Top 10 Investment Lesson

 

If you are looking for role models who are successful investors, there’s definitely no dearth of those. Then there is a smaller group of legendary investors like Warren Buffet who have made billions of dollars not just for themselves but also for their shareholders. But even legends acknowledge that they have role models and people who they look up to. One of these rare individuals is Howard Marks, who is admired even by legendary investors like Warren Buffet. 

The simplest way to introduce Howard Marks would be to say that he is the co-founder and co-chairman of Oaktree Capital Management. This company manages more than US$160 billion in assets, and Howard Marks specializes in finding distressed assets to invest in. Oaktree Capital Management has been quite successful under the guidance of Mr. Marks and has produced post-fees long-term returns of 19% p.a. for its investors. Apart from his investing success, Howard Marks is also admired by investors for his “memos” that provide unique insight into the economy and his successful investing strategies. So it’s definitely worth the effort to take a closer look so that you can pick up a few tips to improve your investing skills. 

In this blog, we will discuss 10 key investing lessons from Howard Marks collected from his memos and his celebrated book – “The Most Important Thing: Uncommon Sense for the Thoughtful Investor”. 

 1. Accept That You Don’t Know The Future

Even the most brilliant person can’t know everything. That’s why Howard Marks has time and again stressed the importance of intellectual humility. By accepting the limits of one’s knowledge, investors can decrease the likelihood of making mistakes arising from overconfidence.

Mr. Marks simply advises that as it is impossible to predict what the future holds, investors would instead focus only on the things that are within their power. For example, while one cannot be certain whether a new wave of COVID will happen in the short or medium term, one can choose whether to invest aggressively or conservatively right now depending on ones’ convictions. 

Now based on that choice, investors can choose appropriate investments across key asset classes like Equity, Debt, Gold, etc. to create a diversified portfolio. Asset allocation and diversification can help maximize returns while reducing overall risk irrespective of future market movements. So, instead of trying to predict the future, focus on what you can control in the present so that you are well-prepared for all possible future outcomes. 

 2. Be A Contrarian When Choosing Investments

One of the biggest mistakes that an investor can make is to take investment decisions based on herd mentality. That’s why Howard Marks suggests that to get higher returns from investments, investors have to separate themselves from the herd. Some of the ways to do this include: 

·        Choosing stocks that are not followed by analysts

·        Examining securities that are unpopular, out of favor or under-appreciated

·        Considering investments that might be controversial 

·        Opting for investments that focus on special situations

·        Making investments in distressed sectors   

Despite the obvious merits of such contrarian thinking, putting such ideas into practice can be difficult. Apart from the fact that you will have to put in significant efforts to research such investments, going against the flow is also challenging at the best of times.  

More importantly, being contrarian just for the sake of it is not the right way to become a successful investor. You also need to ensure that you pick the right investments by implementing the contrarian approach.  

 3. Ensure You Have A High Margin Of Safety

The margin of safety is a cornerstone of value investing which focuses on choosing investments whose market price is lower than their intrinsic value. This is one of the key lessons from Benjamin Graham, the father of value investing, and was first mentioned in his book “The Intelligent Investor”.

The margin of safety is defined as the difference between the real or fundamental value of a business and the price that the investor pays for it. So, the larger the margin of safety, the greater the difference between the actual value and the market price of the investment. The key benefit of a higher margin of safety is that it reduces the overall risk for the investor. 

Howard Marks further suggests that in order to pick undervalued stocks with the highest margin of safety, investors should look beyond the company’s financials and the price. You also need to consider factors like stability, the underlying predictability of the company’s earnings as well as the outlook of the industry it operates in.   

 4. Learn To Interpret Company Information Correctly 

The current information age has made it easier than ever to access a wide variety of information like company financials, analyst reports, news, etc. But the easy availability of information also poses a challenge as everyone has access to the same information. This is why Howard Marks suggests that investors should seek to gain a better understanding of the information that they have on hand. Some ways to do this include: 

·        Getting a clear understanding of the business model

·        Gaining insight into intangible assets held by the company

·        Having greater clarity regarding changing consumer patterns

·        Ensuring better knowledge regarding the company’s internal talent pool

·        Having a superior understanding of the potential impact of technological disruptions 

Having an edge over other investors when evaluating potential investments can significantly improve an investor’s chances of becoming a successful investor. However, investors have to continually work on staying ahead of the pack as almost all company information is readily available to any individual who wants it. 

 5. Always Know The Risks Of An Investment

Unlike the commonly held belief, Mr. Marks does equate risk with the volatility of an investment. Howard Marks considers risk as the probability that an investor might end up losing all of the principal amount invested. So he believes that the best way to reduce risk is to focus on avoiding losses. One way to avoid losses would be to not take any risk, but that might result in significantly lower returns.

So, the alternative is to control the level of risk. Some ways suggested by Mr. Marks to control the risk associated with an investment are: 

·        Diversification of investments across multiple asset classes

·        Periodic rebalancing of the portfolio

·        Understanding and maintaining ones’ risk tolerance

·        Investing for the long term

·        Linking investments to specific goals

However, doing all of this by yourself can be challenging, so choose the smart way by executing your investments with an ET Money Genius membership. Genius is an intelligent investing framework that lets you choose customized investment strategies and portfolios so that you maximize your returns consistently while reducing volatility and ensuring adequate downside protection.    

 6. Know The Probability Of Incurring A Loss 

Most investors understand that in certain situations, losses are unavoidable. But Howard Marks encourages investors to go further and consider the probability of a negative outcome from their investment. This is because different investments feature different risk-reward ratios, so investors need to have a clear understanding of this relationship. Understanding this relationship clearly can help provide unique investment opportunities.

For example, if a stock is considered to be too risky, it will find few takers and this will result in a reduction in the price of the stock. If the fall is large enough, it can increase the margin of safety to such a high level that the risk of investing is substantially reduced. But to benefit from such a scenario, investors have to do their homework and map out the potential positive/negative outcome and the probabilities associated with each outcome.

 7. Understand The Importance Of Market Cycles

Howard Marks is a strong believer of market cycles and their ability to govern various aspects of investing ranging from investor sentiments to stock market crashes. In his book “Mastering The Market Cycle”, he introduced 2 key rules about market cycles: 

Rule 1: Most things will be cyclical

Rule 2: The best investments opportunities arise when other investors forget the first rule.

This is best illustrated by the fact that in general investors tend to overvalue stocks when the going is good and the same stocks get undervalued during tough times. This results in investors witnessing alternate periods of euphoria and depression. Successful investors realize that these are transient phases that offer unmatched opportunity for long-term wealth creation. 

 8. Understand The Impact Of Personal Behavior and Biases

Investment errors can often occur due to an investor’s personal behavior and biases. The ease with which one can access information such as analysts’ views on stocks these days has made it even more difficult to make unbiased investment decisions. While having access to multiple viewpoints easily can be a good thing, personal biases can lead investors to make the wrong decisions. 

In part, this is because markets typically operate in a cycle of greed and pessimism depending upon whether current conditions are favorable or unfavorable. So investors must remember instances where their behavior or bias led them to take the wrong decision. This can act as a reminder so that they do not end up repeating their earlier mistake.   

 9. Do Not Underestimate The Role Of Luck

Once in a while, you might win against all odds simply because you had luck on your side. While such wins might make you seem like a visionary, a seasoned investor would recognize that the end result was just pure luck. In one of his memos, Howard Marks has acknowledged the importance of luck and the fact that even the best investors might at times fail to succeed simply because luck was not on their side.   

He has also stressed that a certain degree of luck is necessary to be a successful investor and it is practically impossible to be right every time. However, Mr. Marks suggests that investors can take some actions to improve their investing “luck”. Such actions include seeking out investment opportunities in spaces that are fundamentally strong but currently out of favor. Another option might be to seek out special situations investing opportunities resulting from one-off events like post-bankruptcy reorganizations, CEO changes, spin-offs, etc.    

 10. Know the 3 Essential Tasks That Make Investors Successful

Howard Marks once commented that even though investing is simple, it is not actually an easy task. He further added to become a successful investor, one must perform 3 key tasks well over and over again: 

·        Work hard to know more about companies and industries you want to invest in

·        Control emotions to make rational decisions

·        Behave in a counter-cyclical and contrarian manner

Performing these 3 tasks well over and over again might still not guarantee investing success, but can definitely improve the chances of becoming a successful investor in the long term. 

Bottom Line

There is a lot that even seasoned investors can learn from Howard Marks and his investment strategies. For new investors, the first step is to get the basics right and Howard Marks has a simple suggestion about how to do it. In his own words, “The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst.” These wise words are definitely a motto that all investors should live by.