When I was growing up, I spent most of my summers playing tennis. I loved the game so much that I even worked a few summers in a tennis club so I could play all the time. It’s a great game with a lot of strategy. What I found interesting at the time was how really good players would lose to players who never really hit the ball hard, but were very consistent in returning the ball and keeping rallies long enough that the talented player would eventually make a mistake. At the time, I never realized that that particular strategy could be carried over to investing but guess what I found out.
I stumbled upon an article about Charlie Munger’s (Warren Buffet’s sidekick at Berkshire Hathaway and some say the real brains behind their success) investment philosophies, one of which is to avoid stupidity when investing. The author tries to explain the concept by linking it to tennis via a book written by Simon Ramos called Extraordinary Tennis for the Ordinary Player. According to Mr. Ramos , the game of tennis, while having uniform rules, can actually be broken into two separate games, one for professional/exceptional players and one for the rest of us.
In the Professional game, matches are won by making winning shots (i.e. service aces, returns for winners, passing shots etc.). The rallys are long and mistakes are kept to a minimum. As a result you win matches by winning points and not by losing points by making mistakes (i.e. hitting the ball in the net, or out of the lines, or double-faulting on serves). In his 1975 essay, The Loser’s Game, Charles Ellis calls professional tennis a “Winner’s Game.” While there is some degree of skill and luck involved, the game is generally determined by the actions of the winner.
In the Amateur game that is played at your local tennis court or tennis club, matches are won as a result of the opponent making more mistakes than the winner making winning shots. Mistakes are more common and so the player making the least mistakes will likely win. According to Mr. Ramos,
“The amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game of tennis gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points.”
Mr. Ramos concludes that, “In expert tennis, about 80 per cent of the points are won; in amateur tennis, about 80 per cent of the points are lost. In other words, professional tennis is a Winner’s Game – the final outcome is determined by the activities of the winner – and amateur tennis is a Loser’s Game – the final outcome is determined by the activities of the loser. The two games are, in their fundamental characteristic, not at all the same. They are opposites.”
So how do you win at tennis? Let’s go back to my observation where I saw many times, a weaker, less skilled opponent beat a physically stronger, more talented opponent mainly by keeping the ball in play. I always thought it was bizarre when the weaker skilled person was just dinking the ball over net while the better player was expending more energy trying to hit the ball hard, but it turns out the weaker players were on to something. Mr. Ramos notes, “… if you choose to win at tennis – as opposed to having a good time – the strategy for winning is to avoid mistakes. The way to avoid mistakes is to be conservative and keep the ball in play, letting the other fellow have plenty of room in which to blunder his way to defeat, because he, being an amateur will play a losing game and not know it.”
Those weaker players I watched win, knew they were not going to win by making winning shots, they had to goat their opponent into making the mistakes to pick up points. We called those type of players “pushers”.
Nice observation Aman, but what does this have to do with becoming a better investor?
It turns out that buying stocks while done in an open environment under a common set of regulations can actually be broken into two different types of games played by professionals who have received formal training and make their livelihood from it and amateurs (i.e. everybody else).
Professional investors, which I would classify as those who work for the financial institutions and are managing portfolios or pension funds are constantly watching the market and have access to more info. The Professionals are playing for 1 percent returns. They are able to react faster to market events and have a better chance of churning out returns. Witness the performance of High Frequency Trading companies and proprietary trading groups at Goldman Sachs etc. These institutions have greater scale to churn profits.
Amateur investors which I would classify as the rest of us who do not work in the financial services industry, while having more access to information (thank you Internet), tend to demonstrate a greater proficiency for losing money or earning sub-par returns. Emotions tend to get the better of them and often make decisions at the wrong times (e.g. buying stocks high and selling them low). Carl Richards has coined the term, “Behavior Gap” to classify this type of investment behaviour.
The point, if I have one, is that most of us are amateurs but we refuse to believe it. This is a problem because we’re often playing the game of the Professionals by adopting professional trading strategies. The financial industry has been for years pushing retail investors to adopt more professional investing strategies. Witness the proliferation of trading products (e.g. Day Trading) and incentives to customers who trade frequently and regularly with lower commissions. Even the recent phenomena by discount brokerages to waive commissions for specific ETF’s can be construed to encourage investors to churn their portfolios. The industry wants amateurs to play the Professional game, but it is a losing game.
So what is an amateur to do? Well if we adopt the tennis analogy, we should approach investing with a mindset to play not to lose.
The Amateur investor has a better chance of success by not playing the Professional investor game and churning their portfolio but by just staying in the market. This can be done either by taking a passive approach by investing in generic Exchange Traded Funds (ETF) or buying and holding high quality, individual stocks for a long period. The point is to be invested and exposed to stock market in bull and bear times.
The strategy to become a successful investor is no different than beating a professional or very good tennis player:
- Invest for the long term and staying invested in the market. Make fewer trades to keep costs down (i.e. keep the rallies going).
- Learn to manage/control losses (minimize hitting the ball into the net).
- Don’t be stupid (i.e. chasing fads, following what the consensus/professionals are doing). Instead investors should be focussed:
- Buying quality, well-run companies that are creating tangible wealth or buying basic simple ETF’s.
- Not overpaying for these investments or averaging the costs over a longer period of time.
Amateur investors should not be playing for 1 percent returns (i.e. trading) like the Professionals do. Amateurs should be playing for 10, 20, 30 percent or greater returns. The longer they can stay in the market, the more of those opportunities will present themselves either naturally or by the foolish behaviour of others and the better their chances of success.
In other words don’t try to make those amazing hitting the ball-through your legs shots like Roger Federer. We should just focus on getting the ball over the net. The moral is avoiding stupidity for investors is much easier than seeking to emulate the behaviour of Professionals. So don’t invest according to the Professional paradigm.
Charlie Munger captures this whole concept of avoiding stupidity perfectly:
"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. There must be some wisdom in the folk saying, `It’s the strong swimmers who drown.’”
As we can see, tennis and investing are intuitively very simple “games”. Your best chance at being proficient in both games is to stay with first principles and avoid the temptation to follow the “in” crowd by executing strategies that are stacked against them.