Monday Morning: Want to quit a loser’s game? Read this

Most people in the world of institutional investing have heard of Charles D. Ellis. Most individual investors and their advisers have not.

That’s unfortunate, because Charlie Ellis wrote what Peter Drucker, the management guru, called “the best book on investment policy and management.”I would go further and say it’s the best book on investing I have ever read. It is insightful, irreverent, clearly and entertainingly written – and brief.

The book is “Winning the Loser’s Game: Timeless Strategies for Successful Investing,” and McGraw-Hill has just published the fourth edition. In this version, Charlie has accomplished something I thought was impossible: He has made an already great book even better.

must reading

This book should be read, and frequently reread, by every investor, and every investment adviser and financial planner. If read, pondered, digested and absorbed, it will save a lot of heartache and greatly improve the chances of a successful investment outcome.

You may not agree with everything Charlie says, but thinking about why you disagree will make you review your own assumptions and biases. That’s half the value of any good book.

More than 25 years ago, Charlie had the insight that investing for most people is a “loser’s game.” He compared it with tennis.

Dr. Simon Ramo, a scientist at TRW Inc., had observed that tennis is not one game but two different games. One form of tennis is played by professionals and gifted amateurs. They win by winning points against their opponents. It is a “winner’s game.” The second form of tennis is that played by most amateurs. They win by exploiting their opponents’ mistakes, not by winning points. It is a “loser’s game.” The outcome is determined by the actions of the loser, not of the winner.

Charlie notes that as the stock market has come to be dominated by professionals at large investment institutions, it has become a “loser’s game.” The amateur is now competing with professionals. The secret to winning now is to lose less than the others lose.

As in golf, another loser’s game, individual investors are usually playing against themselves as well as professionals.

A number of tendencies hamper the individuals: They believe in “hot hands” and winning streaks, and think that recent events matter, even in coin-tosses. They are impressed by short-term success, as in fund performance. They overreact to good and bad news.

They also confuse familiarity with knowledge and understanding, and they believe they know more relative to others than they really do.

Individual investors are impatient, optimistic (it’s better to be objective and realistic, Charlie says), proud (believing their investment performance relative to the market is better than it really is) and emotional.

When do most investors feel most confident about buying? When the market has been declining for a significant period, or when it has been rising? For most, it’s when the market has been rising. Yet, Charlie notes, to be successful an investor should buy when the market has been declining.

To be successful, he says, investors must school themselves to go against the crowd and their own feelings.

And he proposes 10 commandments for the individual investor:

1. Don’t speculate; limit the amounts invested.

2. Save.

3. Don’t do anything primarily for tax reasons.

4. Don’t think of your home as an investment.

5. Never do commodities.

6. Don’t be confused about stockbrokers; you can’t assume they are working for you.

7. Don’t go for new or “interesting” investments.

8. Be aware that bond prices fluctuate too and bonds are a poor defense against inflation.

9. Write out your long-term goals, your long-term investing program and your estate plan; and stay with them.

10. Don’t trust your emotions.

When I look at those 10 commandments, I realize I have violated at least five of them, a couple of them in the past 12 months. I’m sure most investors have, and I suspect many financial planners and investment advisers have failed to prevent clients from breaking a good number of them.

This column has not even scratched the surface of the wisdom in Charlie Ellis’ book. I suggest that planners read it and then give it to their clients to read. Afterward, your discussions with those clients about their investment plans will be far more fruitful.

Mike Clowes is editorial director of InvestmentNews and sister publication Pensions & Investments.