The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor (Amazon Link).
Short Summary
The Most Important Thing is… that there is no single most important thing in investing. Be able to understand, recognise and control your risk. You can’t predict, but you can prepare. Know the relationship between price and value. Second-level thinking is paramount. You have to see what others aren’t seeing, I think of what others aren’t thinking of and react differently to how others react. If you act the same as everyone else you’ll achieve the same as everyone else.
The Author
Howard Marks is currently Co-founder and Co-Chairman of Oaktree Capital Management, which focuses on investing in distressed securities. Marks holds a bachelor’s degree in finance from the Wharton School and an MBA in accounting and marketing from the University of Chicago.
Marks is famous for his investment memos, which Warren Buffett has spoken highly about. Buffett on Marks “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book”.
Takeaways From Each Chapter
There is no single most important thing. All are important. But investing isn’t just pure numbers. You need rational thinking skills to back it up.
Each chapter is broken up into “The Most Important Thing is…”. So here are the most important things from each chapter:
Second Level Thinking
Because your goal is to earn above-average returns, your thinking has to be different. Because if you think and behave the same as everyone else, you’ll achieve the same as everyone else. So, what edge do you have? You have to be able to think of things people haven’t thought of, or see things that they’re missing.
Being right isn’t enough, you have to be more right than anyone else. Thus, you’re thinking is going to have to be different to those who you’re up against.
Understanding Market Efficiency (and Its Limitations)
Marks’ agrees that investors evaluate new pieces of information and asset prices will immediately reflect the consensus views of that information. But, he does not believe the consensus view is necessarily correct.
He uses the example of Yahoo being priced a $237 in January 2000 yet in April 2001 it traded at $11. At that, anyone that thinks that the market was correct at both ends after a 95% drop in price has their head in the clouds. (Which I agree).
“Human beings are not clinical computing machines. Rather, most people are driven by greed, fear, envy and other emotions that render objectivity impossible and open the door for significant mistakes.”. This leaves the door open for second-level thinking investors to take advantage of these downfalls.
Value
Marks says that for investing to be reliably successful, an accurate estimate of intrinsic value is a necessary starting point. And without it, any hope for success is just hope. Price is what you pay, value is what you get. Accurate estimations of an asset’s intrinsic value are critical for steady, unemotional and profitable investing.
Relationship Between Price and Value
No investment is so good it should ignore price and vice versa. There’s no such thing as a good or bad investment regardless of price. If your estimate of value is correct, over the long run the price of the asset should eventually converge with its value.
Attempting to buy an asset below it’s estimated value isn’t foolproof, but it’s the best chance we have.
Understanding Risk
Risk involves dealing with an uncertain future, and since no one can predict the future with any certainty, risk is inescapable. So risk and investing go hand in hand. You have to understand risk, recognize when risk is high, and control risk.
Finance theory often dictates that risk means volatility. Whereas Marks believes there are a number of risks, with volatility probably being the most irrelevant of all.
Risk means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.
Types of risk?
Falling short of one’s goals: Personal and subjective, rather than absolute and objective. Retirees may only need 4 percent per year but a hedge may need 10 percent.
Underperformance: Since no approach works all of the time, even the best investors can have down periods.
Career Risk: Extreme form of underperformance risk where managers are at risk of losing their job.
Unconventionality: the risk of being different. Some managers would rather achieve average performance, rather than the possibility of achieving outsized returns with the chance of being unsuccessful and out of a job.
“Return alone—and especially return over short periods of time—says very little about the quality of investment decisions. Return has to be evaluated relative to the amount of risk taken to achieve it. And yet, risk cannot be measured.”
Recognizing Risk
You can’t control risk if you can’t recognize it. Recognize risk when investors are being too optimistic, being reckless, or paying too high a price for assets. High risk primarily comes with high prices.
“a prime element in risk creation is a belief that risk is low, perhaps even gone altogether. That belief drives up prices and leads to the embrace of risky actions despite the lowness of prospective returns.”
Controlling Risk
The best investors are those who take fewer risks compared to their returns. It could me medium returns and low risk or high returns with medium risk. But Marks sees little benefits with high returns and high risk.
Being Attentive to Cycles
Everything is cyclical. Nothing can go in one direction forever.
“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.”
Awareness of the Pendulum
Mood swings of the market can resemble a pendulum. At one end would be extreme pessimism, the other extreme optimism. Although the midpoint should be ‘the average’, it spends little time there. Often at either end at overpriced or underpriced.
“There are a few things of which we can be sure, and this is one: Extreme market behaviour will reverse. Those who believe that the pendulum will move in one direction forever—or reside at an extreme forever—eventually will lose huge sums. Those who understand the pendulum’s behaviour can benefit enormously.”
Combating Negative Influences
Avoid emotion and ego. Be wary of greed. Greed will overcome common sense, risk aversion and all logic. Don’t succumb to the investing herd. Beware of envy.
Contrarianism
If you behave the same as everyone else, you’ll achieve the same as everyone else. Buffett has said, “the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”
You have to be strong enough to go against the market and back your beliefs in order to be successful. The best investments will be buying when everyone else is selling and vice versa. And those actions will be lonely and uncomfortable.
Finding Bargains
A high-quality investment doesn’t necessarily mean it will be a good buy. The price paid is just a much a factor in returns. Good assets don’t necessarily equate to good buys and bad buys don’t always mean bad buys either. It’s not what you buy, it’s what you pay for it.
Patient Opportunism
You’ll do better if you wait for investments to appear rather than chasing after them. Motivated sellers are the best to buy from. There’s nothing special about buying when prices aren’t low.
The market’s not a very accommodating machine; it won’t provide high returns just because you need them.
Peter Bernstein
Knowing What You Don’t Know
If you don’t know what the future holds, it’s foolish to act as if you do. Overestimating what you’re capable of knowing or doing can be extremely dangerous, but staying within your circle of competence can be a great advantage
Having a Sense for Where We Stand
We might not know where we’re going, but we ought to have an idea of where we are. Try to figure out where we are in each stage of the cycle and what that implies for our actions. Take the market’s temperature and gauge the behaviours of those around you. Are investors optimistic and aggressive? Time for caution. Scared and pessimistic? Time for aggression.
Appreciating the Role of Luck
Don’t be fooled, a great deal of luck is involved in investing. But do try to move the odds in your favour. Luck and skill are not the same. A positive outcome from an aggressive investment may not due to any skill, by rather the right place at the right time. You can make a definition of a good investment and it goes down anyway. Or you could buy blindly and the stock soars. The correctness of the decision can not be decided from the outcome.
Investing Defensively
“There are old investors, and there are bold investors, but there are no old bold investors.” Pretty much sums it up. Don’t be a hero because you’ll blow yourself up.
Avoiding Pitfalls
Avoid common errors like analytical, intellectual or psychological or emotional errors. Make an effort to collect the right information and enough of it. Apply the right analytical processes, perform the right computations etc. Don’t succumb to negative influences. DOn’t get caught in the crowd.
Adding Value
Matching the markets in terms of risk and return isn’t hard. The goal is to add value though and outperform. Aim to be the defensive investor who loses less in downturns, rather than the offensive invest who gains more during upturns.
Reasonable Expectations
What’s your return goal? How much risk can you tolerate? How much liquidity are you likely to require? Your expectations of returns must be reasonable. Anything else will usually get you into trouble. Because usually there is an acceptance of greater risk than what is perceived.
Pulling It All Together
You gotta be an all-rounder. You’ll have to understand risk. Understand the relationship between price and value. Not succumb to negative influences.
You can’t know what the future holds so you need a margin of safety.
Favourite Quotes
“An accurate opinion on valuation, loosely held, will be of limited help. An incorrect opinion on valuation, strongly held, is far worse. This one statement shows how hard it is to get it all right.”
“The possibility of permanent loss is the risk I worry about”.
“Experience is what you get when you didn’t get what you wanted”
My Thoughts
This is one of my favourite investment books alongside Margin of Safety by Seth Klarman and Common Stocks and Uncommon Profits by Phil Fisher. I think Marks does an excellent job of breaking large problems down into manageable chunks and making it understandable. Marks is one of my all-time favourite investors too, I’m a massive fangirl I know.
Further Links
- Mastering the Market Cycle (His other book)
- His Memo’s
- Podcasts: Masters in Business, Tim Ferris, Farnam Street
