Notes from Howard Marks’ Lecture: 48 Most Important Things I Learned on Investing

“If you were to read just five books in your life to become a sensible investor,” I often suggest people seeking my view, “…they have to be Warren Buffett’s letters, Poor Charlie’s Almanack, Peter Lynch’s One Up on Wall Street, Ben Graham’s The Intelligent Investor, and Howard Marks’ memos.”

Well, if you don’t know who Howard Marks is, let me tell you he is the CEO of Oaktree Capital and is one of the most famous investors who manages to keep a low profile, despite managing almost US$ 100 billion. Marks is also the author of an amazing book – The Most Important Thing: Uncommon Sense for the Thoughtful Investor. In its ultimate praise, Warren Buffett writes, “This is that rarity, a useful book”.

I have been reading and re-reading Marks’ memos for a few years now, so was very fortunate to attend a lecture he gave in Mumbai yesterday titled – The Truth About Investing.

It was an enlightening session, just to be in the presence of this legend and hear him out live.

I made some notes from Marks’ lecture, which I present below (most of these are direct quotes from Marks). He calls these lessons as the “brutal truths” of investing. As you would realize while reading the notes, these indeed are brutal truths – stuff that is easier said than done.

Marks concluded his lecture saying what Charlie Munger recently told him – “Investing is not supposed to be easy, and anybody who finds it easy is stupid.”

So I don’t want to feel stupid telling you that what you will read below is easy. But then, in case we are able to practice most of what is written below at most times, we would raise the probability of achieving success in our investment decision making.

Over to Marks and his brutal truths I heard from him yesterday.

On Dangers of Excessive Risk Taking

• Keynes said the markets can remain irrational longer than you can remain solvent. That’s especially true of leveraged investors. That’s the danger of leverage.
• There are old investors, and there are bold investors, but there are no old bold investors.
• Ego, hubris, and overconfidence are killers of investment returns.
• Never confuse brains with a bull market.
• In investing, to succeed you must survive.

On Fallacy of Forecasting

• Two kind of forecasters – one who don’t know, and one who don’t know they don’t know. You must decide which are you.
• Most investors act as if they can see the future. Either they think they can, or they must, or they try to. In my experience, they can’t.
• Nothing is more common than investors who are right for the wrong reasons.
• Investors would be wise to accept that they cannot see the future and they should restrict themselves to doing things that are within their powers.
• We can make decisions not based on what we think could happen in the future, but based on what’s happening today.
• The most important choice that any investor can make in the intermediate term is whether to be aggressive or defensive. Not whether it’s stocks or bonds. Not whether is a developed market or an emerging market. But whether it’s a good time to be aggressive, or it’s time to be defensive. And I believe this distinction can be made on the basis of observations regarding the current situation. They do not require guesswork about the future.

On Humility

• Very few investors have the nerve to say, “I don’t know.” But that’s how you build integrity in your investment process.
• If you start with “I don’t know,” then you are unlikely to act so boldly as to get into trouble.
• Our business is full of people who got famous for being right once in a row.
• One of the reasons why the future is unknowable is randomness. Events often fail to materialize as we think they should. Improbable things happen all the time.
• Anytime you think you know something others don’t, you should examine the basis. Ask yourself – Who doesn’t know better? Why should I be privy to exceptional information? How do I know this that nobody else knows? Am I really that smart, or am I just wrong? Am I certain that I am right and everyone else is wrong? If it’s an advice from some else, ask – Why would somebody give me potentially valuable information? And why would he give it to me? And why is he still working for a living if he knows the future so well? I am always skeptical of people who will tell you the future for five dollars.
• The concept of market efficiency – that price of each asset accurately reflects its underlying intrinsic value, or that the market price is fair – must not be ignored. You can know something and it’s possible to know more than others. But the going in presumption should be that everybody is well-informed, and if you think you know something they don’t, you should be able to express the reason for that. It’s not easy, because everyone is trying just as hard as you are.

On Keys to Success in Investing

• You can know more than others about companies and industries if you work very hard and if they are not fully followed. This is the knowable. You can control your emotions. That’s very important. And you can behave in a contrarian and counter-cyclical manner. I think these are the keys to success in the investment business, not predictions of the macro future.
• While we never know where we are going, macro wise or market direction wise, we should have a good sense of where we are. I think this is very important. And it is possible to enhance your investment results by making practical decisions suited to the market climate.
• Superior results do not come from buying high quality assets but from buying assets regardless of quality for less than their worth. That is the most dependable way to achieve success as an investor. And it is essential to understand this difference.
• If you are investing based on a fact that everybody knows, it can’t possibly constitute an advantage and it can’t possibly have been omitted from the price. So, you must have some knowledge that is different from that of others. The challenge is most of the time the consensus is about right. So, if you have a lifetime of making predictions that are different, you will make a lot of mistakes. You have to be different and better, and that’s hard.
• Being right is not the criterion and it is not necessarily profitable. You have to be just more right than others.
• In investing, one way to gain an advantage over others is by ignoring the noise that is created by the constant, manic stream of opinions and by focusing on things that matter in the long run. Is it better to be right in the short term but wrong in the long term? Or vice versa? Clearly, what matters is being right in the long run. And we can all live with some failures in the short run in the interest of being right in the long run.

On Price Vs Value

• A low purchase price not only creates the opportunity for gain but it also limits the downside risk. So you can enhance return and reduce risk by buying assets where the value is solid and the price is low. The bigger the discount, the greater the margin of safety. And that is something that is highly desirable for people who want to control risk in their portfolios.
• The price of a security at a given time reflects the consensus value. The big gains arise when the consensus turns out to have underestimated reality, or to have mis-estimated reality. To be able to take advantage of such situations, you must be able to think in a way that’s away from the consensus. You must think different and you must think better. It’s clear that if you think the same as everybody else, you’ll act the same as everybody else, and have the same results as everybody else.

On Patience

• Sometimes there are plentiful opportunities for unusual returns with low risks, like after the meltdown of Lehman Brothers (2008). And sometimes the opportunities are fewer and risky. It’s important to wait patiently for the former. You should not act the same regardless of the market environment. You should turn aggressive when things are low, and defensive when things are high.
• When there’s nothing clever to do, it’s a mistake to try to be clever.

On Role of Behaviour

• It isn’t the inability to see the future that cripples most investors. More often, it is emotions. Investors swing like pendulum between fear and greed, and between euphoria and depression, and between disbelief and skepticism. Usually they swing in the wrong direction. They want things after they have risen. And they shun things after they have fallen. This is human nature, and this is one of the greatest enemies of investment returns.
• Most investors behave pro-cyclically not counter-cyclically. And it is to their detriment. It is essential to act counter-cyclically.
• Cyclical ups and down do not go forever, but at extremes the investors act as if they will.
• There are three stages of a bull market –
  • In the first stage, only a few exceptional people begin to realize that things are improving;
  • In the second stage, most people believe improvement is actually taking place; and
  • In the third stage, everybody thinks that things can only get better

  The attractiveness of a stock’s price is dependent on how much optimism there is in the price. So, in the first stage, there is no optimism, and that’s a great time to buy. In the third stage, there is only optimism, and that’s a great time to avoid buying. But, of course, few people buy in the first stage and most people buy in the third stage. As Warren Buffett says – “First the innovator, then the imitator, then the idiot.” How I like to say this is what the wise man does in the beginning the fool does on the end. And this is one of the most important lessons in investing.

• Markets are riskiest when there is a widespread belief there is no risk. This makes investors believe that it’s safe to do risky things.
• In investing, the behaviour of participants alters the landscape (George Soros’s concept of ‘reflexivity’). If people find a bargain, they’ll raise the price so that it isn’t a bargain anymore. It’s not good to assume that the market that offered you bargains in the past will also offer you bargains in the future. And the one thing we must not do is extrapolate asset prices.
• Of the most corrosive of all the difficult human emotions is the feeling to sit by and watch other people make money. Nobody likes that. You don’t like it at 60, you don’t like it at 80, you don’t like it at 100, but when it hits 150, you say, “Okay, I’ll get on board.” And that’s usually closer to the top than it was to the bottom.
• To be a disciplined investor, you have to be willing to stand by and watch other people make money that you passed on. You don’t have to invest in everything. You don’t have to catch every trend. You should invest in the things you know about.
• Success is not good for most people. We all know of people who have been successful that makes them think they are smart, and they have the ability to do everything. Of course, that’s a very dangerous thing.
• Every investment approach, even if sensibly applied, will run into environments in which it is not suited. Buy and hold, growth stocks, value stocks, small stocks, large stocks. And that means even the best of investors will have periods of poor performance. Nobody performs great all the time.
• Investors have to be able to weather periods when the results are embarrassing. This can be very difficult.
• The more you try to be a superior investor, the more idiosyncratic positions you have to take. Invariably they will be unsuccessful for a while, and you will look worse, and the greater will be the pressures to succumb.
• Everybody must invest in a way that is consistent to their personalities. And for a mild-mannered person to be a big risk-taker is bound to lead to failure.
• In investing it’s very important that expectations be reasonable. Aiming too high will either require excessive risk bearing or guaranteed disappointment, or both. And as Peter Bernstein has said, the market is not an accommodating machine. It wouldn’t give you high returns just because you want.

On Importance of Process

• To be a successful investor, you must have a philosophy and a process that you stick to even when the times get tough. This is very important.
• If you don’t have the courage of your conviction and patience and toughness, you can’t be an investor because you’ll constantly be driven to fall in line with the consensus by buying at the top and selling at the bottom. But it’s important to know that no approach will allow you to profit from all kinds of opportunities in all environments. You have to be willing not to participate in everything that goes up, and only the things that fit your approach.

Other Most Important Things

• Success carries in itself the seeds of failure. Failure carries in itself the seeds of success.
• Being too far ahead of your time is indistinguishable from being wrong.
• The average investor does average, by definition, before fee. And below average, after fee.
• Index funds eliminate the risk of underperforming the average (broader market) but when markets go down, they guarantee you will lose as well. So, no one should think that passive investing is low risk.
• Charlie Munger told me that investing is not supposed to be easy, and anybody who finds it easy is stupid.

These are all the notes I have from Marks’ lecture. To read them deeper, I would suggest you to read his memos, and of course his book – The Most Important Thing: Uncommon Sense for the Thoughtful Investor