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How to Win the Loser's Game

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How to Win the Loser's Game, Part 9

October 22, 2014
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Investing passively will ensure that, after costs, you outperform the average active investor. That’s simple arithmetic. But there is a proviso. You must have the discipline to stay the course.

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Part 9, Transcript and References

Last time on How to Win the Loser’s Game…

And that brings us to another important aspect of successful investing.

Whichever route you go down - passive, active or somewhere in between - your behaviour is absolutely critical - particularly at times when emotions are running high.

David Booth, co-founder of Dimensional Fund Advisors, says: “One of the big difficulties is getting people to stay the course when results are disappointing. It should come as no surprise to people that markets go up and they go down. When they go down, there’s a tendency for people to go, Gosh, Are we on the edge of an abyss? Will things really get bad from here? In 2008-2009, it was difficult to get people to stay the course. My heart goes out to these people that were invested in equities, lost half their money then got out and missed the rebound. It may take quite a while for them to get back even again.”

Author Charles Ellis says: “Ben Graham spoke about Mr Market and Mr Value. Mr Value does all the work and Mr Market has all the fun. Mr Market is out there trying to tempt you, tempt you, tempt you every day. He wants you to do something, do something, do something. And he’s really good at tempting you when everything’s positive and everyone’s excited and it looks like a winning situation to be a buyer. But that’s at the highs. He really tempts you to be a seller when everyone says it’s very difficult and the future’s not at all promising, and you can see things going down and down and down. Mr Market is out there, ready to trade whenever you like, and he’s going to tempt you. And if you can ignore him and stay instead with the dull plodder Mr Value, you’ll be much better off.”

Everyone knows the idea is to buy low and sell high, but time and again we do the precise opposite.

This chart shows how much money US investors have put into - and taken out of - equity funds since the late 1990s. The graph peaks in January 2000. In other words, investors were piling in just as the market reached the top. Then, even worse, they baled out just as prices reached the bottom and were about to rise again.

That kind of behaviour is sadly all too typical, and even the professionals are prone to it. The effect on the long-term value of our investments can be catastrophic.

So, how do we as investors curb that sort of self-destructive behaviour? Well, one way is to have an automated approach to investing. So, once you’ve chosen a strategy and the level of risk you’re prepared to take, you leave your investments exactly as they are. Either once or no more than twice a year you should rebalance your portfolio to realign it with your risk tolerance. But again, this can be done automatically.

Merryn Somerset Webb from MoneyWeek says: “There are lots of styles that work over the long term. Value works, dividend investing works, momentum investing works if you get it right. All sorts of things work. But they only work if you stick with them. And one of the problems that active managers have is that it’s very difficult for them to stick with any kind of style because they get buffeted around by opinion, by different methods of valuation, by markets, by what people say to them in the pub, by what their colleagues are doing etcetera. So it’s very hard for them to stick to a strategy. When I see fund managers, and I see a lot of fund managers, they pretty much all tell me the same thing. they have a strategy, they outline their strategy. It’s very often quality-, value- or income-based. They’ve back-tested it - they show me their back testing. It looks great, they go away, and you think, Well, if they do that, that’ll work out very well. But they never do it, or if they do do it they do it for six months or eight months and they’re distracted by something, the strategy changes and their performance suffers as a result. But what fundamental indices do - or indices that are based on any one particular factor - is they force consistency. You have to choose a style, and then the computer makes you stick to that style. And that’s when it works.”

It also helps to have a financial adviser to keep you on track. But not just any adviser. Far too many advisers believe, wrongly, that their primary rôle is to pick the right funds and to persuade their clients to switch to a different fund when, inevitably, their original recommendation underperforms.

Charles Ellis says: “There are two main rôles for an adviser. One is to help individuals understand themselves and what their real financial purposes are, and what their anxieties would be, so they can lay out a sensible, long-term investment programme. And the second is to hold the client’s hand and encourage them to stay in it for the long term, because the long term can be very positive - if only we can stay with it through thick and thin, through the exciting positives and the terrifying negatives that cause most of us to make mistakes.”

Vanguard found Jack Bogle says: “Why in the name of peace do we pay any attention to the stock market? The stock market is a derivative. The stock market is a derivative of what? It’s a derivative of the earning power and dividend yields on, in the case of this nation, US corporations. The dividend yield, plus the earnings growth that follows, is what creates the fundamental return on stocks. The speculative return on stocks, compared to that investment return, is how much people are willing to pay for a dollar of earnings. That carries the market up and down, and in the long run, in the last 100 years, the contribution of speculative return to total market return is zero. And the contribution of investment return, if you happen to have 4.5% dividend yield and 4.5% earnings growth, that’s the 9% you read about in the past for the US market. The stock market is a giant distraction to the business of investing.”

Of course it doesn’t help that we’re constantly hearing about the markets. There are specialist magazines. Almost every major newspaper has a money section. There are radio shows and, of course, entire television channels devoted to the latest on the markets and where the so-called experts think they’re heading.

Igors Alferovs from Barnett Ravenscroft Wealth Management says: “When it comes to invest returns, the media is definitely a bad influence on the retail investor. What the media does is encourage activity. It encourages people to buy and sell. invariably, its not just the cost involved - the unnecessary cost involved in lots of buying and selling, it leaves people making bad timing decisions. For their own benefit, I think investors should block out as much noise as possible.”

And that, in a nutshell, is the secret to winning the loser’s game. First, choose an strategy that’s based on evidence - ideally one designed to capture the returns of the whole market - and then tailor it to your attitude to risk. Secondly, stick to your strategy through thick and thin. Rebalance your portfolio, yes, but most important of all, stay the course.

But we haven’t quite finished. In the tenth and final video in this series, we’re going to be looking at the bigger picture.

The investment industry isn’t just failing individual investors. It’s failing the economy and wider society as well.

So, what can be done about it?

David Tuckett from University College London says: “We’ve got too many people employed in it - doing too much, trading too much, for very small amounts of gain for the population as a whole, but of course a very large transfer of finance into the hands of the people doing it.”

Merryn Somerset Webb says: “There are way too many funds. There’s way too much attempt to produce difference out of nothing.”

Michael Johnson from the Centre for Policy Studies says: “The trade bodies (of which the IMA is one) are masters at doing just enough to keep the show on the road.”

John Bogle says: “There is a system that has failed society. Period.”

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Doug Sykora

A very nice series. Looking forward to the final part. Why didn't you post this on YouTube back when I got my first job in 1974? Wouldn't have mattered. I didn't have a computer back then. :) I will pass this on to some younger folks that I know can get a lifetime of benefit for following your advance. 

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