Continuation of portfolio management highlights from Howard Marks’ book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor, Chapter 4 “The Most Important Thing Is…The Relationship Between Price and Value.” Topics covered: Volatility, Leverage, When To Buy, When To Sell
Volatility
“…most of the time a security’s price will be affected at least as much – and its short-term fluctuations determined primarily – by two other factors: psychology and technicals…These are nonfundamental factors – that is, things unrelated to value – that affect the supply and demand for securities.”
“Investor psychology can cause a security to be priced just about anywhere in the short run, regardless of its fundamentals…The key is who likes the investment now and who doesn’t. Future price change will be determined by whether it comes to be liked by more people or fewer people in the future.”
“For self-protection, then, you must invest the time and energy to understand market psychology. It’s essential to understand that fundamental value will be only one of the factors determining a security’s price on the day you buy it. Try to have psychology and technicals on your side as well.”
Many investors suffer the vicissitude of volatility and deny they are suffering by clinging to the excuse that short-term price fluctuations are merely temporary impairments of capital.
The movements may be temporary, but temporary movements downward still impact your performance trackrecord, capital reinvestment options, etc., and therefore should not be completely ignored.
Howard Marks is undoubtedly a long-term investor, yet he considers the causes and ramifications of volatility “for self-protection.” Afterall, investing is difficult enough, wouldn’t you rather (attempt to) avoid the headwind of downside volatility if and when possible?
Leverage
“Here the problem is that using leverage – buying with borrowed money – doesn’t make anything a better investment or increase the probability of gains. It merely magnifies whatever gains or losses may materialize. And it introduces the risk of ruin if a portfolio fails to satisfy a contractual value test and lenders can demand their money back at a time when prices and illiquidity are depressed. Over the years leverage has been associated with high returns, but also with the most spectacular meltdowns and crashes.”
What about non-recourse debt? (Ethics aside, of course.) Could non-recourse debt make an investment “better” by skewing the ratio of potential loss (your equity cost basis) vs. potential gain?
When To Buy
“No asset class or investment has the birthright of a high return. It’s only attractive if it’s priced right.”
“Believe me, there is nothing better than buying from someone who has to sell regardless of price during a crash. Many of the best buys we’ve ever made occurred for that reason.”
“The safest and most potentially profitable thing is to buy something when no one likes it.”
Before buying a security, consider who is selling and reasons why the seller dislikes it enough to sell. The best buying situations involve discoveries of forced/indiscriminate sellers for XYZ reason(s).
When To Sell, When To Buy
“Since buying from a forced seller is the best thing in our world, being a forced seller is the worst. That means it’s essential to arrange your affairs so you’ll be able to hold on – and not sell – at the worst of times. This requires both long-term capital and strong psychological resources.”
“A ‘top’ in a stock, group or market occurs when the last holdout who will become a buyer does so. The timing is often unrelated to fundamental developments.”
“Well bought is half sold.”
There’s an inherent, inseparable relationship between the act of buying and selling a security.