The Most Important Thing: Uncommon Sense for The Thoughtful Investor

by Howard Marks

Successful investing requires thoughtful attention to many separate aspects, all at the same time.

Second-level thinking is deep, complex and convoluted. The second-level thinker takes a great many things into account: What is the range of likely future outcomes? Which outcome do I think will occur? What’s the probability I’m right? What does the consensus think? How does my expectation differ from the consensus? How does the current price for the asset comport with the consensus view of the future, and with mine? Is the consensus psychology that’s incorporated in the price too bullish or bearish? What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?

All investors can’t beat the market since, collectively, they are the market.

Second-level thinkers know that, to achieve superior results, they have to have an edge in either information or analysis, or both. They are on the alert for instances of misperception. My son Andrew is a budding investor, and he comes up with lots of appealing investment ideas based on today’s facts and the outlook for tomorrow. But he’s been well trained. His first test is always the same: “And who doesn’t know that?”

efficiency is what lawyers call a “rebuttable presumption”—something that should be presumed to be true until someone proves otherwise.

Bottom line: Inefficiency is a necessary condition for superior investing. Attempting to outperform in a perfectly efficient market is like flipping a fair coin: the best you can hope for is fifty-fifty. For investors to get an edge, there have to be inefficiencies in the underlying process—imperfections, mispricings—to take advantage of.

The key turning point in my investment management career came when I concluded that because the notion of market efficiency has relevance, I should limit my efforts to relatively inefficient markets where hard work and skill would pay off best.

value investing and growth investing. In a nutshell, value investors aim to come up with a security’s current intrinsic value and buy when the price is lower, and growth investors try to find securities whose value will increase rapidly in the future.

Investment success doesn’t come from “buying good things,” but rather from “buying things well.”

The discipline that is most important is not accounting or economics, but psychology.

Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge. The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.

Trying to buy below value isn’t infallible, but it’s the best chance we have.

Riskier investments are those for which the outcome is less certain. That is, the probability distribution of returns is wider. When priced fairly, riskier investments should entail: higher expected returns, the possibility of lower returns, and in some cases the possibility of losses.

high return and low risk can be achieved simultaneously by buying things for less than they’re worth. In the same way, overpaying implies both low return and high risk.

“the relation between different kinds of investments and the risk of loss is entirely too indefinite, and too variable with changing conditions, to permit of sound mathematical formulation.”

“There’s a big difference between probability and outcome. Probable things fail to happen— and improbable things happen— all the time.”

The ultimate irony lies in the fact that the reward for taking incremental risk shrinks as more people move to take it.

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.

This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them. . . . Elevated popular opinion, ...

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.

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

The error is clear. The herd applies optimism at the top and pessimism at the bottom. Thus, to benefit, we must be skeptical of the optimism that thrives at the top, and skeptical of the pessimism that prevails at the bottom.

“I’ll buy anything if it’s cheap enough.”

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

the optimism that drives one to be an active investor and the skepticism that emerges from the presumption of market efficiency must be balanced.

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. An opportunist buys things because they’re offered at bargain prices.

“we don’t look for our investments; they find us.”

an investor needs the following things: staunch reliance on value, little or no use of leverage, long-term capital and a strong stomach. Patient opportunism, buttressed by a contrarian attitude and a strong balance sheet, can yield amazing profits during meltdowns.

We may never know where we’re going, but we’d better have a good idea where we are.

the only thing we can predict about cycles is their inevitability.

“if we avoid the losers, the winners will take care of themselves.”

Caution can help us avoid mistakes, but it can also keep us from great accomplishments.

Invest scared! Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high-quality decisions but still be hit by bad luck or surprise events.

be alert to what’s going on around you with regard to the supply/demand balance for investable funds and the eagerness to spend them.

One way to improve investment results—which we try hard to apply at Oaktree—is to think about what “today’s mistake” might be and try to avoid it.

When investor psychology is at equilibrium and fear and greed are balanced, asset prices are likely to be fair relative to value. In that case there may be no compelling action, and it’s important to know that, too. When there’s nothing particularly clever to do, the potential pitfall lies in insisting on being clever.

The superior investor never forgets that the goal is to find good buys, not good assets.

both bullish and bearish—eventually become overdone, profiting those who recognize them early but penalizing the last to join. That’s the reasoning behind my number one investment adage: “What the wise man does in the beginning, the fool does in the end.”

“Being too far ahead of your time is indistinguishable from being wrong.”