The Most Important Thing: Uncommon Sense for The Thoughtful Investor

by Howard Marks

When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.

And, of course, as demonstrated by the experience of Nifty Fifty investors, when everyone believes something embodies no risk, they usually bid it up to the point where it’s enormously risky. No risk is feared, and thus no reward for risk bearing—no “risk premium”— is demanded or provided. That can make the thing that’s most esteemed the riskiest.

They may produce moderate returns with low risk, or high returns with moderate risk. But achieving high returns with high risk means very little— unless you can do it for many years, in which case that perceived “high risk” either wasn’t really high or was exceptionally well managed.

loss is what happens when risk meets adversity. Risk is the potential for loss if things go wrong. As long as things go well, loss does not arise. Risk gives rise to loss only when negative events occur in the environment.

risk control is invisible in good times but still essential, since good times can so easily turn into bad times.

It’s an outstanding accomplishment to achieve the same return as the risk bearers and do so with less risk.

I’ve said for years that risky assets can make for good investments if they’re cheap enough. The essential element is knowing when that’s the case. That’s it: the intelligent bearing of risk for profit, the best test for which is a record of repeated success over a long period of time.

So in most things, you can’t prepare for the worst case. It should suffice to be prepared for once-in-a-generation events. But a generation isn’t forever, and there will be times when that standard is exceeded.

Over a full career, most investors’ results will be determined more by how many losers they have, and how bad they are, than by the greatness of their winners. Skillful risk control is the mark of the superior investor.

there are two concepts we can hold to with confidence: Rule number one: most things will prove to be cyclical. Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

The basic reason for the cyclicality in our world is the involvement of humans. Mechanical things can go in a straight line. Time moves ahead continuously. So can a machine when it’s adequately powered.

The extremes of cycles result largely from people’s emotions and foibles, nonobjectivity and inconsistency.

success carries within itself the seeds of failure, and failure the seeds of success.

The credit cycle deserves a very special mention for its inevitability, extreme volatility and ability to create opportunities for investors attuned to it. Of all the cycles, it’s my favorite.

“the worst loans are made at the best of times.”

Cycles will never stop occurring. If there were such a thing as a completely efficient market, and if people really made decisions in a calculating and unemotional manner, perhaps cycles (or at least their extremes) would be banished. But that’ll never be the case.

“this time it’s different.” These four words should strike fear—and perhaps suggest an opportunity for profit—for anyone who understands the past and knows it repeats.

When investors in general are too risk-tolerant, security prices can embody more risk than they do return. When investors are too risk-averse, prices can offer more return than risk.

I’ve recently boiled down the main risks in investing to two: the risk of losing money and the risk of missing opportunity.

“What the wise man does in the beginning, the fool does in the end.”

In theory with regard to polarities such as fear and greed, the pendulum should reside mostly at a midpoint between the extremes. But it doesn’t for long.

The swing back from the extreme is usually more rapid—and thus takes much less time— than the swing to the extreme. (Or as my partner Sheldon Stone likes to say, “The air goes out of the balloon much faster than it went in.”)

thoughtful investors can toil in obscurity, achieving solid gains in the good years and losing less than others in the bad. They avoid sharing in the riskiest behavior because they’re so aware of how much they don’t know and because they have their egos in check. This, in my opinion, is the greatest formula for long-term wealth creation— but it doesn’t provide much ego gratification in the short run. It’s just not that glamorous to follow a path that emphasizes humility, prudence and risk control. Of course, investing shouldn’t be about glamour, but often it is.

The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd and the dream of the sure thing—these factors are near universal. Thus they have a profound collective impact on most investors and most markets.

To avoid losing money in bubbles, the key lies in refusing to join in when greed and human error cause positives to be wildly overrated and negatives to be ignored.

This is the core of Warren Buffett’s oft-quoted advice: “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”

“Once-in-a-lifetime” market extremes seem to occur once every decade or so—not often enough for an investor to build a career around capitalizing on them. But attempting to do so should be an important component of any investor’s approach.

Given the difficulties associated with contrarianism just mentioned, the potentially profitable recognition of divergences from consensus thinking must be based on reason and analysis. You must do things not just because they’re the opposite of what the crowd is doing, but because you know why the crowd is wrong.

Large amounts of money aren’t made by buying what everybody likes. They’re made by buying what everybody underestimates.

there are two primary elements in superior investing: seeing some quality that others don’t see or appreciate (and that isn’t reflected in the price), and having it turn out to be true (or at least accepted by the market).

in dealing with the future, we must think about two things: (a) what might happen and (b) the probability that it will happen.

Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.

Certain common threads run through the best investments I’ve witnessed. They’re usually contrarian, challenging and uncomfortable—although the experienced contrarian takes comfort from his or her position outside the herd.

a hugely profitable investment that doesn’t begin with discomfort is usually an oxymoron. It’s our job as contrarians to catch falling knives, hopefully with care and skill.

Our goal isn’t to find good assets, but good buys. Thus, it’s not what you buy; it’s what you pay for it.

the necessary condition for the existence of bargains is that perception has to be considerably worse than reality.

whenever “everyone” feels there’s no merit in something, it’s reasonable to suspect it’s unloved, unpursued and thus possibly underpriced.

(a) if nobody owns something, demand for it (and thus the price) can only go up and (b) by going from taboo to even just tolerated, it can perform quite well.

Investment bargains needn’t have anything to do with high quality. In fact, things tend to be cheaper if low quality has scared people away.

You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own.

At Oaktree, one of our mottos is “we don’t look for our investments; they find us.” We try to sit on our hands. We don’t go out with a “buy list”; rather, we wait for the phone to ring.

Investing is the greatest business in the world because you never have to swing. You stand at the plate; the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There’s no penalty except opportunity. All day you wait for the pitch you like; then, when the fielders are asleep, you step up and hit it.

You simply cannot create investment opportunities when they’re not there. The dumbest thing you can do is to insist on perpetuating high returns—and give back your profits in the process.

To wring high returns from a low-return environment requires the ability to swim against the tide and find the relatively few winners. This must be based on some combination of exceptional skill, high risk bearing and good luck.

positioned to be a buyer instead. To satisfy those criteria, an investor needs the following things: staunch reliance on value, little or no use of leverage, long-term capital and a strong stomach.

Predictions are most useful when they correctly anticipate change. If you predict that something won’t change and it doesn’t change, that prediction is unlikely to earn you much money.

the important thing in forecasting isn’t getting it right once. The important thing is getting it right consistently.

That’s the trouble with inconsistent forecasters: not that they’re never right, but that the record isn’t positive enough to inspire

Whatever limitations are imposed on us in the investment world, it’s a heck of a lot better to acknowledge them and accommodate than to deny them and forge ahead.

Investors who feel they know what the future holds will act assertively: making directional bets, concentrating positions, levering holdings and counting on future growth—in other words, doing things that in the absence of foreknowledge would increase risk.