Winning the Loser’s Game

The book Winning the Loser’s Game by Charles D. Ellis was a very pleasant surprise for me. I tend not to expect much from books and am pleased to learn even one interesting thing. Ellis provides consistently solid investing information from beginning to end. The presentation is clear and concise. This book is now my best recommendation for an individual investor looking for a foundation for a lifetime of investing.

This book is in its fifth edition, which makes me regret not ever having seen it before. I certainly could have saved myself from financial mistakes armed with these ideas. Parts of the book are specific to U.S. investors, but they are not central to the main messages.

Among other high-profile roles, Ellis has chaired investment committees at both Harvard Business School and Yale School of Management. But that doesn’t mean that he aims to baffle readers with his academic brilliance. Even concepts I thought I understood well and have seen in other books were explained more clearly and simply here.

While most investing books go through a litany of different investments and approaches an investor can use, Ellis also tells us what we cannot do. “Virtually all how-to books on investing are sold on the false promise that the typical investor can beat the professional investors. He or she can’t, and he or she won’t.” Ellis backs up this bold claim convincingly.

The different ways of trying to beat the market are examined one by one and knocked down. Ellis contends that while less efficient markets in the past made it possible for clever investors to beat the market, today’s markets are dominated by professionals controlling 90% of the money. This makes it impossible for anybody to beat today’s markets consistently. “The problem is not that investment research is not done well. The problem is research is done very well by very many.”

“All the basic forms of active investing have one fundamental characteristic in common: They depend on the errors of others.” To profit, an active investor has to find cases where the consensus estimate of other professional investors is wrong. Even the best do-it-yourself stock pickers have little chance because they are up against an army of professionals.

Ellis’ conclusion is that the best approach to investing involves using low-cost indexing either with index funds or ETFs, whichever works out to have the lower cost. He lists a litany of “unfair” advantages index investing has:

– Higher returns
– Lower fees and expenses
– Convenience
– Lower taxes
– Freedom from errors (fewer decisions)
– Less anxiety

Here are thoughts on some of the details in the book:

Efficient Markets

Ellis believes that markets are very efficient at getting the relative prices of equities right. However, he believes that the entire market can still get under-priced or over-priced.

Emotions

“The principal reason you should articulate your long-term investment policies explicitly and in writing is to protect your portfolio from yourself.”

“It is in ... periods of anxiety – when the market has been most severely negative – that investors predictably engage in ad hoc ‘reappraisals’ of long-term investment judgment and allow their short-term fears to overwhelm the calm rationality of long-term investing.”

Regression to the Mean

It seems that Ellis couldn’t help but suggest some active management at least once. Although he thinks actively-managed mutual funds are a loser’s game, he recognizes that many investors will play it anyway and offers some advice that includes a “good test”.

“If the fund underperformed the market because the manager’s particular style was out of favor, would you cheerfully assign substantially more money to that fund?” He thinks the answer should be yes because “the manager will almost certainly outperform the overall market averages when investment fashion again favors his or her style.”

This seems to contradict the results in Figure 14.1 that show that past mutual fund performance gives almost no information about the future. “The data have zero predictive power – with this one exception: The worst losers do tend to keep losing.”

Old People

We should be tolerant of petty behaviour by old people when it comes to how they control their money because “it’s probably just another way of expressing fear of death.”

Leverage

“Don’t invest with borrowed money.”

Commodities

Speculating in commodities is “not investing because there’s no economic productivity or value added.” Ellis calls commodities a negative-sum game. “Consider the experience of a commodities broker who over a decade advised nearly 1000 customers on commodities. How many made money? Not even one.”

Errata

This book has fewer minor errors than the typical book. I found so few that it isn’t too tedious to list them. In Figure 16.1, the range of inflation percentages should go from 3% to 7% rather than 2% to 6%. On page 132 at the end of the second paragraph, “then” should be “than”.

Conclusion

Winning the Loser’s Game is a clearly-written book that takes a strong stand on how people should invest their money. It will challenge the thinking of many individual investors whether they trust their money to active mutual fund managers or pick their own stocks.

After such a positive review, I should address questions about my motivations. McGraw Hill sent me a free review copy of this book, but I made no promise to give a positive review. I have written reviews for McGraw books that I didn’t like as well. I may be right or wrong, but I have written what I actually think rather than what someone paid me to say.