Active investing—defined as individual security selection and market-timing—has long been shown to be a “loser’s game.” Charles Ellis, in his classic book, Winning the Loser’s Game, demonstrated that while it’s possible to outperform the market, the odds are so poor that it’s not prudent to try. The question, then, is: What is the prudent “winner’s game” for investors?

A sound investment strategy should be grounded in peer-reviewed academic research, not opinions or anecdotes. The overwhelming evidence is that markets are highly, though not perfectly, efficient. This means that most information is already reflected in prices, making it extremely difficult for active managers to consistently outperform after costs. As a result, the most effective approach is to avoid strategies that rely on security selection or market-timing and instead focus on systematic, transparent, and replicable strategies, such as using index funds or quantitative factor-based approaches.

Core Principles of the Winner’s Game

1) Minimize Mistakes and Costs

Ellis’ central insight is that, in a loser’s game, the key to winning is making fewer mistakes: minimizing trading, avoiding market-timing, and keeping costs low. Index funds and systematic strategies help investors avoid the common pitfalls that erode returns, such as excessive trading and chasing hot trends.

2) Risk-Adjusted Returns Matter

If markets are efficient, all unique sources of risk should offer similar risk-adjusted returns. Investors should not focus solely on volatility (standard deviation) but also consider other risk characteristics such as skewness, kurtosis, and liquidity risk. For example, assets with negative skewness or illiquidity may offer higher returns as compensation, but these risks must be understood and managed. Traditional measures like the Sharpe ratio are useful but may not capture the full picture.

3) Diversify Across Independent Sources of Risk

Rather than concentrating on a single source of risk (like market beta), investors should diversify across as many independent, evidence-backed sources of risk and return as possible. To avoid data-mining, these sources should meet all of the following criteria:

• Persistence of a premium: It holds across long periods and different economic regimes.
• Pervasiveness of the premium: It holds across countries, regions, sectors, and even asset classes.
• Robustness of the premium: It holds for various definitions (for example, there is a value premium whether it is measured by price/book, earnings, cash flow, or sales).
• Investability: It holds up not just on paper, but also after considering actual implementation issues, such as trading costs.
• Intuitiveness of the premium: There are logical risk-based or behavior-based explanations for its premium and why it should continue to exist. While investors should prefer risk-based explanations (as risk cannot be arbitraged away), behavioral ones are acceptable if there are identifiable limits to arbitrage (such as the risks and costs of shorting). The momentum factor is an example of a behavioral anomaly that persists for behavioral reasons and limits to arbitrage.

Beyond the 60/40 Portfolio

Traditional 60/40 stock/bond portfolios are dominated by equity risk, with as much as 85%-90% of total risk coming from stocks. Furthermore, bonds and stocks can sometimes decline simultaneously, as seen in 2022, undermining diversification benefits. Investors should look beyond the standard mix and consider additional asset classes and factors that meet the above criteria.

Practical Steps to Diversifying Traditional Portfolios and Playing the Winner’s Game

Investors playing a winner’s game should take the following steps:

• Use low-cost index funds or exchange-traded funds to gain broad market exposure and minimize costs.
• Consider adding factor-based strategies. In our book, Your Complete Guide to Factor-Based Investing, Andrew Berkin and I presented the evidence demonstrating that the size, value, momentum, and profitability/quality factors met all of the investment criteria.
• Diversify further with alternative asset classes such as private credit, real estate, reinsurance, infrastructure, and trend-following strategies, provided they are accessible and cost-effective.
• Focus on setting and adhering to a clear investment policy tailored to your goals, risk tolerance, and time horizon.
• Avoid the temptation to chase performance, time the market, or make frequent portfolio changes.

In our book, Reducing the Risk of Black Swans, Kevin Grogan and I demonstrated that by diversifying across the above-mentioned investment strategies, each with its own sources of risk and return, investors can greatly reduce the potential dispersion of outcomes, reducing tail risk and the dreaded “sequence of returns risk” that retirees face while improving the efficiency of the portfolio.

Avoid Active’s Traps

The winner’s game in investing is not about outsmarting the market but about minimizing mistakes, keeping costs low, and diversifying intelligently using evidence-based strategies. As Ellis emphasized, the surest way to win is to avoid the traps of active management and focus on what you can control: asset allocation, diversification, and disciplined execution.

“In a loser’s game, the one that makes the least strategic mistakes wins … [F]ocus should shift to setting up a clearly written investment policy with an asset allocation that truly caters to those needs. Asset mix is what counts, and market-timing, stock selection, and changes in portfolio strategy should be downplayed.”