Investing legend Charles D Ellis says the process of investment is like a game of amateur tennis, where the winner is the one who makes the fewest mistakes.
He feels the investment process can be termed as a “loser’s game” in which mistakes and unforced errors can cause investors to fall behind their peers.
Ellis says the winning approach to the game is simple to understand and explain, but certainly not easy to implement.
“Winning the active management game requires some indispensable features, importantly high moral character, good governance, and expert knowledge and execution,” he says in his book Winning the Loser’s Game.
Charles D Ellis is the founder of Greenwich Associates and has been a legendary investment adviser for over five decades. He has authored over 17 books, which are a powerful testament to his enduring wisdom.
A graduate of Yale College, Ellis did his MBA at Harvard Business School and a PhD at New York University. His professional career began at the Rockefeller Foundation, where he realised that investment management was indeed what he really wanted to do. He founded investment-advisory firm Greenwich Associates in 1972 and has served as a consultant to large institutional investors and government organisations ever since.
Ellis is also one of only 13 individuals to receive the Award for Professional Excellence from CFA Institute for lifetime contributions to the investment profession.
How the investing game has changed over the years
Ellis says in the early 1950s, investing in the stock market was a winner’s game as 90% of the participants were individual investors and someone willing to take the time and effort to really study about the companies could earn market-beating returns. However, since that time professional investors now make up 90% of the market with a very high skill set.
“When investors trade stocks, mutual funds, or ETFs, they are almost surely trading with other professionals who spend 60-80 hours a week doing something that they may do only once a month. These investors are too good at investing and there are too many of them for any of them to win. Hence the investing game has changed from a winner’s game to a loser’s game,” he says.
How to play the investing game
Ellis says in a loser’s game of amateur tennis, outcomes are determined by the losers’ mistakes, as most of the points are won by the player who does not make mistakes.
Similarly in investing, outcomes are determined not by the great strategy and exceptional execution by the winner . Rather, they are the result of losers’ mistakes rather than the winner’s proficiency.
Hence, the key to winning the investing game is not making mistakes.
“If you can just volley the ball back to your opponent, eventually your opponent will hit it out of bounds or into the net. On the other hand, if you try to smash a shot and crush your opponent (like the pros do), you’re much more likely to hit the ball into the net yourself. The way you win a loser’s game is to not play,” he says.
Ellis suggests the best way to survive the stock market game is to avoid playing and trying to beat the market.
“Simply avoid going into ‘the casino’ and just own the entire market at the lowest possible cost. You do that by purchasing index funds and spending your life energy on something else,” he says.
Beware of investment managers
Ellis says investors should conduct their own research and analysis and avoid letting other professional managers run their portfolios as these managers may be working for them but are actually looking to make their own profit.
“Sensible investors rely on themselves. A strategy of professing ignorance and handing assets to a trained professional invites failure. Ironically, upon acquiring sufficient information to assess the skill of an investment service provider, individuals end up empowered to take control of their portfolios and make their own decisions,” he says.
The secret to long-term investment success
Ellis is of the view that investment should not be treated as an entertainment activity as it is not supposed to be fun or “interesting.” Rather investors should consider it as a responsibility to do well in their investment career.
Ellis feels the secret of long-term success for investors is ‘benign neglect’ as the hardest work in investing is not intellectual but emotional.
“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 The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus–particularly at market highs or market lows–and staying committed to your optimal investment policy,” he says.
Take limited risk
Ellis believes investors should work towards achieving their realistic objectives, but they shouldn’t take on more risk beyond their capacity to achieve their commitments until the investment climate is favourable.
“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,” he says.
Why investors incur losses
Ellis says if investors try too hard to win eventually they end up incurring losses.
He believes investors also incur losses when their actions are driven by their emotions precisely when they need to be the most rational.
“Large losses are forever — in investing and in teenage driving. 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,” he says.
Ellis is of the view that many investors misunderstand experts who advise them to remain careful while investing. They perceive being careful as not doing things that are bold or courageous or creative.
But Ellis believes the right meaning of being careful is to be bold, creative, and courageous while being disciplined and knowing exactly what to do.
Best time to be bold
Ellis says when stocks get cheaper it is bound to be good news for long-term investors.
So investors should try and make bold moves precisely when it seems they should be most afraid.
“It’s absolutely cockamamie crazy to sell stocks after they drop. Instead, you should say, “Today, there’s the first-rate bargain and I’m buying,” he says.
Recognize and avoid mistakes
Ellis is of the view that investors are bound to make mistakes from time to time so they need to recognize their mistakes and understand how to avoid them.
Ellis came up with the list of mistakes that investors make during their investment journey. These include-
1. Trying too hard to beat the market
2. Not trying hard enough and not taking enough risk
3. Being impatient
4. Borrowing too much
5. Being overly optimistic
6. Being proud
7. Being emotional
10 investment commandments
Ellis also listed out 10 timeless investment commandments which can help individual investors make better investment decisions.
2) Don’t speculate
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. Their job is not to make money for you but 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 the 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 and stay with them.
10) Distrust your feelings. When you feel euphoric, you’re probably in for a bruising.
Secret formula to win the investing game
Ellis says the secret formula to win the investing game is to “Plan your play and play your plan to win your game.”
“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,” he says.
(Disclaimer: This article is based on the book “Winning the Loser’s Game ” by Charles D. Ellis .)