Tuesday, December 22, 2009

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.


“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.”


“Don’t invest with borrowed money.”


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.”


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”.


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.


  1. I sort of disagree with his idea that ordinary people can't beat the market. Professionals generally invest based on a short-term investment horizon. If an investor can spot a quality company with serious, but temporary problems, he may be able to pick it up cheaply.

    Also, there are many small companies that professionals cannot really invest in due to limited liquidity. A small investor can wade in these waters to chase the fish the sharks can't get.

    I largely agree though, that most people should just invest in index funds and do something more fun or productive with their free time.

  2. Gene: I've read in several places the ideas that small investors can win in small stocks and by taking a longer-term view. I used to believe it, but now I'm not so sure. There must be some professionally-managed money that thinks long-term, and how many public companies are there that are so small that all professional money ignores them? I'm still thinking about this one.

  3. I am also skeptical of the idea that non-pros can't ever beat the market. I would agree that it's difficult, and perhaps uncommon, but never?

    I do like the ETF approach and I think there are lots of ways for regular folks to manage their own investments without professional help. What is his position on whether to use an advisor or not?

    Thanks for the detailed review. I'm putting this one on my reading list.

  4. There has actually been a study of retail investors which showed them outperforming the market. see my post reporting this here http://canadianfinancialdiy.blogspot.com/2007/10/individual-investors-can-outperform.html

    The efficient market theory seems like the efficient market paradox: the market is efficient as a whole only if smart investors, whether individual or institutional, find inefficiencies and exploit them, making excess profit. If I understand efficient market theory correctly it only says there is no systematic bias in under- or over-pricing, not that there is never any under- or over-pricing, and that it is hard to tell the difference between the two.

  5. 2 Cents: It's always possible for non-pros to outperform the market by luck. Ellis is saying that non-pros have no expectation of outperforming. The way he phrases it is that they cannot have sustained outperformance.

    I'm not sure what Ellis thinks of advisors. He may have said something about this, but I can't remember reading anything. He is certainly down on added costs, and he thinks that investors need to set their investing policy to avoid future bad emotional decisions. Perhaps a by-the-hour advisor could help set investing policy, but that may undermine the investor's ability to keep emotions in check. If the investor doesn't take the time to understand how to use indexing effectively and develop his own simple policy plan, can we really expect him to react reasonably to the next bear market?

  6. Canadian Investor: The study you cite was conducted with 11 years of data on the Oslo stock exchange. Ellis claims that it takes several decades to get statistically-significant evidence of alpha. Ellis also says that alpha existed a few decades ago when pros didn't dominate markets. I wonder if pros currently dominate the Oslo exchange. In any case, the study you cite seems to disagree with others (who are at least as credible) who say that alpha among individual investors doesn't exist (or is extremely rare). I'm not completely convinced either way yet.

    I can see where efficient market theory seems like a paradox, but I think it can be resolved. Pricing errors do exist, but are very small because of the efforts of experts.