In this video, I will present the five main takeaways from The Most Important Thing -
Uncommon Sense For the Thoughtful Investor, written by Howard Marks.
For those of you who don't know him, Howard Marks is one of the greatest investors of all time, and he has a track record
similar to that of, well, for instance, Warren Buffett and Peter Lynch.
A fun fact is that it was actually Buffett himself who pushed Howard Marks to write this book in the first place,
which gives a hint of what level he's at.
Howard noticed that when he spoke to people investing in his funds, he often said: The most important thing is A ... and
the the most important thing is B, etc, etc
And he realized that there are quite a few things that you need to understand in order to become a successful investor.
Howard put these guidelines together in this book.
I'm going to present five of these most important things.
If you manage to follow all five, you've come a very long way towards securing your future financials.
And I do hope that you've had your coffee, because these takeaways are all of major importance, and
they do require some serious thinking.
Takeaway number 1: Risk: understand, recognize and control it.
Howard allocates three chapters to risk and divides it into: 1. Understanding risk,
2. Recognizing risk, and
3. Controlling risk
Let's start with the first one.
The most important thing is understanding risk.
There are lots of unfortunate misconceptions regarding risk.
For example,
riskier assets do not necessarily provide higher rates of return.
Otherwise, they wouldn't be riskier!
Risk doesn't come from weak fundamentals, for instance, alone,
because basically any investment bought at the right price may be a profitable investment.
Figuring out what an asset is worth and then comparing that to what it costs is what enables a margin of safety.
The most important thing is recognizing risk.
In order to be able to achieve above-average results,
you need to have a way of identifying what risk a certain asset carries, and then deciding if that is reasonable
compared to the risk that the market is expressing through the price of the asset.
Let us take an example.
Pretend there's a company called Metflip, which is selling at a p/e ratio of
300. In other words, the market is expressing that Metflip is a surefire bet.
You are not convinced though, as lately, the company has experienced an increased level of competition.
Also, you realize that, in order for Metflip to reach an average p/e ratio of about 20,
it will need to increase its earnings by 15 times, which is a huge increase,
especially if the company is large to begin with, and
especially if the competition is increasing.
This example is of course a bit simplified,
but the point is that investing in Metflip at the current valuation
cannot be considered investing, but it's more like gambling.
Favourable outcomes could perhaps increase the price a little bit, but it's already stretched at this point. However,
unfavorable outcomes would scare the sh** out of the investing community, and the price could drop by quite a lot and
still be expensive.
This is what's called a bad risk reward.
Small upside, large downside.
And the opposite is also true. At a low price,
favourable outcomes have a high expected return and the unfavorable outcomes will only result in small losses as they are
anticipated and already accounted for in the stock price.
Again,
high-quality assets can be risky, and
low-quality assets can be safe. It's just a matter of the price paid for them.
To finish off this part on risk: The most important thing is controlling risk.
The road to long-term investing success runs through risk control more than aggressiveness.
Skillful risk control is the mark of the superior investor.
Over an entire lifetime of investing the result will have more to do with the sizes of investment losses than the magnitude of winners.
Warren Buffett is on to the same thing when he says that "rule number one: is never lose money, rule number two is:
don't forget rule number one.
To make things more complicated though ..
The fact that the benefits of controlling risk only comes in the form of losses that don't materialize,
makes it difficult to measure.
Takeaway number 2: Be aware of these cycles
Cycles will never stop occurring. If there was such a thing as a completely efficient market, and people
really made decisions in a calculating and unemotional manner, perhaps cycles would be banished, but that'll never be the case.
The most important thing is being aware of the cycles, as it's a tool that gives you an edge towards the market.
Howard Marks compares the market to a pendulum that swings from one side to the other.
The extremes are the turning points at each end.
Although the midpoint of its arc best describes the location of the pendulum on average,
it spends very little time there.
Instead, it's almost always swinging towards or away from the extremes of its arc, between
euphoria and depression, between greed and fear, and between overpriced and underpriced.
Cycles are self-correcting and they reverse on their own.
Success creates the seeds of failure and failure creates the seeds of success.
Periodically, investors decide that a trend is never-ending.
When times are good, they believe that the trend will continue upward forever, and
neglect risk.
When times are bad, however,
they focus only on vicious cycles that are self feeding and believe that they will never end.
Howard's interpretation of today's market environment is that now is not the time to be aggressive.
Let's listen to some of mr. Howard's own words, from late 2018.
I firmly believe that I never know where we're going,
but I think I know where we are. Certainly, with the recovery almost ten years old and the bull market almost ten years old,
I think that the probabilities have shifted in a negative direction.
Keep your eyes open and look for major turning points.
Be aware of where we stand in the cycle at the moment, and you will tilt the odds in your favor.
Takeaway number 3: Mind your psychological influences
The biggest investing errors come not from factors that are informational or
analytical, but from those that are psychological.
The most important thing is combating negative influences.
Greed and fear, the occasional dismissal of logic and reason,
being envious,
ego etc, etc are all psychological forces that can have powerful negative influences.
As mr. Buffett puts it: "be greedy when others are fearful, and fearful when others are greedy."
This translates well to Howard Marks resemblance with the pendulum, remember?
As the S&P 500's p/e ratio currently is at about 23,
one can question how big the upside really is from here?
It might be better risk reward right now not to go along with the herd, but to instead play it safe on the sidelines
You know what you have but not what you're gonna get.
Psychological traits are universal and become very powerful when affecting a group, which is then called herd behavior, and
this can make whole
populations make bad decisions.
This is to a large extent due to confirmation
bias, where you confirm your wrong beliefs by the help of your peers, and
ignore information that contradicts your own worldview.
This is even more common during market extremes, again the pendulum, and
results in mistakes that can damage your portfolio returns for a lifetime.
There are several guidelines that increase your odds of minding your psychological influences.
Stick to the concept of intrinsic value and margin of safety, that, for example
Benjamin Grahm discusses in his "The Intelligent Investo" by the way, link in the description.
Also,
use the other principles from this video and try to look at the market from a sober point of view and
avoid investing when you're feeling greedy, envious or fearful.
Takeaway number 4: Don't be a sheep in a herd
"To buy when others are despondently selling and to sell when others are euphorically buying, takes the greatest courage,
but provides the greatest profits.
//Sir John Templeton
The most important thing is contrarianism.
While the most investors just follow the current trend, the best investors a lot of times do just the opposite.
When there's a broad consensus among the investment community,
it means that most investors have already acted, and the current price reflects those actions.
If a lot of investors have bought a stock because current conditions are perceived as good, the price is then high.
This leaves a lot of risk, but only a small upside.
The opposite also holds true - if the consensus of the market perceives a company to be in an unfavorable position,
the price is often low, which reduces the risk and provides a large potential reward if there would be any favorable news.
However, being a contrarian is not an easy task.
In the first phase, you must apply second level thinking, and make a judgment that contradicts the one of your peers.
This requires both knowledge and confidence.
Secondly, you need to have stamina because your predictions might not unfold directly.
So, as an example: While people were making tons of money in the dot-com era, a
person like Howard Marks waited on the sidelines, and saw everyone else getting richer at a rapid pace.
The effort required to stay out of such a bubble should not be underestimated. As
Charlie Munger, Warren Buffett's right-hand man says:
"Investing is not supposed to be easy. Anyone who finds it easy is stupid."
Takeaway number 5: The role of chance
"Randomness contributes to (or wrecks)
investment records to a degree that few people appreciate fully. As a result, the dangers that lurk in thus far
successful strategies often are underrated."
The most important thing is appreciating the role of luck.
You cannot judge the propriety of an investment decision based on the outcome, which is also a rule for life in general.
Sometimes, good decisions produce bad outcomes, and sometimes bad decisions produce good outcomes.
It's rather common that investors build their portfolios in order to maximize profits, based on their forecasts of the unknown.
If, by random chance, their forecasts are correct,
they are then perceived as
geniuses, even though it may have been a bad investment that in fact was more likely to have gone the other way.
Every single day there are investors betting on a bear market. At some point, some of them will turn out to be right.
But it does not automatically make them right in their forecasts. It may just have been luck.
An intelligent investor will invest in a way that limits his downside but which leaves a large upside.
High priority should be placed on limiting the exposure to risk and random events that could severely damage returns.
Again, mr. Buffett: "never lose money". That is how you get compounding to work for you. By the way,
check out my other video on "The Snowball", which explains compounding more in detail - how you get the eighth wonder of the world
working for you.
Whew!
Thank you Howard! That was a lot of new knowledge!
Am I the only one who's in need of a recap right now?
Pay attention to risk.
Control risk by figuring out what an asset is worth, and compared that to what it costs -
insist on a margin of safety.
Think about where in the market cycle we're at right now. Is the market greedy or is it fearful?
Avoid psychological errors by focusing on fundamentals.
Only dead fish follow the stream - be a contrarian.
Zoom out and use the movement of the herd to your advantage.
Remember some bad decisions produce good outcomes.
Therefore, an investment decision can never be judged on its outcome alone.
If you feel a bit dizzy now, don't worry. It's just the new knowledge being processed by your brain.
Recall Charlie Munger:
"Anyone who finds investing easy is stupid".
Bye for now!