Image credit: Nikolaus Knupfer, “Solon Before Croesus,” ca 1650-1652, J. Paul Getty Museum
I did this interview with the renowned investment consultant Charley Ellis in June 2001. It still rings true, because wisdom never goes out of style. I especially like the part where he talks about how investing, like manufacturing cookies or toothpaste, is supposed to be boring: “If you find anything interesting, you’ve found something wrong.”
Wall Street’s Wisest Man
What if, whenever the stock market went insane, you could get a painless vaccine that would keep you calm and steady? And imagine that this medicine could make you rich if you took it regularly.
I just got a strong dose of this wonder drug myself — by having breakfast with Charles D. Ellis. The medicine he administers is called wise advice. And thanks to the booster shot he gave me, I’ve never felt more optimistic as an investor — despite the carnage in the market over the past year.
Ellis, 63, has four decades of investment experience. In the 1960s, he helped manage the Rockefeller family’s fortune and punctured “go-go” stocks as an analyst at Donaldson Lufkin & Jenrette. Later, he founded Wall Street’s top consulting firm, Greenwich Associates, which provides financial advice to everyone from Goldman Sachs to Fidelity and T. Rowe Price, and he currently oversees the $10 billion endowment fund at Yale University. Ellis has also written trailblazing articles and books, including “The Loser’s Game” (a 1975 article that spurred Vanguard’s founder, Jack Bogle, to introduce the first index fund for individual investors) and Investment Policy, a classic book reissued in 1998 as Winning the Loser’s Game. (Disclosure: I helped edit the revised version but took no fee.) His new book, Wall Street People, paints an array of intriguing portraits of some of the great investors of the past century.
So on a drizzly day this April, I sat down for breakfast with Ellis at the Yale Club in Manhattan. Fueled by several cups of black coffee and his own boundless mental energy, Ellis held forth for what seemed like a brisk hour and a half. Only after I stepped back into the rain did I realize that we’d talked for nearly five hours. Here’s some of what we touched on.
Q. You’ve often said that long-term investors should root for stocks to go down, not up. Why?
A. If you’re buying something, wouldn’t you rather pay less for it than more? When stocks get cheaper, how can that not be good news for a long-term investor? There are very few times when you should be bold, and history shows that those times are precisely when it seems you should be most afraid. It’s absolutely cockamamie crazy to sell stocks after they drop. Instead, you should say, “Today there’s a first-rate bargain and I’m buying.”
Q. That’s easier said than done.
A. Ben Graham and Warren Buffett have talked about a charming, seductive manic-depressive gentleman named Mr. Market. Every day he shows up on your doorstep offering to do business with you. When he’s manic, he’ll offer to buy your stocks or sell you his for absurdly inflated prices. When he’s depressed, his prices go ridiculously low. The mistake most people make is answering the door just because Mr. Market knocks. You don’t have to let him in. Why should you buy just because he’s excited? Why should you sell just because he’s down in the dumps? A long-term investor shouldn’t care about market prices.
Q. So what should investors care about?
A. Back in 1963, I was in a training program at Wertheim & Co., and one day the firm’s senior partner, J.K. Klingenstein, was our guest speaker. As he was about to leave, one of the trainees blurted out, “Mr. Klingenstein, you’re rich. How can we become rich like you?” Everyone else was mortified, and J.K. was clearly not amused. But then his face softened, and you could see that he was taking the question very seriously and trying to sum up everything he’d learned in a lifetime on Wall Street. The room was silent as a tomb, and finally Mr. Klingenstein said firmly, “Don’t lose.” Then he stood up and left. I’ve never forgotten that moment. That’s what investors should really care about: Don’t lose. Don’t make mistakes. They cost too much. Most of the destruction of investment value occurs in small, private, anguishing experiences that are never discussed and never recorded, because people were doing things they never should have done.
Q. You don’t mean we should stay out of the stock market because we might lose money?
A. That’s not what losing means. In investing, losing means taking decisive action at the worst possible times — being driven by your emotions precisely when you need to be the most rational.
Trying too hard to win eventually means losing. To win the Indianapolis 500, you first have to finish the Indianapolis 500 — that’s five hundred laps around and around that oval. If you try too hard on just one lap, you won’t live to finish. And just think about the Forbes 400 [the magazine’s list of America’s richest people]. The turnover on that list is incredible. So many fortunes have been snuffed out by the temptation to try harder.
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. That’s why it’s not the beginners who tend to die at skydiving and why most car accidents happen within a few miles of home. There’s a saying in the British Royal Air Force that investors need to remember: “There are old pilots, and there are bold pilots, but there are no old, bold pilots.”
Q. So why do so many of us insist on trying so hard, not least to beat the market?
A. Because we’re human beings. Even in our advanced society, there’s a curious belief in magic. It’s a virulent form of the triumph of hope over experience.
Q. As a consultant, you’ve urged managers of endowments and pension funds to create — and then live by — a formal “investment policy.” What’s that — and should all of us have one?
A. It’s a written statement of what you believe as an investor and what you can hold on to even when everyone you know is either excited or scared to death of the market. Go to a continuous-process factory sometime — a chemical plant, a cookie manufacturer, a place that makes toothpaste. Everything is perfectly repetitive, automated, exactly in place. If you find anything interesting, you’ve found something wrong.
Investing is a continous process too; it 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. So, the purpose of an investment policy is simply to ensure that your continuous process never breaks down.
Visualize yourself looking back when you’re 80 years old, reviewing whether you invested your money wisely. Ask, “What is it I can trust myself to do in good times and in bad?” Then write it down on one side of a single sheet of paper — when you’ll put money in, how you’ll manage it, when and why you’ll take it out. The best plan, for most of us, is to commit to buying some index funds and do nothing else. Benign neglect is the secret to long-term investing success. If you change your investment policy, you are likely to be wrong; if you change it with a sense of urgency, you’re guaranteed to be wrong.
Q. Why index funds?
A. 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% 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.
But I don’t have to play against them. Instead, I can hire them — by buying an index fund. Then they all work for me for free, because stock prices express the best judgment of all the investors out there. Most of the time, those prices are approximately right, so most of the time you’ll be wrong if you second-guess them. Factor in fees and trading costs — not to mention taxes — and you have to do about 20% better than average before your costs just to match the index after your costs. Stock picking is a loser’s game, but Wall Street loves creating the perception that you can win at it.
Q. For investors who refuse to index, how do you suggest picking a fund?
A. If you’re not prepared to stay married, then you shouldn’t get married. And if you’re going to opt for an actively managed fund, pick one in which you’d be comfortable doubling your investment whenever the manager has a dreadful two or three years. If not, you’re making a mistake. Because he will have a dreadful two or three years. I guarantee it. Every good manager does.
Q. And what should an investor look for in the fund manager?
A. You want an organization designed to help exceptionally talented investors gather information and use it rationally so that their best research comes through. Only novel “soft-shelled” ideas produce extraordinary returns, because the obvious ideas are already reflected in a stock’s price. So you need a fund company that is systematically organized around low turnover and long time horizons, and that has a collegial atmosphere.
Q. Are you thinking of the Capital Group, which runs the American Funds?
A. No one else has been so consistently excellent for so long.
Q. You’ve said that there are three ways to succeed as an investor. What are they?
A. 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.
I’m not smart enough to succeed the intellectual way, and I can’t work hard enough to succeed the physical way. But the emotionally difficult way takes very little time and makes no intellectual or physical demands on you at all. Statistically, judging by how the public invests, most people don’t like the emotionally difficult path. Then again, more and more people are trying it; the amount of money in index funds has been rising year after year. The emotional path is the only reliable way that I know of to succeed.
Q. When will this bear market end?
A. As Rhett said to Scarlett, “Frankly, I don’t give a damn.” You’d have to be self-deluding, maybe certifiably nuts, to try answering that. And the answer doesn’t matter anyway. If you ran a commercial tree farm, would you ask for up-to-the-minute bulletins on how the forest was growing today? How many people are investing for success this year, this month, this week, this day? Most people’s true time horizons are much longer than they think — 50 years, even more. They should be investing for success over a lifetime — or more than one lifetime, because part of what they’re investing will go to their kids after they’re gone. “When stocks get cheaper,” says Ellis, “how can that not be good news?
Click here to download PDF: 6.01Ellis
Source: Money Magazine, June 2001