Ellis, Winning the Loser’s Game, 6th ed.

Those who are convinced they can consistently beat the market will find Charles D. Ellis’s book depressing reading. The underlying thesis of Winning the Loser’s Game: Timeless Strategies for Successful Investing, 6th ed. (McGraw-Hill, 2013) is that in recent decades investment management has evolved from a winner’s game to a loser’s game because “the market came to be dominated by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with overly cautious custodians or overly confident amateurs who are out of touch with the fast-moving market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to ‘winning’ is to lose less than the others lose.” (pp. 5-6)

Put another way, and here I invoke Michael Mauboussin’s The Success Equation, we are faced with the paradox of skill: “As skill improves, performance becomes more consistent, and therefore luck becomes more important.” That is, as the population of skilled investors rises, with individual retail investors moving to the sidelines, the variation in skill narrows and luck plays a greater role in outperformance. And, as we all know, luck is not predictable. That an investor manager has outperformed the market in the past two or three—or even fifteen—years in no way guarantees that his luck will continue. Bill Miller of Legg Mason is, of course, the poster child for this truism.

However you slice it, Ellis argues that the individual investor must reconcile himself to the fact that he will not get outsized returns year after year, whether he hands his money over to a fund manager or (normally even worse) pursues the do-it-yourself route. Instead, he must plod along, trying to minimize mistakes. Ellis puts it in less tortoise-like language: “As all grandparents and most parents know—and as most grandchildren will come to know—the real test of a good driver is simple: no serious accidents. And as all flyers know, safe, dull—even boring—is the essence of a good flight. The secret to success in investing is not in beating the market any more than success in driving is going 10 MPH over the posted speed limit. Success in driving is being on the right road and moving at a reasonable speed.” (p. 51)

What are some of the mistakes investors make? They pay too much in fees, they trade too often, they ignore tax considerations, they fail to diversify, and they have no clearly defined objectives.

And if you still think that active management is the way to go, Ellis offers a couple of sobering statistics: “Over 10-year periods, two out of three active managers’ results fall below the market averages—and below index funds. Over longer periods, more fall below.” And “Those managers who fall short fall short by nearly twice as much as those who do better do better.” (p. 153) He adds, “Yes, Virginia, some managers will always beat the market, but we have no reliable way of determining in advance which specific managers will be the lucky ones.” (p. 166)

There are more than 500,000 copies of Winning the Loser’s Game in print. Whether readers acted on Ellis’s advice or promptly ignored what they were told I have no way of knowing. Creators of mutual funds and ETFs certainly listened. There is now a virtual supermarket of index and quasi-index funds and ETFs available. Some have higher fees than others, some trade more frequently than others, some (beware!) are pegged to bizarre indexes. All in all, the investor still has his work cut out for him. Ellis is standing by to lend him a helping hand.