The lesson of The Loser’s Game

More years ago than I care to remember, I interviewed Charles Ellis, and wrote about it in a Motley Fool article.
Charles Ellis? You can be forgiven if you don’t know the name: Ellis is something of an investor’s investor, cited as a significant influence by several of the world’s most notable investors and investment writers.
Yet what many regard as his key insight came back in 1975, in a widely-cited academic article entitled The Loser’s Game, published in The Financial Analysts Journal

Diminishing returns

Ellis’ argument was a very simple one, and stemmed from his work advising investment companies, back in the early 1970s.

“I was fairly deep into investment management, and was working very closely with people in the investment profession,” he told me. “And I knew that investment was really challenging, because you were looking at very smart people who were working very hard.”
And yet, he saw, this investment energy was very clearly failing to deliver the goods – despite all those very smart people working very, very hard at it.
A lot of effort was being expended, and yet – over time – the rewards of that effort were declining.
And no one could figure out why. 

Loss avoidance

A keen tennis player, Ellis one day stumbled across a statistical study of how leading tennis players won their games.
“Winners had a particular style of play,” he recalled. “Their goal was to keep the ball in play long enough for the other person to make a mistake.”
Or, as The Loser’s Game puts it:

“Professionals win points, amateurs lose points. Professional tennis players stroke the ball with strong, well-aimed shots, through long and often exciting rallies, until one player is able to drive the ball just beyond the reach of his opponent.
Amateur tennis is almost entirely different… the ball is fairly often hit into the net or out of bounds, and double faults at service are not uncommon. The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor… gets a higher score because his opponent is losing even more points.”

Mistakes sap returns

Ellis realised that this was the very behaviour that he was seeing in the world of investment. In other words, long-term success came from avoiding mistakes.
Put another way, your goal as an investor is to make fewer mistakes than the next investor.
Ellis’ insight was a powerful one, and was subsequently expanded into a popular book, Winning the Loser’s Game. Now in its seventh edition, over 500,000 copies have been sold.
Yet sadly, investors continue to make avoidable mistakes.

Common failings

They buy for the wrong reasons. They sell for the wrong reasons. They sell when they should have bought, and vice-versa. They don’t look at basic valuation metrics. They under-value income, and over-value growth. They panic, and over-react, when they should have taken a longer-term view.
All of these and more are very, very common. And also very avoidable.
What to do? Stop and think, for one thing. If in doubt, sit on your hands. And most of all, have some kind of strategy, and stick to it.

Doing nothing is not a crime

It’s difficult, I know. Humans are generally predisposed towards action: doing something is seen as preferable to doing nothing – even when doing nothing is the smartest course of action.
If it helps, adapt Warren Buffett’s ‘punch card’ analogy to include selling, as well: imagine that you can only make so many trades in your investing lifetime, and so it is important to make them very carefully.
And above all, don’t be in a hurry to either sell, or buy. We are investors, not traders. Think long-term, not short-term.

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