Words Worth

Insights from Howard Marks' latest memo

Howard discusses what matters and what doesn't matter to an investor

Howard Marks Memo | Insights from Marks’ latest memo

Our readers would be familiar with Howard Marks and his memos. In his latest memo, 'What Really Matters?', Howard shares his thoughts on what matters and what doesn't for an investor. This memo will help you understand the mentality and ideas that you need to shun in order to become a better long-term investor. Here are some snippets from his memo.

What doesn't matter: Short-term events
"One of the critical mistakes people are guilty of - we see it all the time in the media - is believing that changes in security prices are the result of events: that favorable events lead to rising prices and negative events lead to falling prices. I think that's what most people believe - especially first-level thinkers - but that's not right. Security prices are determined by events and how investors react to those events, which is largely a function of how the events stack up against investors' expectations."

"It's clear from observation that security prices fluctuate much more than economic output or company profits. What accounts for this? It must be the fact that, in the short term, the ups and downs of prices are influenced far more by swings in investor psychology than by changes in companies' long-term prospects. Because swings in psychology matter more in the near term than changes in fundamentals - and are so hard to predict - most short-term trading is a waste of time . . . or worse."

What doesn't matter: The trading mentality
"Most people buy stocks with the goal of selling them at a higher price, thinking they're for trading, not for owning. This means they abandon the owner mentality and instead act like gamblers or speculators who bet on stock price moves."

"Each time a stock is traded, one side is wrong and one is right. But if what you're doing is betting on trends in popularity, and thus the direction of price moves over the next month, quarter, or year, is it realistic to believe you'll be right more often than the person on the other side of the trade?"

What doesn't matter: Short-term performance
"Obviously, no one should attach much significance to returns in one quarter or year. Investment performance is simply one result drawn from the full range of returns that could have materialized, and in the short term, it can be heavily influenced by random events. Thus, a single quarter's return is likely to be a very weak indicator of an investor's ability, if that. Deciding whether a manager has special skill - or whether an asset allocation is appropriate for the long run - on the basis of one quarter or year is like forming an opinion of a baseball player on the basis of one trip to the plate, or of a racehorse based on one race."

What doesn't matter: Volatility
"It's essential to recognize that protection from volatility generally isn't a free good. Reducing volatility for its own sake is a suboptimizing strategy: It should be presumed that favoring lower-volatility assets and approaches will - all things being equal - lead to lower returns."

"Volatility should be less of a concern for investors:

  • whose entities are long-lived, like life insurance companies, endowments, and pension funds;
  • whose capital isn't subject to lump-sum withdrawal;
  • whose essential activities won't be jeopardized by downward fluctuations;
  • who don't have to worry about being forced into mistakes by their constituents; and
  • who haven't levered up with debt that might have to be repaid in the short run.

Most investors lack some of these things, and few have them all. But to the extent these characteristics are present, investors should take advantage of their ability to withstand volatility, since many investments with the potential for high returns might be susceptible to substantial fluctuations."

What doesn't matter: Hyperactivity
"Develop the mindset that you don't make money on what you buy and sell; you make money (hopefully) on what you hold. Think more. Trade less. Make fewer, but more consequential, trades. Over-diversification reduces the importance of each trade; thus it can allow investors to take actions without adequate investigation or great conviction. I think most portfolios are overdiversified and over-traded."

What matters
"What really matters is the performance of your holdings over the next five or ten years (or more) and how the value at the end of the period compares to the amount you invested and to your needs."

"I think most people would be more successful if they focused less on the short run or macro trends and instead worked hard to gain superior insight concerning the outlook for fundamentals over multi-year periods in the future. They should:

  • study companies and securities, assessing things such as their earnings potential;
  • buy the ones that can be purchased at attractive prices relative to their potential;
  • hold onto them as long as the company's earnings outlook and the attractiveness of the price remain intact; and
  • make changes only when those things can't be reconfirmed, or when something better comes along."

"The hard part is executing better than most people: That's the only route to market-beating performance. Since average decision-making is reflected in security prices and produces average performance, superior results have to be based on superior insight. But I can't tell you how to do these things better than the average investor."

Suggested read: Investing wisdom from Howard Marks

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