The Most Important Thing

Sep 27

Howard Marks is the Co-Chairman of Oaktree Capital Management a leading global investment management firm.  Mr. Marks is regarded as a leader within the investment management industry.  His breadth of knowledge is often highlighted within his memos that are published on a regular basis and his book, The Most Important Thing.

Mr. Marks and I share many of the same investment and wealth planning principles.  I wanted to share with you specifically four core themes and subsequent insights from his book that lay the groundwork of a solid investment process.  Many of which are key tenants to my own investment practices and processes that I utilize at TAMMA.  (All of the bullet points below come directly from Marks’ book, The Most Important Thing)

First & Second Level Thinking

  • To be right, your thinking has to be different in order to beat those whose thinking is the same.
  • Investment approach be intuitive and adaptive rather than be fixed and mechanistic.
  • First-level thinkers look for simple formulas and easy answers. Second-level thinkers know that success in investing is the antithesis of simple.
  • Different and better: that’s a pretty good description of second-level thinking.

Understanding Risk

  • “Risk” is—first and foremost—the likelihood of losing money.
  • Much of risk is subjective, hidden and unquantifiable.
  • In regard to risk, “the first step consists of understanding it. The second step is recognizing when it’s high. The critical final step is controlling it.”
  • “There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time.” That’s one of the most important things you can know about investment risk.
  • Bottom line: risk control is invisible in good times but still essential, since good times can so easily turn into bad times.  Risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well.
  • Several things go together for those who view the world as an uncertain place: healthy respect for risk; awareness that we don’t know what the future holds; an understanding that the best we can do is view the future as a probability distribution and invest accordingly; insistence on defensive investing; and emphasis on avoiding pitfalls.

Impact of Psychology

  • The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.
  • Many people possess the intellect needed to analyze data, but far fewer are able to look more deeply into things and withstand the powerful influence of psychology.
  • What, in the end, are investors to do about these psychological urges that push them toward doing foolish things? Learn to see them for what they are; that’s the first step toward gaining the courage to resist. And be realistic. Investors who believe they’re immune to the forces described in this chapter do so at their own peril. If they influence others enough to move whole markets, why shouldn’t they affect you, too?
  • 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. The result is mistakes, and those mistakes are frequent, widespread and recurring.

Investment Philosophy

  • There’s no simple solution: no formula that will tell you when the market has gone to an irrational extreme, no foolproof tool that will keep you on the right side of these decisions, no magic pill that will protect you against destructive emotions. As Charlie Munger says, “It’s not supposed to be easy.”
  • Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.
  • First, the process of investing has to be rigorous and disciplined. Second, it is by necessity comparative. Since we can’t change the market, if we want to participate, our only option is to select the best from the possibilities that exist. These are relative decisions.
  • Simply put, we must strive to understand the implications of what’s going on around us. When others are recklessly confident and buying aggressively, we should be highly cautious; when others are frightened into inaction or panic selling, we should become aggressive.
  • Without enough time to ride out the extremes while waiting for reason to prevail, you’ll become that most typical of market victims: the six-foot-tall man who drowned crossing the stream that was five feet deep on average
  • Short-term gains and short-term losses are potential impostors, as neither is necessarily indicative of real investment ability (or the lack thereof). Surprisingly good returns are often just the flip side of surprisingly bad returns. One year with a great return can overstate the manager’s skill and obscure the risk he or she took.

Just like in football, there is an offense and a defense.  Investors need to decide what type of investor that they are and the associated investment process that comes along with that decision.  You can be aggressive, defensive, or take a balanced approach of the two but you cannot be all three.  The danger lies in trying to go between these three styles rather than committing to one approach and developing a strategy for the long run.

Be aware that whatever approach or style that you choose, there will be times when one approach will be in favor with the markets while your approach is out of favor.  And while it may be tempting to change your approach, you do so at the risk of blowing up your entire game plan.

It takes time, focus, and knowledge to manage investment assets.  If you don’t feel comfortable handling this important responsibility on your own, then you should seek out an expert advisor.

What I am Reading

  • The Cost of Holding On (NYT)
  • How to Finance a Vacation Home That’s Also a Short-Term Rental (WSJ)
  • Disrupting Your Own Happiness (A Wealth of Common Sense)
  • How to pick a financial adviser, could be the most lucrative decision you ever make (Washington Post)
  • The More Cash People Have, the Happier They Are (WSJ)