FOOL ON THE HILL
Should You Be in Stocks?

Long-time investor and author Charles Ellis recently shared some insight on investing. His main message: For most people, stock picking is a loser's game, but for those who want to try, there are three ways to beat the market.

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By Whitney Tilson
May 29, 2001

Last week I read an interview in the latest Money magazine with Charles Ellis, who is the author of many investment books (the best known is probably Winning the Loser's Game) and who currently oversees the $10 billion endowment fund at Yale University. I thought his comments were interesting enough to share with you and urge you to read the entire interview. Below are some highlights and my comments.

Investing is not a game
I've long been concerned that investing has become America's latest, most popular sport, in which people partake for entertainment, excitement, or to have something to talk to their friends about. I can understand this -- I too enjoy investing and like talking about it -- but I never forget that the point of investing is to compound money at a decent rate over a long period of time, while minimizing the chances of permanent losses. Ellis agrees that investing "isn't supposed to be interesting. It's a responsibility. If you go to the stock market because you want excitement, then sooner or later you will lose. Everyone who thinks the stock market is a game loses -- everyone, to the last man, woman, and child."

The perils of overconfidence
Even those who treat investing seriously run the risk of becoming overconfident, a topic I addressed in The Perils of Investor Overconfidence. As Ellis notes, "in a rapidly rising market, the faster you trade, the better you'll do -- and that makes you forget that those whom the gods would destroy, they first make confident. The more you know, the higher the odds that you'll make a serious mistake."

The arrogance of stock picking
It's hard to beat the market, as evidenced by the few people who are able to do so over time. And the penalties for trying can be severe. As Warren Buffett noted in his 1982 annual letter to Berkshire Hathaway shareholders, "the market, like the Lord, helps those who help themselves. But, unlike the Lord, the market does not forgive those who know not what they do."

Ellis uses a compelling analogy to underscore the difficulty of being a winning stock picker:

"Watch a pro football game, and it's obvious the guys on the field are far faster, stronger and more willing to bear and inflict pain than you are. Surely you would say, 'I don't want to play against those guys!' Well, 90 percent of stock market volume is done by institutions, and half of that is done by the world's 50 largest investment firms, deeply committed, vastly well prepared -- the smartest sons of bitches in the world working their tails off all day long. You know what? I don't want to play against those guys either."

He concludes that "stock picking is a loser's game, but Wall Street loves creating the perception that you can win at it."

How to beat the market
While I think Ellis's general message, which I echoed in a column that remains my all-time favorite, The Arrogance of Stock Picking, is correct, he overstates his case a bit. I think small investors, with enough time and the right training and temperament, can beat the market. To do so, however, one must have a clear strategy and the capabilities to succeed in executing that strategy. Ellis lays out the strategic options:

"You can succeed intellectually, physically, or emotionally. The intellectual way is how we would all like to succeed: being so smart that we understand things more clearly and see farther ahead than every other investor. The pre-eminent example, obviously, is Warren Buffett. But people like him are very, very, very rare.

"The physical way to succeed is simply to work harder, to start at dawn and grind away till midnight and carry home a heavy briefcase full of research and keep working right on through the weekend too. This way is the most popular on Wall Street, where nearly everyone seems to try it. And for some of them, this way works -- well, I can't say I've met many people for whom it actually works, but they must think it does, or they wouldn't keep trying so hard.

"The third way to succeed as an investor is difficult emotionally. When that seductive fellow Mr. Market comes around, you have to pay absolutely no attention to him, no matter what happens. You have to control your emotions, and most of the time that means the best thing to do is nothing. If you can't control your emotions, being in the market is like walking into a heated area wearing a backpack full of explosives.... The emotional[ly difficult] path is the only reliable way that I know of to succeed."

I agree with Ellis's thinking, but he goes too far in the last sentence. Controlling emotions is necessary but not sufficient for investment success. The key, in my mind, is not being better in one of the three areas he cites -- it's to be better in all three areas.

Ellis cites Warren Buffett's intellect, but Buffett didn't build the greatest investment track record in history because he's a lot smarter than average -- really smart people in the investment business are hardly rare. Buffett is also supremely analytical and rational, and -- even at his age, when he could be resting on his laurels -- thinks about investing constantly (at least when he's not playing bridge). As Charlie Munger noted at the Wesco annual meeting, "Warren spends 70 hours a week thinking about investing."

Why does Buffett do this? Because he loves it. That's the final piece of the puzzle that Ellis doesn't mention. I don't know any successful investors who don't love what they do, independent of the money. Forgive me for quoting Donald Trump, but he was right when he said, "The money's just a way of keeping score."

Conclusion
As you think about whether you want to be a stock picker, I urge you to do an honest self-assessment. What exactly are your competitive advantages that are going to enable you to beat the smart, "deeply committed, vastly well prepared" people at the top investment firms in the world? If you can't come up with good answers, then there's no shame in investing in a mutual or index fund.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/.

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