“The markets are a classroom where lessons are taught every day. The keys to investment success lie in observing and learning.” – Howard Marks
I just finished The Most Important Thing by legendary investor Howard Marks of Oaktree Capital. Marks is one of the greatest value investors of all-time and the book cover even comes with the seal of approval from the Oracle of Omaha himself which reads:
“This is that rarity, a useful book.” – Warren Buffet
Marks actually touches on a number of important things, so let’s dive right into some of the best stuff from this great book.
1. It’s hard to do the right thing as an investor. But it’s impossible to consistently to the right thing at the right time. Think market timing and rebalancing here. It’s impossible to consistently jump in and out of the market at the perfect time, which many investors think they can do with the benefit of hindsight. And when rebalancing from your winners to your losers most of the time you will probably be early, but that’s how it works when investing in an uncertain future. You can’t expect to call the tops and bottoms in the markets perfectly. No one can.
2. When priced fairly, riskier investments should entail: higher expected returns, the possibility of lower returns and in some cases the possibility of losses. Many investors don’t understand the relationship between risk and reward for risky investments. Stocks don’t always perform in line with their historical averages. The can lose money or have long periods of underperformance. But they are still your best bet at building wealth in the long-term.
3. Investing concerns exactly one thing: dealing with the future. Yet it’s clearly impossible to “know” anything about the future. This is the conundrum investors are constantly grappling with. We would love to be able to predict the future but it’s not gonna happen. This causes us to look for forecasts that mesh with our current outlook. It’s much better to have a historical construct and see where we stand at the present.
4. Risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well. There are many ways to control risk: diversification, rebalancing, having a long time horizon, thinking globally, asset allocation, etc. But completely avoiding risk means you will subject yourself to lower returns and earnings on your money. It’s all about balancing your risk tolerance with your stated goals.
5. The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological. Just about every investor has access to the same information these days. If anything we now have too much information to sift through. What matters is how you choose to react to the fire hose of data and opinions that are always coming at you. You also need to have a consistent process with your research and always seek out opinions that differ from your own to keep yourself honest.
6. Every once and a while, someone makes a risky bet on an improbable or uncertain outcome and ends up looking like a genius. But we should recognize that it happened because of luck and boldness, not skill. This has to do with Michael Mauboussin’s paradox of skill. In an activity such as investing, where skill has continued to improved throughout the years, luck becomes much more important in shaping the results. Don’t let a lucky bet fool you into believing you or anyone else can consistently win the lottery by investing in longshots.
7. In both economic forecasting and investment management, it’s worth noting that there’s usually someone who gets it exactly right…but it’s rarely the same person twice. Along the same lines as no. 6, perma-bears are continuously forecasting a crash while perma-bulls always call for ever-higher markets. Eventually both will be right but that doesn’t make them prescient. Wait long enough and any prediction can come true. The question is – how long do you have to wait for them to be right?
8. In the world of investing…nothing is as dependable as cycles. Fundamentals, psychology, prices and returns will rise and fall, presenting opportunities to make mistakes or to profit from the mistakes of others. They are givens. Human nature moves the markets to places they shouldn’t fundamentally go. Greed moves them higher and fear moves them lower. And it will always be this way.
9. When others are unworried, we should be cautious; when investors are panicked, we should turn aggressive. You can take advantage of the human nature of investors by keeping a cool head. Buying into falling markets and selling into rising markets is the only way to buy low, sell high. Since it goes against everything your greedy and fearful mind is telling you, make it automatic and rebalance periodically.
10. Economies and markets cycle up and down. Whichever direction they’re going at the moment, most people come to believe that they’ll go that way forever. This thinking is a source of great danger since it poisons the markets, sends valuations to extremes, and ignites bubbles and panics that most investors find hard to resist. It’s easy to get caught up in rising or falling markets. Everyone is happy when markets are rising. They’re all making money. It’s hard to believe that the good times could ever end. Remember, this time is never different. What goes up, must come down (and vice versa). Mean reversion is a powerful force of nature.
11. When there’s nothing particularly clever to do, the potential pitfall lies in insisting on being clever. Doing nothing is one of the best things that an investor can do 99% of the time. Have your goals changed? Have your circumstances changed? Has your willingness and ability to take risk changed? Has your time horizon changed? If the answer is no, don’t do anything and follow your investment plan.
Simple, but not easy.
The Most Important Thing