Winning the Loser’s Game

Winning the Loser’s Game
By Daily Reckoning Contributor

07/14/05

Investing is a loser’s game - good investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They play it safe, avoid errors in judgment - and stick to the basics.

My stepdaughter Rachel is 11 years old.

I’ve been watching her play softball every summer since she was eight. Each game is both tragic and comic…

When the ball is hit in the air, you can bet it’ll hit the ground, occasionally taking a split-second detour into some hopeful little girl’s glove. When the ball is hit on the ground, it is generally hit with pinpoint accuracy, as it nearly always goes right through the legs of the fielder closest to it.

Runs are scored in Rachel’s softball games when somebody drops the ball. There are no homeruns hit over the fence. Many runs are the result of four walks in a row. There are few successful defensive plays of any kind. Balls are thrown but rarely caught. Bases are stolen routinely because the girls are trained to hold onto the ball lest they throw it away, allowing a second base to be stolen.

Loser’s Game: Beating Yourself vs. Beating the Competition

Rachel’s games are nothing like major league baseball games. In the major leagues, home runs are hit out of the park and double plays are thrown in most games. Strikeouts don’t happen because the batting is bad, but because the pitching is so amazingly good. It’s just like in the Ellis book, Winning the Loser’s Game. The little leaguers don’t get beat by the competition; they beat themselves by making errors. The professional ballplayers don’t beat themselves; they are simply outperformed by the competition.

Ellis reports on Dr. Simon Ramo. In his book, Extraordinary Tennis for the Ordinary Tennis Player, Ramo found that, "professional tennis is a winner’s game: The outcome is determined by the actions of the winner. Amateur tennis is a loser’s game: the outcome is determined by the actions of the loser, who defeats himself." War is another loser’s game. According to historian Admiral Samuel Eliot Morison, "the side that makes the fewest strategic errors wins the war." Tommy Armour’s book, How to Play Your Best Golf All the Time, says, "the best way to win is by making fewer bad shots."

Investing is a loser’s game. And it never becomes a winner’s game. It’s like my stepdaughter’s softball league. All you have to do is not make huge mistakes. You never focus on beating a competitor. The greatest investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They mostly just play it safe and avoid big errors. Warren Buffett’s quote on this matter can’t be repeated often enough:

Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.

Loser’s Game: It’s All About the Basics

I’m beginning to believe that investing is mostly about ruthlessly following basic precepts like, "Never lose money." You never really graduate to the advanced class, because there isn’t one. You simply realize that it’s all about the basics, and then you stop losing money… and start getting rich. Like most of the traits that make a successful investor, this one goes against human nature. We humans love to complicate things. But with investing, the simple answer is the one towards which you should gravitate. As Ben Graham writes on page 147 of The Intelligent Investor, "security analysts today find themselves compelled to become most mathematical and ’scientific’ in the very situations which lend themselves least auspiciously to exact treatment."

Not only do we humans want to complicate things. We also have a bias toward action. This is simply the tendency to want to "do something" and not remain passive. It’s even worse that this bias serves you well in virtually any other business but investing. Tom Peters listed "a bias toward action" as the number one trait of effective managers in his classic work, In Search of Excellence.

Warren Buffett once said something like, "Lethargy bordering on sloth strikes us as intelligent behavior." If I were to recommend more than five or six stocks a year in these pages, maybe you should question the quality of those ideas.

Unlikely as it may sound, I think that if you do nothing but decide right here and now that you’ll make fewer investment decisions and avoid bad ideas, your performance will improve dramatically. This is something you hardly ever read about in newsletters, because newsletter editors have a bias toward feeding the typical reader’s desire for new stock picks. Editors aren’t bad people. It’s just that most readers think they’re paying for the production of a certain number of ideas. Most editors lose subscribers if they don’t recommend a brand new stock every month.

How many stocks should you own at one time? Any amount you want, as long as it’s not too many.

In October 1994, Warren Buffett addressed a room full of graduate students at Kenan Flagler business school in North Carolina. He told them, "I made a study back when I ran a partnership of all our larger investments versus all our smaller investments. The larger investments always did better than the smaller investments. There’s a threshold of examination and criticism and knowledge that has to be overcome or reached in making a big decision. You can get sloppy about small decisions. You’ve all heard about somebody who says, ‘I bought 100 shares of this or that because I heard about it at a party the other night.’ There is that tendency with small decisions to think you can do it for not very good reasons. I think larger decisions are helpful in that regard." During the same talk, Buffett said, "If you have 10 great ideas in your life, you can afford to give away 5 of them, because that’s all you’ll need."

If you simply decide to make fewer investment decisions, you’ll naturally take greater pains to make better decisions. Says Buffett, "Your default position should always be short-term instruments. And whenever you see anything intelligent to do, you should do it." Buffett also said that asset allocation, a Wall Street obsession, is pure nonsense. Asset allocation is Wall Street B.S. for when Abby Jo Cohen announces, in a very pompous way, that now she’s going to recommend that you put 65% of your money in stocks, and 35% in bonds, when before it was 60% in stocks and 40% in bonds. People actually pay a lot of money for that kind of advice. Educated people. People who would otherwise impress us with their connections and money and power.

Jim Rogers is somebody else you ought to listen to on the subject of managing your own money. He used to work with the famous billionaire trader George Soros. Rogers drove around the world twice, once on a motorcycle and once in a car, and wrote a book about global investing after each trip. Rogers told author John Train in 1989 that you should, "take your money, put it in Treasury bills or a money-market fund. Just sit back, go to the beach, go to the movies, play checkers, do whatever you want to. Then something will come along where you know it’s right. Take all your money out of the money-market fund, put it in whatever it happens to be, and stay with it for three or four or five or ten years, whatever it is. You’ll know when to sell again, because you’ll know more about it than anybody else. Take your money out, put it back in the money-market fund, and wait for the next thing to come along. When it does, you’ll make a whole lot of money."

Of course, a tangible margin of safety isn’t always necessary, but it’s hard to argue with. Making a mistake doesn’t mean the principles are wrong. It means I need to work harder to get them right. I’d encourage you to do the same.

Regards,

Dan Ferris
for The Daily Reckoning

http://dailyreckoning.com/winning-the-losers-game/