the other life events that require meaningful sums of money often trump “sound investment policy.”
Individual investors, particularly those without a personalized investment policy, create what the author refers to as a “paradox.” He writes, “funds with very long term purposes are…managed to meet short term objectives.”
The author cautions against market timing and asset allocation. He writes, “analysis shows over and over again that the trade-off between risk and reward is driven by one key factor: time.” The author’s prescription is for both investment managers and their clients to hold to their investment policy, “the most powerful antidote to panic.”
Finally, the author reminds the reader of the tax impact of active trading. In what has become “typical” portfolio turnover of 100% annually, after tax investment performance is often reduced by 3% or more. We tend not to think about the impact of taxes, particularly as the financial services industry tends to avoid highlighting, but ultimately it is the after tax performance that funds our retirement, kids’ college education and vacations. The IRS is never far away.
While this may feel daunting to the uninitiated, the cost of investing and personalized advice is falling. Vanguard, where Ellis was once a director, has not only driven the costs of investing to the lowest level in history, but also heavily invested behind the Certified Financial Planner advisor model for their robo-advisor offering, Vanguard’s Personal Advisory Service. As this hybrid robo-advisor model evolves, at Vanguard and elsewhere, the author’s recommendations may finally be within grasp of individual investors.
In the meantime, when it comes to investing some of us might be better off trying a little less hard.
Thanks for reading.
I’ve written on Money, Investing, Healthcare, Nutrition, Behavior, and other (mostly) related topics, more on Medium, LinkedIn, and Quora. After theHelloWallet sale to Morningstar we built a digital platform, HSA Coach, that combines this acquired book-knowledge into user-friendly financial guidance. We are particularly focused on incorporating Health Savings Accounts into a saver’s broader investment portfolio, with some personalized calculators to allocate between your HSA and 401(k). More coming. Available for free in theApp Store and Google Play.
As always, comments and reading suggestions on this and other topics welcome.