Winning the Loser's Game

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.


Dan Ferris
for The Daily Reckoning

July 14, 2005

Dan Ferris has spent over ten years studying the commodities markets, making countless correct predictions about the price moves of electricity, oil, natural gas and coal in the process. In his monthly advisory service, Extreme Value, Dan seeks out promising companies trading far below their current worth

"It’s a financial system that depends on mugs," says our old friend, Martin Spring, " – lenders willing to risk their capital for low returns, voters who think they can enjoy state benefits without paying for them through taxes, shareholders who believe that balance sheets are geared up for their benefit rather than executive rewards, consumers blind to the risks of personal debt."

Martin did not even mention the muggiest part of it: America’s daffy system of imperial finance, wherein the homeland shuffles towards poverty in the happy fantasy that spending more money makes it wealthier.

But the mugs are ready to believe anything. They are the people Oscar Wilde was talking about when he said they "know the price of everything and the value of nothing." Here at The Daily Reckoning, we love them; they make our work so entertaining.

One poor mug is highlighted in today’s papers – Bernie Ebbers. The fool believed he could roll up the telecom industry without actually knowing anything about the telecom business. He thought it was all about stock promotion. He was mostly right. Now the fellow faces 25 years in the hoosegow.

Even dumber were the mugs that bought the stock. They didn’t know anything about the telecom business either. All they knew was that the stock was going up…and some other mug had told them to buy stocks went they went up.

We feel sorry for Ebbers. What he did surely deserves public humiliation…and he should be forced to make financial restitution – to the extent he is able. But why make a criminal case of it? Stock market mugs should have known better. And what is the stock market for but to separate fools from their money? Why do people howl so when the work is done? If the investors think they were misled, let them come forward and see what he can get out of Ebbers’ hide. We so no reason why the taxpayers should have to feed and house the man for the next quarter century just because investors were mug enough to buy WorldCom stock.

But the argument is that Ebbers committed a crime against society; we must make an example of him to discourage misconduct in others. If we don’t, every Tom, Dick and Harry will be cooking the books and Americans will lose faith in Wall Street. If it were it not for a few rogues like Ebbers, say the dreamers and prosecutors, investors could put their money into Wall Street with as much confidence as buying a beer in an Irish pub. But anyone who believes that is a mug, if not a mental defective.

We bring up a couple of items from today’s International Herald Tribune as evidence – if any were needed.

First, we note that the "wage gap widens" between people who earn a living by working for it, and those who get their money from "finance." The poor working stiffs are working more than ever – just to keep up appearances. "Bulk of workers are treading water," says the IHT, summarizing. But people nevertheless seem to have more money to spend – from refinancing houses, Microsoft’s $3 billion dividend payment, and other sources:

"Robert Mellman, an economist at J.P. Morgan, noted that the increases recorded in wage income in the last quarter of 2004 and first quarter of this year were principally the result of a flurry of exercised stock options," says the paper.

The investors who actually bought the stocks didn’t notice that their shares had been diluted. But that is the sad state to which modern American capitalism has been reduced. It’s the workers, managers and financial hustlers who get the loot – not the capitalist mugs, whose pockets are picked without them even knowing it.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street…

"As Chinese steel production soars, so does demand for all forms of iron – whether that form is ‘ore pellets’ from Brazil or manhole covers from Shanghai."


Bill Bonner, with more views from London and elsewhere:

*** Investors aren’t the only ones losing faith in American capitalism – The Conference Board’s latest survey of CEOs shows that chief executives across the country are significantly less confident about the U.S economy now than they were in the first quarter.

"While overall confidence remains relatively positive, the latest reading reflects growing concerns that U.S. economic growth may be slowing down," says Lynn Franco, Director of The Conference Board’s Consumer Research Center. "And, while the outlook for corporate profits remains optimistic, rising interest rates and oil prices may curb business leaders’ projections."

The survey also illustrates that the majority of CEO’s don’t expect economic conditions to improve in the short-term, either.

Hmmm…when "Captains of Industry" start acknowledging the dismal state of U.S. economy, we know things can’t be good.

*** "The oil prices just seem to keep climbing and climbing, and new records for retail gas prices seem to keep popping up across the nation. Florida prices just hit a new all time record of over $2.30 a gallon on average," Kevin Kerr tells us, reporting from hurricane country.

"Let me tell you the tension can be cut with a knife down here in the Caribbean, as people scramble to protect their belongings. Shipping rates are skyrocketing as terminals brace for what could be a very chaotic season, as the newest threat, Hurricane Emily approaches the islands.

"From all accounts, the locals, one of whom I spoke with last night seemed to have the wisdom of the ages, she said that all expectations are for a very rough tropic season in the Caribbean and Gulf…and that may spell even higher gasoline prices.

"The scenario now seems very possible based on the idea of two quick devastating hurricanes in rapid succession hitting the Gulf Coast. Just three major facilities like the BP rig, going under and $3 gasoline is highly likely – if not even more. $75-80 crude oil would certainly be possible if disruption was significant, and it would be. Science fiction…hardly! More like science fact…

"The truth is, this whole oil production system is hanging by a fine thread, and there is little room for major error, and those that see it differently are living in fantasy land."

*** "Bush is monitoring the housing boom," reads a headline in today’s Washington Post…don’t you feel relieved now, dear reader?

Our own Lord Byron of Pittsburgh:

"I thought that, with all that Mr. President has on his plate with the war in Iraq, and riding his bicycle; and the world oil situation, and riding his bicycle; and the rise of China, and riding his bicycle; and the unsustainable current account deficit, and riding his bicycle; and the massive federal deficits and debts, and riding his bicycle; and all the rest of those strategic issues on his plate, and riding his bicycle… I figured that old GWB might just be too busy to worry his head about a little old housing boom.

"But we are now reassured. Fear not! Bennie Bernanke, that former Princeton Tiger and recently coronated Chairman of the White House Council of Economic Advisors is on the prowl. Ben (a.k.a. ‘le Tigre’) is quoted as saying, ‘(O)ur best defenses against potential problems in housing markets are vigilant lenders and banking regulators, together with perspective and good sense on the part of borrowers.’

"Vigilant lenders and banking regulators? These are the same economic war criminals that have gotten us to where we are now, standing at the edge of the debtors’ abyss. And ‘good sense on the part of borrowers?’ Someone is smoking drugs, and it is not moi. Are these the same ‘good sense borrowers’ who have been taking out such financial crack-cocaine as ‘interest-only’ mortgages, and ‘negative amortization’ mortgages for the past couple of years? Are these the same lending-worthies who have ‘taken out just a bit of equity’ to fund their Caribbean cruise?

"What world does this Bernanke-man inhabit? I guess it is the same Princetonian environment that gave us Woodrow Wilson, but that is another story entirely.

"Seriously, comrades. It concerns me that Ben Bernanke might become the next Fed Chairman. Could anyone do a worse job than Alan Greenspan? We might just live to find out."

The Daily Reckoning