Book of the Week: The Most Important Thing Illuminated
07 Nov 2016
I wanted to read The Most Important Thing, but I wound up reading The Most Important Thing Illuminated, which had added unneeded commentary. I can see why you would annotate something like the bible, but this is not really a book you need to add annotations, especially smack dab in the middle of the text, which breaks the reader’s flow. The author, Howard Marks, is a cofounder of Oaktree Capital Management. The book grew out of a series of memos he sent to his investors. Instead of blog posts turning into a book, this is a bunch of memos turned into a book. If you’re looking for specifics, you won’t find it here. This is a collection of a lot of different “most important things” that investors need to consider in order to be successful. It is not one thing that makes you rich, but a lot of small things.
Experience is what you got when you didn’t get what you wanted —Howard Marks
When Marks puts it that way, I would rather be inexperienced. How’d you make all that money? I dunno, it just sort of happened. Reward and Risk
the worst loans are made at the best of times —The Economist
If you believe in efficient market theory, then you can never beat the market, because everything will be properly priced. There are a bunch of historical events that illustrated that the market is not efficient. Inefficiency is how active investors make money.
Risk means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.
People equate volatility to risk, because they don’t know any better. Risk is more concerned with downside potential. The slope of risk / reward line has changed, so people are getting less return for the same amount of risk as they were getting earlier due to dropping interest rates. Portfolio Building
investment is the discipline of relative selection —Sid Cottle
It is not about making money in the absolute sense, you need to make money subject to certain constraints. What amount of risk are you willing to take on? What assets will you not invest in? What types of investment instruments can you utilize.
- a list of potential investments
- estimates of their intrinsic value
- a sense for how their prices compare with their intrinsic value
- an understanding of the risks involved in each, and of the effect their inclusion would have on a portfolio being assembled.
What you’re really looking for is underpriced assets. Here are some features to look for.
- little known and not fully understood
- fundamentally questionable on the surface
- controversial, unseemly or scary
- deemed inappropriate for “respectable” portfolios
- unappreciated, unpopular and unloved
- trailing a record of poor returns
- recently the subject of disinvestment, not accumulation
This sounds nice and anyone should be able to find underpriced assets, but this is not usually the case. You need to be big enough to get deals to come to you. When people knock on your door looking to sell is when you make money as a professional investor. These opportunities are not available to everyone. You need to know the constraints of the other party. To buy when others are forced to sell, you need to be disciplined enough to hold cash when conditions call for it. Sometimes you wind up in situations when there is too much money chasing too few opportunities. Discipline
This is one of the hardest things to master for professional investors: coming in each day for work and doing nothing. —Joel Greenblatt
Humans act upon their emotions. The two most relevant emotions to investing are fear and greed. It is hard to hold on to your convictions and not jump on the bandwagon. In order to make more than market returns, you need to be a contrarian. This involves being disciplined enough to not act on emotion. Most of the money I lost was due to the fear of missing out. You would think I would have learned by now, but it is hard. Investing is not easy. Lessons from a Crisis Those who forget the lessons of the past are doomed to repeat themselves.
- Too much capital availability makes money flow to the wrong places
- When capital goes where it shouldn’t, bad things happen
- When capital is in oversupply, investors compete for deals by accepting low returns and a slender margin for error
- Widespread disregard for risk creates great risk
- Inadequate due diligence leads to investment losses
- In heady times, capital is devoted to innovative investments, many of which fail the test of time.
- Hidden fault lines running through portfolio can make the prices seemingly unrelated assets move in tandem.
- Psychological and technical factors can swamp fundamentals
- Markets change, invalidating models
- Leverage magnifies outcomes, but doesn’t add value.
- Excesses correct.
Winner’s Game Versus Loser’s Game You should know whether you’re playing a winner’s game or a loser’s game. Professional tennis players can control where they put the ball, so points are won mainly by hitting winners. Amateurs don’t have that skill, so they win by keeping the ball in play and trying to avoid hitting the ball out of the court. Amateurs win by avoiding mistakes. Professionals win by going for winning shots that the opponent cannot return. You should know what type of game you’re playing to match your strategy. It is sexy to have exceptional games, but it is easier to avoid losses. Any lucky idiot can make money when times are good. The trick is to not lose money when times are bad. Resources