Successful investing requires thoughtful attention to many separate aspects at the same time. The Most Important Thing by Howard Marks covers these key aspects in layman’s language and without a lot of finance jargon, though it covers the concepts of investment theory.
Superior Investing
- Efficiency is not universal and inefficiency is necessary for superior investing
- To be successful, investing requires an accurate estimate of intrinsic value
- Investors can base their decisions on intrinsic value or on expectations of future price movements
- Day traders may not always make good decisions if they focus solely on small price movements rather than the underlying value of the asset
- There are two approaches to investing based on fundamentals: value investing and growth investing
- It’s difficult to consistently make the right decisions as an investor, and it’s impossible to do so at the right time.
The Market Complexity
- It’s impossible to get every investment decision right all the time due to the complexity of markets and the influence of psychology
- It’s better to have an intuitive and adaptive investment approach rather than a fixed and mechanistic one
- A simple strategy for getting market returns is to invest in an index fund that buys a little of everything
Everything is Cyclic
- Most things are cyclical due to the involvement of humans, who are emotional and inconsistent
- During a bull market, a few forward-looking people may first believe things will get better, then most investors will realize improvement is taking place, and eventually everyone will conclude things will get better forever
- Analytical ability, objectivity, resolve, and imagination are needed to think things will get better and to take advantage of inefficiencies and mispricings for superior performance
- Mistakes in investing often occur due to human emotions and psychological factors such as the desire for more, the fear of missing out, the tendency to compare to others, the influence of the crowd, and the dream of a sure thing.
Being too far ahead of your time is indistinguishable from being wrong.
Investing: Success and Failure
- Investment success comes from buying things well, rather than just buying good things
- It’s important to carefully consider the price of an investment and whether it’s fair
- The best investments are those where you can buy from someone who has to sell regardless of price, but it’s not possible to make a career out of buying from forced sellers and selling to forced buyers
- Investing is a popularity contest and it’s dangerous to buy something when it’s at the peak of popularity, but it can be potentially profitable to buy something when no one likes it
Everything should be made as simple as possible, but not simpler.
Second Level Thinking
- Second-level thinking involves having better insight, intuition, sense of value, and awareness of psychology than others in order to achieve consistently above-average results
- Second-level thinking involves thinking more powerfully and at a higher level than first-level thinking, which relies on assumptions and conventional wisdom
- First-level thinkers tend to think the same way as others about the same things
- To outperform the average investor, it’s necessary to outthink the consensus and be able to think differently from the crowd.
Outperform the Market
- Asset prices reflect the consensus view of the significance of information, but this view may not be correct
- To outperform the market, it’s necessary to hold a non-consensus view
- The efficient market hypothesis suggests that it’s not possible to beat the market
- Riskier investments don’t always produce higher returns
- To achieve superior results, investors need an edge in either information or analysis, or both, and should be on the lookout for instances of misperception
The Bubble Effect
- In bubbles, people may be willing to pay any price for an asset and may prioritize market momentum over value and fair price
- There are several ways to achieve investment profits, including benefiting from a rise in intrinsic value, applying leverage, selling for more than the asset’s worth, and buying something for less than its value
- Risk is an important consideration in investing because it’s a bad thing to be avoided or minimized, it should be taken into account when considering an investment, and it should be assessed when evaluating investment results.
Risk
- Risk is primarily the likelihood of losing money, and it’s important to consider the possibility of permanent loss
- There are several types of risk, including falling short of one’s goal, underperformance, career risk, unconventionality, and illiquidity
- Risk can arise from weak fundamentals, even in a stable macroenvironment, and it can be deceptive
- Skillful investors can get a sense of the risk present in a given situation by considering the stability and dependability of value and the relationship between price and value
Risk means more things can happen than will happen.
The Rabbit hole of Risk
- In booming markets, those who take the most risk may achieve the best results, but there is a difference between probability and outcome, and probable and improbable things may not always happen as expected
- Risk cannot be measured and it is often invisible before and after an investment, except to those with unusual insight
- Risk can only be judged by experienced second-level thinkers.
Best Case and Worst Case
- The value added by a portfolio manager comes from reducing risk at a given return, rather than achieving higher returns at a given risk
- The ability to intelligently bear risk for profit can be demonstrated through a record of repeated success over a long period of time
- It’s important to be prepared for once-in-a-generation events, but it’s not necessary to prepare for the worst case scenario
- Risk control is the best route to loss avoidance, but risk avoidance may lead to return avoidance as well
In theory, there’s no difference between theory and practice, but in practice there is.
