Charley Ellis has been a voice of common sense in the world of investing for more than 50 years. His book, Winning the Loser’s Game, which explains why low-cost, buy-and-hold indexing is the rational choice for all investors, has become a classic. He’s now aged 85 but still working.
Charley recently spoke to Cameron Passmore and Benjamin Felix at the Rational Reminder podcast, and we’d strongly urge you to listen to the whole episode.
The interview contains a wealth of wisdom about investing, but here are six lessons that caught our attention.
1. Success is all about minimising mistakes
“A loser’s game is any competitive activity, where the outcome is not controlled by the winner, but it’s actually controlled by the loser. Golf is a good example. People that are really good at golf will shoot less than par, by two or three strokes on a regular basis. A lot of other people are proud to be able to shoot 90. There are some people who’ve never broken a 100. Well, the difference between the two groups is the mistakes of the people who’ve never broken a 100 and make all the time.
“Another loser’s game is tennis. If you look at your game, or at least my game, how many times do you win a stroke, instead of hitting it at the net, hitting it out of bounds, laying it up so easily for the other person hit it back, that you’ve essentially forced yourself into a loss? If you could cut back on the number of mistakes and let the other guy increased the number of mistakes he made, you’ll come out the winner of a loser’s game.
“That’s what investing is all about. Most of the activity that most of us spend our time engaged in, in investing actually doesn’t help. It actually does harm. Our long-term results are impoverished by the mistakes that we’ve made along the way.
“In investment management, if you could just reduce the number of mistakes you’ve made, you would come out as a winner. The easy summary of all that is, if you index, you won’t be making any mistakes. You have to choose the right index, that’s fair. If you index, you won’t be timing the market, you won’t be trading too much, you will get excited about something you just heard from a friend of yours who heard from a friend of his that looks like it might be a really great idea.”
2. Active managers do more harm than good
“It’s gotten harder and harder and harder to be an active manager, and successful at the same time. More and more people have accepted indexing is a perfectly rational way of taking advantage of the realities of the market, then not getting suckered into doing things that actually do you harm. It does take a sense of humour, and it does take an appreciation for history to realise. I know you’re wonderful. I know you’re terrifically talented. I know you work very, very hard. But you’re actually not helping yourself, or your clients.
“The perception is, you’ve got brilliantly talented people working hard for you all the time, that’s true. That perception is that they’re going to be able to make a real difference to your economic situation. That’s very unlikely to be true. What’s very, very likely to be true is you’re going to make a wonderful difference to their economic situation.”
3. Outperformance gets harder as aggregate skill increases
“Back in the 60s, there might have been as many as 5,000 people worldwide, involved in active investing. More than half of them would have been in the US. The next largest group would have been in the UK, and then have been sprinkled with people, some in Hong Kong, some elsewhere, trying to figure out what they could do to get a comparative advantage.
“Well, today that 5,000 has been increased to something like 2 million, 2 million people does transform the nature of the market, and anything. Okay, so participants are really good. They also have terrific educations. You have MBAs all over the place today. That was a very rare thing years ago. You have PhDs, you have MDs. You have people who’ve got all kinds of skills in there competing all the time. The intellectual level has been raised and raised and raised. Then you think, “Well, what kind of equipment do they have?” We had slide rules. What do you guys have?
“Well, we have more computing power in our pocket than an IBM 360… Everybody’s got a Bloomberg terminal. Everybody’s got Internet access. Everybody’s got terrific computing power. Everybody’s part of this fabulous worldwide network of information from all the major securities firms, with branches in all the major economies around the world, piling information into the system and making it available to everybody who wants to compete.”
4. Indexing is the rational choice for everyone
“I don’t know of anyone that I would say should not (index). It gives you a couple of examples. Most of us, who knew him at all, had the highest regard for David Swensen, who was the Chief Investment Officer for Yale and turned into one of the truly outstanding records of achievement. It’d be very hard to make an argument, David Swensen should have been indexing. He started, when he first took on the responsibility, he had most of the fund in indexing. Then gradually found ways that active investing of the kind that he was particularly good at doing could make a justified case that you’ll get an incremental return by not indexing, but by being active.
“Some of that was portfolio structure. He was not exactly the first, but one of the first to consider hedge funds. He’s one of the first to get involved in private equity. He was one of the first to get involved in venture capital. He was one of the first to get involved in creative real estate. That is a man who was extraordinarily bright, a rigorous thinker, and very disciplined in everything he did. He found that there were places he could get a competitive advantage structurally because parts of the market weren’t being all that well attended. Big change from then to today.
“Today, many other institutions are doing hedge funds and private equity and real estate and international and all kinds of other things like that. At the time, he was able to create quite a significant comparative advantage. The second thing, all of us who knew David had to stand in awe at his skill. He was awfully good at selecting individual managers. He had over 100 different investment managers. If you looked at this list, I promise you, you would not have been able to say, “I know 20 names on this list.” Most people couldn’t come close. Most people would say, “I know two or three names, but the rest I’ve never actually heard of.”
“Candidly, you’ve got better things to do in terms of trying to figure out, what kind of investing is best for your organisation, or for you as an individual? Defining the purpose of the investing is for most people where they could really do a lot of good for themselves by being very active about that part of investment management.”
5. Disciplined investing is like raising teenage children
“You got to recognise… all of us are always our own worst enemies. This is not because we’re mean-spirited people. It’s just that we’re human beings and we tend to make mistakes.
“How people feel is a very important part of the reality. It’s not how they feel today. It’s how will they feel when it doesn’t look like things are going the right way. That’s a little bit like the secret to raising teenage children, is to be able to take a long-term view, if you’re going to get upset about what they did, or didn’t do in a particular day, you’re not going to have an easy time being a parent. If you’re able to keep in mind, “No, no, no. By the time they’re 30, they’re going to be people I really like a lot,” you’ll be fine.
“I think the main thing (investors can do to manage their behaviour) is study the markets enough so that you realise how skilful the price setting really is, and how hard it is for anybody to do better and say, “I’ll take what’s available.”
6. The most important thing is to know yourself
“The first and most important thing any of us can do as individuals, or as institutions, is to figure out what is it about us that’s different? Then if you use individuals in as you’d say, playing field for a second, we differ a lot in terms of our age, our ability to save, how much we have saved, our attitude towards gifts to members of our family and inheritance. We differ in terms of our desires to accumulate for philanthropic purposes. We differ in terms of risk tolerance, or comfort. I mean, short-term risk tolerance and long-term risk tolerance, both. We differ substantially in how much we enjoy investing, and whether we’re interested in it or not. Are we willing to spend a lot of time trying to figure ourselves out what makes us tick? What’s our psychological weakness? What do we have to be protecting ourselves against? All sorts of things like that.
“When you get all of those together, it’s my own personal, simple summary, we’re all unique. Each one of us is different. You and I wear eyeglasses, but I’m sure that your prescription for your eyeglasses is a little different from mine. You probably wear a different size shoes than I do. Your family likes you to wear certain colours more than my family likes me to wear. One after another after another after another differentiation. We are wonderfully different. If we just have a little bit of reverence and appreciation for the fact that we’re all different, and then find out what’s right for us and stay focused on what’s right for us, I think we’ll be very, very well advanced.
If you could find out what makes you particular, you could probably do a great job starting from there to build an investment program that’s really right for you and your family.
“I’m an art history major, but I had friends who were engineers. They all told me the same thing. Most of engineering is learning how to figure out and define the problem. Solving the problem is not very hard. Most of us candidly, with regard to investing, have not figured out what is the problem.”
You’ll find plenty more wisdom from Charley Ellis on TEBI. Just use the search box at the top of the page.
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