There is little doubt that investing can be a challenge.
Howard Marks, co-chairman of Oaktree Capital Management, echoes that belief and famously wrote about a conversation he had with the well-known investor Charlie Munger:
“(He) once told me something about investing that I keep going back to: ‘It’s not supposed to be easy. Anyone who finds it easy is stupid.’ While it’s pretty simple to achieve average results, Marks notes “it shouldn’t be easy to make superior investments and earn outsized returns.”
Everyone wants to make money, but they also want to find ways allowing them to do it without commensurate risk. People work hard, searching for bargain securities and approaches to give them an edge, thus driving out opportunity for easy money. Securities become more fairly priced. Marks points out that people who think it can be easy overlook substantial nuance and complexity.
Part of one’s ability to succeed is achieving second-level thinking — doing things different and better. Remember, your goal in investing isn’t earning average returns; you want to do better than average. Thus your thinking has to be better than that of others — both more powerful and at a higher level.
First-level thinking is simplistic and superficial, Marks argues, and just about everyone can do it. All the first-level thinker needs is an opinion about the future. First-level thinkers see what’s on the surface, react to it simplistically and buy or sell on the basis of their reactions.
Conversely, second-level thinking is deep, complex and convoluted. Second-level thinkers double-think (and triple-think) every angle of every situation.
Superior investors know — and buy — when the price of something is lower than it should be. And the price of an investment can only be lower when most people don’t see its merit. If everyone realizes it, they’ll have bought, in which case the price no longer will be low.
Marks says the best buys are usually found in the things most people don’t understand or believe in. The fact that something isn’t widely accepted usually serves as a green light to perceptive (and contrary) investors. For Marks, the bottom line on risk is simple: the riskiest thing in the world is the widespread belief that there’s no risk.
The problem that befalls most people is the failure to distinguish between fundamental risk and investment risk. What needs to be remembered is the defining role of price. Regardless of whether the fundamental outlook is negative or positive, the level of investment risk is determined largely by the relationship between the price of an asset and its intrinsic value.
Although counterintuitive, there is no asset so good that it can’t become overpriced and thus risky, and few so bad that there’s no price at which they are a safe buy. Only those who can see this logic can hope to become superior investors.
Superior investment results can only stem from a better-than-average ability to figure out when risk taking will lead to gain and when it will lead to loss. There is no alternative, but by definition, only a very small percentage of investors possess superior skill. In the end, according to Marks, there’s only one absolute truth about investing: It isn’t easy. ●
Umberto P. Fedeli is CEO at The Fedeli Group