Legendary author and investor Charles Ellis talks meme stocks and crypto, and reveals how anyone can beat the market, in a special interview for CNBC Pro subscribers. Ellis, who founded Greenwich Associates in 1972, has been loud and clear for decades about his investing philosophy: Active investing is a loser's game. As detailed in the new edition of his book, "Winning the Loser's Game ," most investment professionals do not outperform when adjusted for fees and risk, making active investing not worth the time and money. In this exclusive interview with Jenny Harrington , CEO of Gilman Hill Asset Management and a CNBC contributor, Ellis reveals how an average investor can get a leg up. Ellis and Harrington also discuss: What he thinks of the meme stocks and how that trend will end His new 11th commandment for investing How compounding worked for his friend Warren Buffett. Jenny Harrington : Charley, the first edition of "Winning the Loser's Game" was written in 1985. And you've probably seen and written about a lot of manias. So I'm curious what you make of what we've seen this year. The manias and craziness in GameStop and AMC , have you ever seen anything like this before? And how do you win the losers game in 2021? Charles Ellis : We're all human beings. And we all do the same, ridiculous and shrewd and thoughtful, and wise and caring, and ridiculous things. We mix it up pretty well. So most of us have some habits that we think we probably should stop. I used to be a smoker. I used to drink. I don't drink anymore and I don't smoke anymore. And I don't plan to go back. But that was a matter of choice at the time to do it and a choice to stop. And we all do the same sort of thing in the investment world. We make mistakes on a regular basis. And the trick is to make as few small mistakes as possible. And one way to do that is don't play other people's games, then, as you and I both know, there's a game going on. It's very recreational and a lot of fun, sometimes very exciting. And for some, it'll probably be even really rewarding. But for most people, it's going to be something they'd rather not discuss 10 years or 20 years from now. Harrington : Do you think that the rules of investing have ever changed? And do you think they even can change? Ellis : Well it depends what you mean by the rules. Regulations have changed considerably. And how to be successful has changed in its details quite substantially. But the basic idea of investing is laid out by John Burr Williams, in his marvelous book, which he said, "The value of an investment is the stream of future dividends that you will get if you own a particular investment." And you want to think about it that way. And if you do, it gives you a rational discipline to your thinking. That was true in the 1920s when he wrote his wonderful book and it has been true in every decade since then. And it will be true in every decade in the future. Harrington : Is there a place for active investing? Ellis : I am so in favor of active investing. You'd be astonished, but what I mean by active investing myself is actively figuring out who you are as an investor, actively figuring out what would be the best investment program for you over time. Actively thinking about your investment program, maybe every five years, maybe every 10 years and actively staying on your program, instead of wobbling around and drifting. So I'm a big fan of active investing of that kind. Now I recognize there are a very small fraction of the people who are involved in investing, are really good at and have found an area where they can be really successful as active investors. As you know, from our past discussions, I happen to believe you're one of those people. It's not the only way to do it, you tend towards value in high dividend investing, and I think makes a great deal of long-term sense. But are other people who believe in deep research on individual companies of all kinds and picking out the right companies to invest in if they're not working in the 1,000 largest companies, and they have extraordinary analyst skills to do deep dive research on individual companies? I believe that a small team of people with relatively modest assets can do a terrific job and over time, will outperform the market averages that we all see. The part that I find most exciting is that anybody, anybody can outperform the market. And I mean, seriously, I can guarantee you to be in the top quartile. And candidly, I would be willing to guarantee you, you will be in the top half of the top quartile, if you will index and hold on, and stay with it. 'Pick them off one at a time' Harrington : Charley, do you think a major influx of young investors who reject the professional advice as the loser's game, ultimately could turn the market back into a winners game? In other words, is there more opportunity for professional ambassadors, if less informed investors start to flood the market? Ellis : Sure, I think that anytime you get a group of innocent, hopeful, ideally ambitious participants to come into the market and do something they don't really, really, really understand that professionals will sit on the sidelines and pick them off one at a time. Harrington : I think that's probably a lot of what happened this year, too. It'll be interesting to see how it plays out. Ellis : Yeah, the nice thing is, it may have happened quite a lot. But those to whom it happened, will not mention it will not discuss it. And only those who lucked in came through and didn't get nailed, will have anything to say. And they'll say quite often, so you'll have the feeling if you're just an outside observer, there must have been quite a lot of successes out there. Harrington : One of my favorite parts is your 10 commandments. And I was wondering if there's one of your 10 commandments that you think is the very most important for people to pay attention to? Ellis : Yes, I do. It would be the first one: save. Because most everybody understands, conceptually, at least, you can't invest what you have not saved. And the sooner you can start saving and see it as a very positive way of creating and using the value for your own life. And the value. So if you really want to accomplish saving is the secret. Harrington : It's funny, I work with a lot of clients, sometimes on their asset allocations. And what you find is that the asset allocation plays a much smaller role in the overall investment success than exactly what you just said, which is the saving — the saving and the lack of crazy spending has a much bigger impact on the total portfolio return. Ellis : Until you get up to substantial assets. And then candidly, I think that, yeah, what you're doing with your portfolio really comes into play. But you can't do it until you get a portfolio. And the only way to do that is to save. Long-term market returns Harrington : The stimulus limit is going in a different direction. But this stimulus over the past year, I guess you could even really say since 2001, the stimulus that we've seen pumped into the economy and into the market has been extraordinary. What do you think the long term and short term consequences of that will be? Ellis : Let me divide it into two parts, the part that the Federal Reserve and the federal government should and are paying most attention to. They care a great deal about employment. And they care a great deal about people who are, quote, unquote, marginal in the workforce. And they would like very much to see those people well rewarded for what they can do if they go to work and stay at work. And as a nation, that's exactly what ought to be going on. And there's another group, those are the people who are principally investors. And candidly, they have had an unbelievably free ride. Because the Federal Reserve has been driving interest rates down to a very low level, as you know today that unbelievably low level if you go back and look at his history. But they have been doing it on purpose for the economy and our society. It happens to have incidentally rewarded individuals who have been owners of bonds or stocks or houses or apartment buildings. You just have to be careful as to who are you looking at. And for whom are you working. Harrington : Right. One of the things that I wonder and worry about is with all this stimulus is what's the ultimate fallout? So there's the two parts you discussed. And then there's the longer term part. And so what I wonder is... if the historic market return, has been in the 8% to 10% range, because of stimulus, will that 8% to10% range be lower in the future? Do you think that it's possible to sustain such a high 8% to 10% annualized market return with what's going on? Or do you think that's really the fallout that the stimulus dampens? Ellis : I think you could argue it is possible. But I think it's very improbable. And I can't believe that it should all probable for anything except short periods of time. Harrington : And then here's the question on kind of investor behavior. One of the things that I find — on one of the investment committees that we that we work on together we always talk about managing the emotions of the individuals whose portfolio you're investing. And one of the things that's difficult on that is saying, "Oh, the market returns 8% to 10% over time but one year you're up 20 one year you're down 10 then up 15." That's really difficult. How do we think about the pendulum always swinging too far? Why does the pendulum always swing too far? Does it need to? Is that just human nature? Ellis : Well, it's not a pendulum, it's the behavior of people. And people do tend to take any good idea too far and make it into a not very good idea, even to a bad idea. When we look at the market crash in 1929, the market had gone up and up and up in ways that just, you look, in retrospect, if you saw the raw data and said this market is going to crash. And you'd be right. If you did the same sort of a thing with the change in interest rates in the 70s, you knew that there was going to be a terrible crash in the stock prices. Actually, it was at least as bad as '29 in the 70s if you do inflation and nominal losses. Cryptocurrencies Harrington : I keep thinking about cryptocurrencies and that they're kind of like trading. I mean, this is to me, that they're kind of like trading commodities. They're speculation that are ultimately driven on other people's behavior. Is there a way to frame them from a trading or investing perspective? What do you think of cryptocurrencies? What do you make of them right now as an investment? Ellis : I thought you were going to ask what do you think of cryptocurrencies as it's a very exciting and imaginative field with some very, very smart people trying to figure out how to do it, and then you put in the hooker at the end and as an investment. I can't imagine it being an investment now for anyone who is not a profoundly experienced — and it's hard to become a very experienced — expert in what cryptocurrencies are all about. Or a psychiatrist playing against the fools of the crowd. Either of those I can understand, but it's not a game I want to play and it's not a game I'm going to play. In the meantime, I do think there's a real chance that the creative genius, particularly some of the people with advanced mathematical skills, are going to develop things that would be just marvelous in terms of their ability to be helpful to their society as a whole. Harrington : So, Charley, we talked about your 10 commandments. If you could do another one, do you have an 11th commandment? Ellis : Know yourself and understand the problem that you're trying to solve. And the problem is different for each individual. Harrington : There are 7,700 exchange-traded funds out there. How do you get started? Where do you start? Ellis : It's a little bit like how do you start eating ice cream? You start eating vanilla, and plain vanilla would be either the total market index or the Standard and Poor's 500 index, which represents a very substantial fraction of the total market. And don't, for God's sake, don't do anything that you thought was an exciting, interesting ETF, because it's got leverage in it, or because it's doing some unusual or specialized kind of investing. Leave all of that for five or 10 years later, when you've become an expert in the field, and you really know everything, and dabble with it a little bit if you want to. But most of us who are serious about investing and savvy enough to be indexing are still investing primarily in the plain vanilla, which is still America's most popular ice cream flavor. Harrington : What are the core principles of investing? Ellis : Saving is necessary. Diversification is wise and sensible. Indexing makes great sense. And steady persistence over the long term makes great sense. Harrington : So it's really not that complicated. It just feels complicated. Ellis : Saving is really important. And the great thing about saving is to look at it as a way of winning by accumulating assets that you can then invest, and they work for you 24 hours a day, 365 days a year. And it's a marvelous reality, this compounding that comes with investing is terrific. The second thing is diversify, and diversify as much as you can. And the easy way to do that is an index fund across a very large range of stocks, like the S & P 500 is a popular version, the total market takes you even wider diversification. But diversification is really, really helpful, partly because we don't know what's going to be exciting and positive. And partly, we don't know what's going to be disappointing and negative. And the best protection against missing the first and getting too much of the second, is diversification. Third thing is minimizing fees is a very good idea because once you paid the fees, they are gone forever. And if you think about how you could accumulate, the not paid fees, that does compound in a very, very nice way....And that takes you to the final one, which is compounding is the great secret in investment success. Warren Buffett is my favorite investor. I've enjoyed a friendship with him. And I think the world of what he's accomplished. But if you had Warren Buffett with all the same talent, but he started after he finished business school, as an investor, and he stopped at when he retired at 65, Warren would only have a little over $2 billion. And as all of us know, he has a great deal more than $2 billion. And that's because he had plenty of time working for him and compounding, and that compounding is an incredible power. And most of the impact of compounding takes place in the last 10% of whatever period of time you're looking at. So start early, stay in as long as you possibly can, and let compounding work for you. On Buffett and compounding Harrington : One of my favorite quotes is Albert Einstein when he says, "Compounding is the eighth wonder of the world." I also think one of the things that you and I know, through and through as professional investors, but I'm not sure if new investors know is the 7-10 rule, which is that if something grows at 7% a year, it doubles every 10 years. And I think that's really important for people to think when they are putting everything they've given them to work and thinking about how to allocate their portfolio. If you can just get a 7% return on your portfolio in 10 years, it'll double. Ten years after that it will double again. Compounding really is amazing. Ellis : It'll double again, double again, double again. It's really stunning. Harrington : Charley, throughout your book one of the things that you refer to over and over is benign neglect. How far can someone let that go before they need to actually be proactive with their portfolio? Where's the fine line between needing to be active and a participant and letting benign neglect really work for you? I always think you know, when people are always sticking their finger in their portfolio, they're just messing things up. They should stand back and let it go. So where's the line between benign neglect and active management? Ellis : Well, most of us do way too much decision making about investing. And those who are doing decision making about each individual security in a portfolio are doing way, way too much. If you take the typical mutual fund that's got a 40% turnover, 40% changing their mind, my Lord, what's that make for the average length of time that they own securities in the portfolio? It's a little over two years, geez, that's not a very long period of time for compounding to really get in there and work at it. And then there's a cost that goes with making decisions, transaction costs. And then there's taxes. You only pay taxes when you realize the gains. You put all those things together and all of us are making a mistake more times than not, when we make a decision. The third dimension is, realize you know, everybody else reads the same newspapers and magazines and listens to the same television programs and reads the same books. We all know pretty much the same kinds of things and pretty much the same detail. And we read the newspapers about what's going on in politics, and international relationships and bad relationships, good relationships, bad politics, and good politics. So we're much more equal to each other than we realize in our knowledge base. And if we react on that sort of thing all the time, we're going to be acting in ways that are congruent with each other and it's very hard to beat somebody who is doing the same thing you're doing when you're doing the same thing that they're doing. So benign neglect helps us reduce the number of mistakes that we make. I think the greatest training for investing is probably to be a parent of teenage children because every parent of teenage children realizes at some point or another, less is better. Fewer instructions works better. Fewer decisions works better. And the kids are going to grow up to be nice young people and you'll be terribly proud of them after they've left home. — CNBC producer Emily Lorsch contributed to this article
Legendary author and investor Charles Ellis talks meme stocks and crypto, and reveals how anyone can beat the market, in a special interview for CNBC Pro subscribers.