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Investors' real job

Are you focused on the wrong investment goal?

Investors’ real job: Mastering risk controlAnand Kumar

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dhanak हिंदी में भी पढ़ें read-in-hindi

Here's a statement many investors will find provocative: Making money is not an investment manager's real job. Anyone can make money because, most of the time, markets go up. Investors and investment managers' real job is risk control.

This was what Howard Marks said at a conference a few years ago. Marks, whom I have quoted earlier in these pages, is a successful fund manager and a respected writer on investing. His widely-read memos are so valued that even Warren Buffett has said that he considers them essential reading. Incidentally, in the same speech, Marks also said, "Our business is full of people who got famous by being right once in a row," but I'll write about that some other time.

What's more, what is true for investment managers is just as true for individual investors. The current state of all equity-based investments in India is a perfect example. Pretty much everyone and everything has made money since roughly April 2020. There have been some brief hiccups here and there, but by and large, for many years now, we have been in a situation where it's not that hard to make money. Now we can argue how long this will continue and so on. But as Marks pointed out, there is a cyclicality to all markets that cannot be denied.

Marks' insight illuminates a critical aspect of investment that is often overshadowed by the allure of quick gains: the importance of risk management. This principle holds true not only for the seasoned investment manager but also for the individual investor navigating the complex landscape of equity-based investments. The surge in market values is exciting, but it masks the underlying volatility and the inevitable downturns that characterise financial markets. No matter how well - or not - the underlying economy and businesses do in the years to come, it's a certainty that there will be periods of severe downturns in equities. Therefore, understanding and mitigating that risk isn't an option - it's a necessity. Mark those words; 'certainty' and 'necessity'. I'm not using them casually.

This underscores the notion that success in investing isn't merely about picking winners but about preserving capital during such inevitable periods. Marks' philosophy serves as a stark reminder that while markets may rise and fall, management of risk remains the constant cornerstone of a successful investment approach. This wisdom is particularly relevant in today's environment, where the euphoria of past gains can easily cloud the judgement of even the most astute investors. The strange thing is that this euphoria happens to almost everyone, regardless of how many times they have been through this cycle. The only cure is to know about it and consciously guard against it.

When the cycle is heading upward, it's a common fallacy to think that it will not reverse. However, those who know that it will reverse sometimes suffer from an even bigger fallacy - that it's possible to predict when and how the reversal will come. Marks quotes the 19th-century American humourist, Mark Twain, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." This prediction business is what gets people into trouble.

It's this unpredictability in the markets that makes Howard Marks' advice so crucial. Investors, lured by the promise of high returns, often overlook the fundamental principle at the micro level that the only constant in the market is its inherent unpredictability. This oversight can lead to overly aggressive strategies, where the focus is more on the potential for gains rather than on the preservation and mitigation. This emphasis on risk management will make investors adopt a more disciplined and cautious approach, recognising that the ability to manage risk effectively is what separates successful investors from the rest.

Furthermore, this insight is yet another challenge to the idea that timing the market is a viable strategy for outperforming it. The fallacy of market timing guides investors towards the danger of acting on what they believe to be certain about the future. Instead, a strategy focused on risk management, diversification, and a long-term perspective is more likely to make them richer.

Also read: Don't be a victim

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