How to Win the Loser’s Game

It’s no secret that it’s incredibly tough to beat the market. Anywhere between 75% and 90% of mutual funds underperform the S&P 500.

Investment pioneer Charles D. Ellis called it in his classic 1975 article, “The Loser’s Game.” In the prize-winning piece, Ellis compared stock market investing to a game of tennis played between two amateurs.

Why amateurs? Because as opposed to professional tennis matches, which are marked by few mistakes (a “winner’s game”), amateur matches are filled almost entirely with unforced errors (a “loser’s game”). Therefore, the best strategy for an amateur to take is to, well, not try so hard! Amateurs should simply focus on getting the ball inbounds and letting their opponents beat themselves.

  • Research of 516 equity funds between 1998 – 2008
    • Only 1% of funds are able to produce sufficient returns to offset trading & operating costs
    • Left nothing for investor
    • 99% failed to delivery any outperformance
    • 22 years of performance data to be 90% sure that outperformance is down to skill
    • It is not worth paying fund managers to manage your assets
    • In order to reduce management fee, they make it up by trading more so they can charge more
    • There are “active funds” who charges more than a standard “passive fund” like an ETF, but are pure scams since the active fund isn’t actively managed and tracks an index
    • Less is more: Bigger the brand, more you pay, the worst the performance
  • Fund Fees: more than just management fees
    • Management fees
    • Jurisdiction fees
    • Bid offer spread
    • Admin fees
    • Taxes
    • Stamp duty
  • Efficient market theory:
    • hypothesis that states that share prices reflect all information available and it’s impossible to game the system
    • stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices
    • therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments
    • Asset prices respond to new information, which is, by nature random
  • Modern portfolio theory:
    • Theory on how risk-averse investors can construct portfolios to maximize expected return based on a given level of market risk
    • MPT can also be used to construct a portfolio that minimizes risk for a given level of expected return
  • Fama-Fench 5 factor model:
    • Market risk
    • Size
    • Value: stocks below some book to market ratio on average outperform markets as a hole
    • Investment: companies that increases capital investment tend to produce poorer subsequent performance than those that don’t
    • Profitability: higher future earnings = higher stock returns
  • Principles of why value investing works:
    • People will overpay for the dream of getting rich quick. Therefore, glamourous stocks get overvalued
    • People don’t like to look closely at ugly
    • Humans are not good at dealing with uncertainty

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Ricky Young

My belief is that financial freedom cannot be obtained by just a 9-to-5, but a combination of smart investing and passive income. This is my journey to achieve financial freedom.

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