There are multiple styles of investing in the stock markets. Different books teach you the basics of different styles. You need to find a style which matches your personality and skills. For me- this style was value investing and the voice that resonated very strongly with me was Howard Marks.
This book – “The Most important Thing – Uncommon Sense for the Thoughtful Investor” by Howard Marks is in my list of the top 3 investment books that have influenced me.
I first came across Howard marks through his memos. Mark’s memos are one investment document that I look forward to devouring every quarter. The wisdom to words ratio of his memos are par excellence. His first book – The Most Important Thing – is by far one of the best “investment philosophy” books that I have read.
This is not a How-To book though. There are others by Peter Lynch, Pat Dorsey to name a few authors that do a much better job on teaching how to pick a good stock.
Early on in my investing career I read such books and with a mix of skill and luck (honestly more luck than skill) managed to identify many good investments. However when I look back now- I realise despite picking so many winners -my overall portfolio outcome left a lot to be desired.
Howard’s book in my view is crucial to building the “investment framework”- without which stock picking skills are useless.
This is where Howard’s book helps fit in the missing pieces. It provided the foundation and fertile soil allowing my stock picking skills to bloom into a garden of flowers.
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The Most Important Thing
There are 21 chapters in this book. I would classify them in the following categories
- The Skill of Stock Picking: Superior insight, Having a sense of value and understanding the relationship between price and value.
- Risk: Understanding, Controlling and Mitigating Risk
- Timing: Not in the literal sense – but an understanding of market cycles and where we stand in the cycle (this was the subject of his second book – Mastering the Market Cycle)
- Reasonable Expectations: Being reasonable about finding bottoms and being satisfied with “Good-enough” returns.
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Stock Picking Skills
I think most investors start at #1 – understanding value and trying to pick winners. If you are not good or atleast above average at this – the rest do not matter in my view. You would be best suited to stick to passive investing through a good mix of mutual funds and prudent asset allocation and rebalancing.
The opposite is also true. Having good stock picking ability without understanding risk or being reasonable is also a disaster waiting to happen. This is where I was as an investor before I encountered Howard . I had no idea about the risk I was taking to achieve returns. I did not have a portfolio allocation approach. “Reasonable expectations” was meant for the oldies, I used to say with youthful exuberance.
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Risk
Here is how Howard Marks defines Risk
“Risk Means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.”
This paragraph hit home the value of risk mitigation for me.
“Since there are more good years in the markets than bad years, and since it takes bad years for the value of risk control to become more evident in reducing losses, the cost of risk control – in the form of return foregone- can seem excessive. In good years in the market, risk-conscious investors must content themselves with the knowledge that they benefited from its presence in the portfolio, even though it wasn’t needed. They’re like the prudent homeowners who carry insurance and feel good about having protection in place… even there’s no fire.
Controlling the risk in your portfolio is a very important and worthwhile pursuit. The fruits, however, come only in the form of losses that don’t happen. Such what-if calculations are difficult in placid times.”
The subject of risk was extremely counterintuitive – but the insurance analogy hit home. You hate paying insurance premiums ( life, health etc). You know however that if the black swan event in your life were to happen (death or debilitating illness) -that’s when the value of insurance really come to the fore. You obviously don’t want such events to happen( who wants to die?) – but you know that eventually it may. Similarly with the markets – you know there will eventually be bad years and you don’t want to wiped out by blind risk taking or inappropriate risk mitigation.
In my case- the risks weren’t investment risks but other life risks. I didn’t realise the importance of cash allocation till I needed cash for an emergency. Not planning an emergency fund- hit me hard and I had to sell my stocks to meet these emergencies. I’ve written about this subject in more detail here
Reasonable Expectations
The other major learning from this book was having “Reasonable Expectations”. What was interesting was this did not just mean being reasonable on the upside but also on the downside.
See this extract from the book. [Emphasis supplied by me]
Everyone wants to know how to make the correct judgments that can lead to investment success and lately people have been asking me, “How can you be sure you’re investing at the bottom rather than too soon?” Finding the bottom is one of the thing about which our expectations have to be reasonable. My answer is simple: “You Can’t”
Reading this was such a liberating moment for me. If the demi-gods of investing can’t predict the bottom – why should mere mortals like me worry.
Another excerpt that re-inforces this belief.
“Our disinterest in market timing means – above all else – that if we find something attractive, we never say, “Its cheap today, but we think it’ll be cheaper in six months, so we’ll wait” Its just not realistic to expect to be able to buy at the bottom””
Adding Value
This is an interesting chapter towards the end of the book where Marks discusses what does it take for an investor to add value.
He speaks about two contrasting investors – Aggressive Investors and Defensive Investor and tries to distinguish between how these styles add values.
The matrix below will give you a better insight
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Summary
There are books on investing and there is this book. I would rank this at the very top in the list of investment classics. You must read and reread this book every 6 months to ensure that you imbibe Howard’s philosophy into your style. This book will speak to different people differently depending on where they are in their investment journey and hence reading this again will you more insights as you grow as an investor yourself.
Get your own copy of “The Most Important Thing” by Howard Marks today.
