Winner's games can and do sometimes become loser's games. That is what has happened to the "money game" we call investment management. A basic change has occurred in the investment environment; the market came to be dominated in the 1970s by the very institutions that were striving to win by outperforming the market. And that shift made all the difference. No longer was the active investment manager competing with cautious custodians or amateurs who were out of touch with the market. Now he was competing with other experts. ... So many professional investment managers are so good, they make it nearly impossible for any one to outperform the market they now dominate.
The key question under the new rules of the game is this: How much better must the active manager be to at least recover the costs of active management? Recovering these costs is surprisingly difficult. Such superior performance can be done and is done every year by some, but it has not been done consistently over a long period of time by many. . . .
Believing that investment management had evolved into a loser's game, Ellis drew this conclusion: Just as the path to victory in amateur tennis is to play a passive, patient game while letting your opponent take the risks, so the logical strategy for the amateur investor should be the same.
There are advantages to playing a loser's game. Most investors, consciously or subconsciously, are caught up in playing a winner's game. They're trying to "beat the market." They buy financial magazines and investment newsletters that offer a dizzying array of stock and mutual fund recommendations, and they feel they must respond to fast-breaking news events and trade with a short-term perspective. Theirs is an active strategy where they work harder and take extra risks in what is usually a futile attempt to "win."
In a loser's game, the strategy is more passive (and relaxing!). The path to victory lies in minimizing mistakes and being patient. This describes our Just-the-Basics portfolios where we refuse to play the performance game. Instead, we simply invest in selected "index" funds, which, by definition, are going to give us returns similar to the market as a whole.
An investment strategy based on indexing has many advantages to offer. Chief among them are the minimal effort required to set up a simple portfolio whose only need is occasional rebalancing, and the knowledge that by merely following the market you're likely to outperform the majority of actively-managed mutual funds over an extended period of time. Even during the past decade, which favored actively-managed funds (because they could underweight plummeting tech stocks and hold cash as the bear market set in), only 45% of actively-managed stock funds outperformed the S&P 500.
Compared with most other investment possibilities, simple indexing is likely to be the best option, which is why we often recommend it for those with index funds in their company retirement plans or for other investments where Upgrading isn't possible (as in college 529 plans). As we indicated earlier, we think Upgrading is likely to be the more profitable path for those willing to keep up with a more active strategy. But indexing is preferable to most other investing methods, and is simple enough for anyone to apply successfully.
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