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Investors can learn a lot from Theo Epstein’s decision to leave his position as the president of the Chicago Cubs baseball team.
Epstein, for those of you who don’t know him, is credited with ending the Cubs’ 108-year World Series drought in 2016. He is also credited with leading the Boston Red Sox in 2004 to overcome their World Series drought of “just” 86 years. In both cases he did it with a disciplined, data-driven approach to assembling his team’s roster.
His approach, often referred to as “analytics,” was celebrated in the best-selling book “Moneyball: The Art of Winning an Unfair Game,” by Michael Lewis. A movie based on the book was released in 2011, starring Brad Pitt and Jonah Hill.
Mike Pesca, host of Slate’s daily podcast “The Gist,” went so far in his commentary on NPR to refer to Epstein as “Baseball Jesus.” So Epstein’s resignation in November was clearly a big deal, especially since he still had a year remaining on his contract with the Cubs.
What does this have to do with investing? Consider one of the reasons Epstein gave for stepping down: His data-driven approach has led to winning more games at the cost of making the game boring. “Executives like me, who have spent a lot of time using analytics and other measures, have unwittingly had a negative impact on the aesthetic value of the game and the entertainment value of the game.”
Something similar can be said about investing, which has undergone an analytics revolution that is just as big as baseball’s. One of the primary consequences of that investment revolution has been the growth of index funds. Those funds have undoubtedly improved the investment performance of countless investors. But, undeniably, it has also made investing boring.
Because of this revolution, investors have had to engage in honest self-reflection about why they are investing in the first place. To what extent are they in the markets because it’s fun and exciting, rationalizing their involvement by telling themselves that they’re enhancing their lifetime wealth?
Winner’s games and loser’s games
A good place to start as you engage in this self-reflection is the distinction between “winner’s games” and “loser’s games,” which was introduced 50 years ago in “Extraordinary Tennis For The Ordinary Player,” by Simon Ramo. The book focused on the difference between the type of tennis played by professionals and that played by amateurs. In the former, the victor wins more points by taking risks and actively beating his opponent; this is a winner’s game. In a losers’ game, which is what the rest of us play, the victor makes the fewest mistakes and wins by taking the fewest risks, letting his opponent beat himself through unforced errors.
Credit for applying this distinction to investing goes to Charles Ellis, the founder of Greenwich Associates, the financial consulting firm. In a seminal article for the Financial Analysts Journal in 1975, Ellis argued that investing is a loser’s game in which the best strategy is not to try to beat the market. Let other investors try to pick stocks that will outperform the index or engage in market timing; they sooner or later will make mistakes that lead them to underperform a broad-market index fund.
The loser’s game is boring. To win at loser’s game tennis, for example, the best strategy is to simply lob the ball back every time. You should never try a high-risk passing shot, an overhead slam or a great serve. You wouldn’t have much fun, even if you started winning more games. Your buddies would soon stop inviting you to play. Come on, take some risks, they would urge you.
The functional equivalent of lobbing the ball back in tennis is to buy and hold an index fund. The functional equivalent of your tennis buddies urging you to take some risks and have some fun are the rags-to-riches stories about stocks that made a killing (can you say “Tesla” or “Bitcoin”?).
How to balance analytics and excitement
Fortunately, there’s a way to be true both to the analytics revolution in investing and to have some fun. It was introduced in the 1970s and 1980s by the late Harry Browne, editor of a newsletter called Harry Browne’s Special Reports. You may know of Browne as the Libertarian Party’s candidate for president in the 1996 and 2000 elections. His recommendation, elegantly simple, is to divide your investments into two categories — one a speculative portfolio and the other a permanent portfolio.
The former, which would contain a small fraction of your overall net worth, would be where you try your hardest to beat the market. The latter, in contrast, involves owning buy-and-hold index funds for the long term with little or no change other than periodic rebalancing. By doing so, you’re staying true to Ellis’ insight about investing being a loser’s game. You also get to stay engaged and excited about the market through your speculative portfolio, continuing to take risks and play the winner’s game.
Another virtue of dividing your assets into these two portfolios is that you have a real-time scoreboard of your speculative abilities. The odds are overwhelming that, over the long term, your permanent portfolio will do better than your speculative portfolio. But so long as your speculative portfolio doesn’t contain an inordinately large portion of your net worth, there is no harm in trying.
To use yet another sports and entertainment analogy: There’s nothing wrong with spending a night at the casino, so long as you set yourself a limit to how much you’re willing to lose and you commit yourself to leaving when that limit is set.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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