Before you all start rolling your eyes at me for stating the obvious, hold on and hear me out.  It is one thing to say don’t lose money, it is quite another to do it.  Long-term investment success depends on not losing, i.e. not taking major losses.  If you focus on the downside (risk), the upside (profit) will take care of itself.

Too often investors get caught up in the thrill of victory focusing their attention on big gains and “making a killing” in the market.  Slow and steady wins the race.  Speed kills. Even though we know that accidents most often happen to drivers that are speeding and going too fast, the allure of fast money and the quick buck can lead to straying from a disciplined investment approach and taking long shot wagers.  When this happens, you have left the realm of investing and entered the arena of gambling (speculation).

Large losses are forever. A 50 percent loss requires a doubling in value of the asset just to get back to even. Ask yourself, how often have you known an asset to double in value and in what time frame? It takes roughly seven years for an investment to double in value earning a 10% annual return. By avoiding large losses (play defense), the winnings will have every opportunity to take care of themselves. Manage your downside. Play good defense. Avoid big mistakes. In investing, as in sporting competition, learn to cut your losses (eliminate mistakes) and the winners will follow.

In an article published in the Financial Analysts Journal (1995), “The Loser’s Game,” Charles D. Ellis writes convincingly about the inability of professional money managers to “beat the market.”[1] He sites a study conducted by an eminent scientist, Dr. Simon Ramo of TRW.

Ellis writes, “Simon Ramo identified the crucial difference between the Winner’s Game and the Loser’s Game in his excellent book on playing strategy, Extraordinary Tennis for the Ordinary Tennis Player. Over a period of many years he observed that tennis was not one game but two. One game of tennis is played by professionals and a very few gifted amateurs; the other is played by all the rest of us.

After extensive scientific and statistical analysis, Dr. Ramo summed up his findings this way: Professional tennis players win points; amateurs lose points. Errors are seldom made by professional players. Expert tennis is what Ellis calls a Winner’s Game because the ultimate outcome is determined by the actions of the winner. On the other hand, the amateur duffer seldom beats his opponent, but he beats himself all the time. The victor in this game gets a higher score than the opponent, but he gets that higher score because his opponent is losing even more points. 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 ordinary player can win games and matches again and again by following the simple strategem of losing less, and letting the opponent defeat himself. 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. An opponent who tries to win a losers game will try to beat you by winning, but he is not good enough to overcome the many inherent adversities of the game itself. The situation does not allow him to win with an activist strategy and he will instead lose.”

This unfortunately is the same situation you face as an investor. In the long-run, you can not win with an activist strategy (market timing/security selection). Sure, every once in a while you will play a “hunch” and be rewarded, but this will only foster a false sense of confidence in your ability to repeat your good fortune. That is a trap and will come back to haunt you. In time your efforts to “win” will only increase your error rate. Over time you will start to underperform the market. This is how the ordinary investor loses in the Loser’s Game. According to Ellis, Ramo instructs in his book, the strategy for winning the Loser’s Game is to lose less. Avoid trying too hard (or in the case of the market, invest in an index fund that correlates well with the market and avoid trading, i.e. timing the market). In brief, as Ellis puts it, by losing less become the victor. If you can’t beat the market, you certainly should consider joining it. An index fund is one way.

Five Ways to Win the Loser’s Game:

1. Know Thy Self. What are your financial objectives? Are they achievable and realistic given your tolerance for risk? What is your risk tolerance? Can you stomach short-term fluctuations in wealth to achieve long-run investment success? Are you willing to put forth the work needed to be successful? Do you have the necessary skills and know-how to be a winning investor.




2. Define Your Long-Run Objectives: Set wealth goals. What are your financial needs? How much income will you need in retirement? Are you saving to provide for your children’s college education? Do you have the discipline and patience to pursue a long-run investment strategy? Plan the race that is right for you. Run your own race to achieve your own realistic objectives.




3. Do Not Try to Beat the Market: Forget about the notion of beating the market in the long-run. At best, you can hope to replicate the performance of the market. How do you expect to beat the market when it is made up of so many professionals? Professionals armed with vast resources. More resources than you can ever hope to have. Eventually, if you own enough stocks and hold a diversified portfolio, you will be the market, i.e. you can expect your portfolio to generate market returns. Oh yeah, every once in a while you will have a winner that makes you think you’re smarter than everyone else and that you can earn out-sized returns (get rich quick). Just remember, a baseball player with a .200 batting average will hit a home run every once in a while as well. That doesn’t mean he all of a sudden has acquired the skills to be a .350 hitter.




4. Diversification: Countless academicians and investment professionals have confirmed and endorsed the benefits of diversification (spread your risk over many bets; don’t put all your eggs in one basket). Stock portfolio (a portfolio made up of individual stocks) diversification can be achieved through the random selection of a number of stocks (usually 30 or more on an equally dollar weighted basis).The primary benefit of diversification is that for a given amount of risk, investors can expect to achieve a higher rate of return from an efficiently constructed portfolio (where the holdings in the portfolio are sufficiently uncorrelated). The basic concept that an investor can reduce portfolio risk simply by holding instruments which are not perfectly correlated (diversified) derives directly from the principles of Modern Portfolio Theory.




5. Have an Investment Policy: Investment policy (or more commonly, asset allocation - the division of investable funds among investable assets i.e. stocks, bonds, and cash) has been shown to account, on average, for 93.6% of the variation in total return in a sample of portfolios (corporate pension plans) studied.[2] In the past, criticism was directed at the study - or more accurately, its interpretation by the industry - and raised doubts about its applicability to general investors. Twenty years since being published debate continues over the importance portfolio policy (asset allocation) plays in the construction and subsequent performance of an individual’s set of investments. However, it would be hard to find any investment professional who would disagree with the notion that the initial decisions made regarding portfolio policy will play an important role in the outcome of any long-term investment strategy.

The market is dominated by institutional investors. Consequently, investing today is a Loser’s Game. You can’t win at investing by trying to “beat the market.” You simply must avoid losing.

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[1] “The Loser’s Game,” Charles D. Ellis, Financial Analyst Journal / January-February 1995: 95-100. Reprinted from FAJ (July/August 1975): 19-26.
[2]” Determinants of Portfolio Performance,” Gary P. Brinson, L. Randoph Hood and Gilbert P. Beebower, Financial Analysts Journal, (July/August 1986):39-44.

The opinions and views expressed in this article do not necessarily reflect the views of InvestingMinds.   InvestingMinds did not prepare and does not endorse such content.  Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments.  No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

Breaking with tradition, I’ll give you the moral of the story first: “Slow and steady wins the race”. Like you didn’t know that? But do you really understand it? The Greeks were pretty sophisticated mathematicians so it’s entirely possible that the concept of compound interest was already well understood when “The Tortoise and The Hare” was written. However, had they been sophisticated marketers the famous Aesop’s fable would have been converted into a 60 second spot for the local bank because it serves as a great example of how perseverance and responsible behavior really pay off when it comes to investing. And apparently we all need a 60 second spot like this to remind us of something that, at one level, is intuitively obvious.

I guess I needed to be reminded as well. Despite my quantitative background and the fact that I know all the formulas for calculating compounding it wasn’t until I read a Wall Street Journal article a couple of years ago that I finally put two and two together and realized the simple implication of compounding for investors: Start saving early.

Since a picture is worth a thousand words let’s do a simple example involving twin brothers Tory and Harry. Tory is the responsible one that starts an IRA at the age of 22, squirreling away $2,000 per year while Harry waits 10 years, figuring that he will quickly catch up to his brother by saving $4,000 per year. After all, it can’t be that hard to catch up to someone who only has a $20,000 lead, right?

So, to make the calculations easy let’s assume that the savings are invested at the beginning of each year and return 10% each year - reasonable assumptions. Here are the results over Tory and Harry’s lifetime:

Guess what? Harry never catches up - and for a simple reason. The income that Tory earns on his $20,000 head start exceeds the extra $2,000 that Harry is saving each year in perpetuity. By the time they both reach 65 Tory’s nest egg has grown to $1,435,810 while Harry’s account is a paltry $1,080,097. In fact, if Harry wants to have even a prayer of catching up he needs to start no later than 7 years after his twin brother. It’s no wonder that Albert Einstein referred to compound interest as “the greatest mathematical discovery of all time”.

I was lucky in that I instinctively saved everything I could from an early age despite not fully appreciating what I was doing. But suppose you have followed Harry’s strategy for most of your life and now you’re looking at this example and you’re thinking it’s too late? Well, you can’t do anything about the past but every minute that goes by without a mid-course correction is another minute wasted. Start saving as much as possible right now! You can start by cutting back on the Starbucks. That has to be worth at least $1,000 per year.

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

Dollar cost averaging is an investment “strategy” that is credited with almost magical abilities by many investment advisers. The argument goes something like this: You can’t pick the highs and lows of the market so just invest a constant amount in regular intervals and you will buy more shares when the market is lower and fewer shares when the market is higher. Thus your average cost per share will be lower over time. Well, something has always bothered me about this argument but I could never quite put my finger on it. The idea of a mindless process producing better than average results over time just didn’t sit well - not to mention that this argument sounds vaguely like the crazy practice that some people engage in where they buy more of a stock that has moved down from their initial purchase price only because that will lower their average cost (like they still aren’t in the hole on the original purchase?).

Don’t get me wrong; there are clearly a few benefits to dollar cost averaging, not the least of which are psychological. First, with a disciplined investment strategy you won’t be tempted to time the market. Second, when prices drop the blow is softened by the belief, rational or not, that you now get to buy more shares at a lower price. But aside from the psychological benefits there is also a savings discipline that comes with dollar cost averaging. Your income is earned in a relatively steady stream and dollar cost averaging forces you to save it as it is earned.

But this notion of being economically better off simply by spreading out your investments over time just doesn’t hold water. All you really need to know to see the fallacy of this claim is that the market tends to move up over time - i.e. it has a positive expected return. Therefore, the faster you put your money in the faster it’s going to grow. So, if you’re sitting on a pile of money the smartest strategy is actually to invest it all as soon as possible in one big lump sum. Sure, it may go down shortly after you invest but it’s just as likely to go up. End of discussion.

Well, there are probably a lot of advisers out there that aren’t satisfied with this explanation and that’s why Dr. John Greenhut, an Associate Professor of Finance in the College of Business and Technology at Texas A&M University, wrote a rather comprehensive expose on Dollar Cost Averaging. His article, Mathematical Illusion: Why Dollar-Cost Averaging Does Not Work, appears in the October 2006 issue of The Journal of Financial Planning.

In his article Dr. Greenhut exposes the mathematical illusion that seems to produce stellar results from dollar cost averaging. As he points out, the apparent success of this technique often results from unfair or flawed assumptions about stock price movements that work in favor of dollar cost averaging - namely, that assumptions are often made that stock prices vary around a mean by constant dollar amounts when in fact the variation actually tends to occur in constant percentage terms. Dr. Greenhut provides ample illustration that these assumptions are flawed and he proves that lump sum investing is at least as good as dollar cost averaging. However, he then goes on to argue that since the market is always expected to drift upward lump sum investing is actually superior to dollar cost averaging and he cites the academic research that supports this conclusion. He even goes so far as to examine historical data on over 1600 companies and empirically demonstrates that dollar cost averaging is only superior if a stock is in a downtrend.

Since you don’t know ahead of time if the market or an individual stock is going to be in a downtrend and since your best guess at any point in time is that an investment will drift upward you might as well invest your money as fast as possible and forget about dollar cost averaging - unless of course you need a little psychological boost.

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that it is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

To the uninitiated, it is not always obvious how to go about forming and organizing an Investment Club. When starting an Investment Club, there are a few basic steps to be considered. This article attempts to ease those concerns. Below are some recommendations and tips for forming and running a club.

First, talk to friends and family and find out who might be interested in pooling some funds together to manage and as well pitch-in to share in running the club. You might start by using the tools here at InvestingMinds to help you network with and solicit the interests of friends and family in forming an investment club. As well, if you feel starting a new investment club is beyond your current interest, you might want to consider joining an existing club (How do I join an existing Investment Club?)

When first getting started, it is a good idea to have some general information to distribute to prospective members.  Include such information as the benefits of joining an investment club, a description of the club and what it is all about, and what new members can expect from joining a club.

You will want to hold an orientation meeting for interested participants and be prepared to assess the group’s chemistry and determine whether or not there is a strong enough commitment. Be prepared to cover subjects such as, how the club will be organized and run, member goals and objectives, benefits of membership and level of commitment.

Prior to holding the meeting you will want to brush up on club structures and legal entity. It is important to agree on how you will be organized legally and operationally. Investment clubs are generally formed as general partnerships, but could also be formed as limited liability companies or limited liability partnerships (in states that allow them). While an investment club could incorporate, the double tax treatment on corporate distributions makes the corporate structure less desirable than a partnership. Typically, a general partnership does not generate any tax liability on its own; instead, any tax liability is passed through to members each year. Investment club partnerships must file Form 1065 and Schedule K-1s with the IRS each year, and with states that require partnership filings. Investment club accounting software can facilitate the management of a club’s books and the preparation of tax filings. The NAIC guide includes sample legal language for contracts and agreements. Don’t neglect the paperwork issue. Failure to organize as a legal entity and complete the necessary paperwork, will result in far more headaches than the time it takes to do the work. You can start out by looking over the sample partnership agreement supplied by the NAIC.

Other matters to consider before forming a club. Do all of the members have realistic risk and return goals? If someone wishes to double their investment in two years, and do it on margin, this may prove to be impractical and out of sync with the rest of the members. Although everyone comes to a club with different ideas of what constitutes a good investment, it is important to set down some general guidelines for constructing and managing the portfolio. It’s usually a good idea to have some common basis regarding a general investing philosophy and approach.

If after meeting with prospective members of the club, and all agree to move forward, then it is time to start thinking about specifics regarding club operations. You will want to establish a regular meeting time, place, length, and format. As well, outline the various items of business you plan to cover at each meeting and allocate an amount of time for each. You may wish to assign a chairperson for each meeting and agree on a set of individual responsibilites. Who will be the officers of the club? What will be their responsibilities? What are the non-officer member’s roles and responsibility (Q&A, research, topical discussions, bookkeeping, hosting, education, etc.) You will need to think about on what terms will new members be allowed to enter the club and how to handle the departure of existing members.

How much money is needed to get started? Most clubs operate on the basis of making a monthly contribution. There should probably be some agreed upon minimum monthly contribution with the ability to exceed this amount if desired. Additionally, you may choose to start with a minimum lump sum contribution and see how it goes managing these funds. You may choose to have a regular contribution schedule on top of an initial funding to start the club.

What is an ideal number of members? Typically, club sizes do not exceed a dozen or so people due to the physical limitations of being able to hold a meeting in someone’s home, or say a coffee shop or restaurant. However, with the virtually unlimited space of a “virtual conference room” it would not be unrealistic to have a membership grow to a few dozen or more members. Thus, it would only make sense to include an online presense in your club format to deal with membership growth, convenience and expediency.  At InvestingMinds, it is easy to create an online investment club. Using the club formation tools within Investor Community, just follow the directions for setting up a club (create a club).

There are many good books and references that are relevant to club investing. Some suggested readings might include Peter Lynch’s One Up on Wall Street, Beating the Street, and Learn to Earn, Robert G. Hagstrom’s The Warren Buffet Way, and Graham and Dodd’s The Intelligent Investor as good places to start. In addition to the books referenced earlier, you might want to consider these helpful guides to organizing and running an investment club, Davis and Thorsell’s Starting and Running an Investment Club: Recipes for Success and Marsha Bertrand’s Getting Started in Investment Clubs. Lastly, running an investment club meeting is not unlike running a board or committee meeting. Although it may seem overly formal to consider such measures as adopting Robert’s Rules of Order for running an investment club, you can never be too careful when managing yours and other peoples money in a committee or group setting. Thus, the President or Chairperson for the club should be familiar with the rules for running group meetings and have enlightened all members to the needs to follow such rules. Some references to consider on the subject are Robert’s Rules in Plain English 2e: A Readable, Authoritative, Easy-to-Use Guide to Running Meetings (Robert’s Rules in Plain English) by Doris P. Zimmerman and Robert’s Rules for Dummies by C. Alan Jennings.

What is a typical organizaton structure for a club?

Typical clubs have[1]:
· A president/presiding partner, who sets meetings, presides over them, and plans activities.
· A vice president/assistant presiding partner, who fills in when needed and might also run the education program.
· A financial partner/treasurer, who deals with the brokerage, buys and sells stock, and keeps records of the club’s holdings as well as each member’s share. (This needs to be a careful, detail-oriented, and responsible person.)
· A recording partner/secretary, who keeps minutes of each meeting, reminds members of meetings when necessary, and possibly mails out minutes to members who miss a meeting.
· Some clubs have a separate education officer, responsible for planning (with the input of the group) an educational program, which might include presentations, field trips, guest speakers, and assigned reading.

Investors often have questions about choosing a broker to execute their orders. First, we would recommend avoiding “full-service brokers” unless of course the club includes such a broker who is willing to offer the services of his firm at a significant discount. Instead, we prefer to use discount brokers. Using a full-service broker essentially defeats the purpose of forming a club…benefiting from the work and collective efforts of the group rather than relying on the advise of a broker. Since clubs are self-reliant and self-directed, there is no need to pay hefty commissions to full-service brokerages. Consider taking advantage of the incredibly low commissions offered for by discount brokers. Buying and selling shares online can cost as little as $8 or less per trade. Visit the InvestingMinds’s Discount Brokerage Center (Coming Soon!) for more information about how to evaluate and choose a broker. You can actually sign up for an account there, too!

Typically, Investment Clubs meet with their membership on a regularly scheduled basis (once or twice a month) to discuss strategy and investment performance. In addition to holding informal get togethers, it is also practical to incorporate an online presence into your club. Often busy schedules and the inconvenience of meeting in a physical location can make connecting and conducting meetings in cyberspace more practical. Thus, given the hyper-speed pace of the marketplace, and the impact that rapid decision-making can have on portfolio performance, adding online club capability to any investment club is an important requirement for efficiently managing an investment portfolio in today’s digital economy. At InvestingMinds, we make it easy for you to organize and conduct meetings, research investments, communicate with members, network with other clubs, and manage your investments all at the click of a mouse. (For more information, see How does joining InvestingMinds benefit our Investment Club?)

Education is an important aspect of the investment club experience and a reason why we have developed on the site what we believe to be one of the best and most extensive financial education resources for investors. We would encourage you to nominate an education officer who will be responsible for planning an educational program, which might include presentations, field trips, guest speakers, and assigned reading. Some skills required on the road from amatuer to sophisticated investor might involve learning how to read an annual report, calculating financial performance ratios, and understanding various stock valuation methods. You can learn more about these basic skills by clicking on the link or visiting the InvestingMind’s Investor Resource Center.

[1] “Starting and Running a Profitable Investment Club,” Thomas E. O’Hara and Kenneth S. Janke, Sr., Three Rivers Press, New York, NY.

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Note:  To create an online investment club, visit (Create A Club) at InvestingMinds.

The opinions and views expressed in this article do not necessarily reflect the views of InvestingMinds.   InvestingMinds did not prepare and does not endorse such content.  Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments.  No part of this document may be reproduced in any manner without the written permission of InvestingMinds.