It had become a weekly tradition—a break away from their hectic work weeks.
Jim and Roger loved their weekly tennis appointment. They met up at the local court every Thursday at 8 pm. Both were equally good tennis players and this annoyed both to the point where their matches often grew into vivid fights.
Although Jim and Roger were bettering each other, they were still amateurs. They acted like they weren’t, though. The sport had grown on them so much they met up every other weekend in front of the TV to watch a professional tennis match, pick up some techniques, and down some beers.
It was again Thursday, and Jim and Roger agreed to play a full match. Both fully determined to win, they put on their best tennis outfit, warmed up diligently, and even brought their wives to the game to count points and keep the rules in check. This was serious business.
It started with exciting rallies. Jim sent powerful shots across the net while Roger made a great effort to return miraculous slices. When Roger sent a hard slam, Roger would attempt a backspin. On it went until they both had a set to their score.
Even as they fatigued, Jim slams hard balls and Roger slices away. It may have looked like a pro tennis game if it wasn’t for one thing: the ball was rarely kept in play. Jim and Roger could only return three or four balls until it was out of bounds or into the net when one of them attempted a brilliant but daring shot.
Roger saw the pattern and changed his strategy. Rather than trying to make brilliant shots, he prudently focused on keeping the ball in play. Whenever the ball was set up for a perfect shot, he would remain careful and calm, only focusing on getting the ball inside his opponent’s court.
It worked brilliantly.
For every diligent ball sent by Roger, Jim would jump vainly around the court trying to hit a perfect shot that would be out of reach for Roger. But while he succeeded sometimes, he didn’t the majority of times. Frequently, the ball went right into the net or out of line. Roger ended up winning the game while Jim raged on about how it could have happened.
The secret was that Roger realized he was playing a loser’s game and acted accordingly. Instead of winning the match by skill, he let Jim defeat himself.
This lesson applies to many aspects of life: know the kind of game you’re playing before playing it.
The loser’s vs winner’s game idea originates from Simon Ramo in the book, Extraordinary Tennis for the Ordinary Tennis Player. Dr. Ramo, a scientist and statistician by heart, tested his hypothesis of the loser’s game in a tennis match by a clever but simple method. Instead of counting points the conventional way, all he did was count points won vs points lost. What he found was a consistent tendency: In pro tennis, ~80% of the points are won due to brilliant shot execution; in amateur tennis, ~80% of the points are lost due to unforced errors. While professional tennis players play a winner’s game, amateur tennis players play a loser’s game.
His conclusion was simple: to win at amateur tennis, you need to avoid mistakes. And the way to avoid mistakes is to be prudent, keep the ball in play, and let the other guy defeat himself. The other guy will try to beat you but an activist strategy won’t work. His effort to win more points only increases his error rate. It works because the opponent doesn’t realize that he’s playing a loser’s game.
Give the other fellow as many opportunities as possible to make mistakes, and he will do so.—Simon Ramo
It’s not just tennis. Any game can be assessed through the mental model of the winner’s and loser’s game. What’s important is whether you can figure which one you’re dealing with and adjust your strategy accordingly.
Winner’s games are ones in which the outcome of the game is dependent on the player’s ability, like chess, sprinting, and weightlifting.
Loser’s games are ones where the players struggle to compete against the game itself. In such games you make more progress getting ahead by avoiding mistakes rather than making brilliant decisions. War is the ultimate loser’s game. Casino gambling is, of course, a loser’s game. Amateur tennis is a loser’s game.
There are also fields where the game flips mid-way. For instance, in a boxing fight, fighters spend lots of energy in the beginning to try to knock each other out. If none of them succeeds after a couple of rounds, the game is about endurance and who can survive the most punishment. A winner’s game turns into a loser’s game.
There is one big loser’s game that continues to fool billions of people. It’s likely the most thrilling of them all, and it sucks people in every day in the attempt to win the game through a winner’s game strategy. But because it’s an attempt to do the impossible, it almost never works.
The loser’s game of investing
It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.— Charlie Munger
It’s gradually becoming a known fact that the majority of pro money managers—the ones who have devoted their career and day to picking stocks—are not beating the market. The market is beating them.
In his 1975 paper titled “The Loser’s Game”, published in the Financial Analysts Journal, author Charles Ellis wrote about this phenomenon. His thesis was later turned into a book.
Charles Ellis writes:
The belief that active managers can beat the market is based on two assumptions: (1) liquidity offered in the stock market is an advantage, and (2) institutional investing is a Winner’s Game.
Both assumptions are false. But the investment game continues to suck in bright, articulate, and overconfident individuals who erroneously try to play a loser’s game by treating it as a winner’s game. They manage money for outsized gains, expose their clients to too much risk, and rake up too many transaction fees in the process.
Why? Because these people all compete against themselves and try to do it faster than the other. By the time of Ellis’ paper in 1975, the institutional share of the stock market had risen from about 30% to 70% over the past decades while the typical equity portfolio turnover had gone from 10% to 30%. Those figures have increased to about 80% institutional investing while turnover for the average equity fund has likely rocketed to somewhere between 90% and 100%. The hunt for alpha has become a race against time.
A winner’s game turns into a loser’s game when the players all flock to the same place based on the wild successes of the early players. So the investing game wasn’t always a loser’s game. The game switched over time, starting somewhere in the 1960s.
The people who came to Wall Street in the 1960s had always been—and expected always to be—winners. They had been presidents of their high school classes, varsity team captains, and honor students. They were bright, attractive, outgoing and ambitious. They were willing to work hard and take chances because our society had given them many and frequent rewards for such behavior. They had gone to Yale and the Marines and Harvard Business School. And they were quick to recognize that the big Winner’s Game was being played in Wall Street.
Couple that with how the playing tools have evolved: Bloombergs on every desk, CFA charters, high-frequency trading, computer simulations, globalization, the Internet, and so on. And since institutional investors are in a race for bigger AUM dependent on quarterly performance, no wonder why the players can’t beat themselves in their own game. Their efforts to beat the market are no longer the most important part of the solution. They’re the most important part of the problem.
How to win the loser’s game of investing
There are a few principles that allow you to play the loser’s game of investing successfully. They’re not about being smart, although that’s a useful trait.
It’s not necessary to do extraordinary things to get extraordinary results.—Warren Buffett
Charles Ellis suggests two solutions: 1) join the market by investing solely in index funds or 2) follow the four following principles.
Principle #1: Make sure you’re playing your own game.
Know your circle of competence and know it well. Learn the central lessons of behavioral finance that go against your success and entice you to try and play a winner’s game—particularly since Mr. Market is one of the most entrancing seducers of all time.
Principle #2: Keep it simple.
It’s a blessing that you don’t have the problem many pro money managers face which is delivering quarterly performance. You don’t need to make a decision before it’s right in the center of your strike zone and then you can afford to sit on your ass.
Simplicity, concentration, and economy of time and effort have been the distinguishing features of the great players’ methods, while others lost their way to glory by wandering in a maze of details.
Principle #3: Concentrate on your defenses.
Your competition puts almost all its research effort into making purchase decisions. Therefore, in a loser’s game, most time should be spent on making sell decisions.
Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the loser’s game.
Eliminate the stuff that’s highly levered or works against the interests of society. Let someone else pick that stuff. Let the other guy lose so that you can win. Make sure that you can keep playing by hitting shots that make the next shot easy.
There are old pilots and bold pilots, but there are no old, bold pilots.—E. Hamilton Lee
Principle #4: Don’t take it personally.
In investing, working harder isn’t correlated with getting a better outcome. We’re all, as a group, captives of the normal distribution of the bell curve. The way to give yourself the biggest chance of being on the right side of the curve is by fishing in the less-crowded pond. Your success will not come from being better at analyzing businesses. It will come from finding opportunities in places where others aren’t looking.
Most of the people in the investment business are “winners” who have won all their lives by being bright, articulate, disciplined and willing to work hard. They are so accustomed to succeeding by trying harder and are so used to believing that failure to succeed is the failure’s own fault that they may take it personally when they see that the average professionally managed fund cannot keep pace with the market any more than John Henry could beat the steam drill.
