The Most Important Thing Book Review – Howard Marks

It’s interesting that The Most Important Thing book was written because Howard Marks used to repeatedly say this expression in client meetings. He would usually tell clients To become a successful investor,  the most important thing is A,B,C.
 
So after many years of successfully managing lots of money, he put all these guidelines in this book (Amazon link).
 
If you don’t know who Howard Marks is, he’s an American investor known for his respectable memos. These are economic insights he writes every quarter or so. He has been writing them for 30 years.
 
This is not a book review per se, but more like my own commentary on the most important points of the most important book 🙂
  • Price is what you pay, value is what you get
  • Understanding and recognising risk
  • Markets always move in cycles
  • Roughly know where we stand in the cycle
  • Being stingy pays off in investing
  • Being a contrarian gets rewarded but it's hard
  • Patience is gold
  • Not everything is skill - luck plays a role too!

1. Price is what you pay, value is what you get

The relationship between price and value is probably what separates superior investors from below-average ones. It’s not an easy task and the relationship changes over time.

Take flights for example. I fly on 7A and have paid £200 when the person at 7B has paid £140 for the same exact flight. Maybe they booked it earlier, maybe not. Maybe the airline’s algorithm determined that in my area people are more wealthy and it should charge them more! It doesn’t matter. What matters is that I paid more for the same value.

More extreme examples come to mind, such as… Bitcoin. Has the Bitcoin improved so much between 2014 and 2017 to justify a 7000% increase? Probably not. People changed and learned more about it which is why hype combined with supply and demand worked out the new price.

Now you could argue that because of the bitcoin network being available to more people it is now more valuable as a product. But I doubt most people buying it were using it for what it is, a currency, rather than a way to make a quick buck. So was I! 

All these apply so much to investing as well as life in general. Figuring out what an asset is worth and comparing to its cost gives us an idea of whether it’s a good investment or not. Gives us a margin of safety as Graham would put it. 
 
scale-price-value

I was trying to convince a colleague that buying Amazon because it’s a great company doesn’t necessarily mean it’s a good investment. It’s the price you pay for Amazon that matters, not only Amazon as a company. there are no good or bad stocks. Any bad company can be a good investment at the right price.

People say London is not where you want to invest right now. But what if I manage to buy at a 20% discount? What about 40%? You get the gist of it. Understanding the relationship between price value allows us to understand risk. 

2. The most important thing is recognising risk

Each asset like stocks bonds and property have specific expectations.

Most people think that by making riskier investments they should get higher rewards. It certainly doesn’t always work this way, otherwise risky investments wouldn’t be risky!

"And when risk bearing doesn’t work, it really doesn’t work and people are reminded what risk’s all about."

Also, most people believe that quality is what determines the riskiness of an investment. I’ve certainly heard:

  • I’ve bought Amazon, this is a low-medium risk investment,
  • Can’t go wrong with central London Buy To Let
So recognising risk is all about understanding the expectations vs reality of an investment. Low quality companies can be great investments and high quality ones can be very risky! It all depends on the price you pay for them.

So recognising risk is all about understanding the expectations vs reality of an investment. 

3. Market Cycles Matter!

Cycles exist in investments. Not everything goes up smoothly as World’s productivity – GDP. Why? It’s because people are sometimes greedy and sometimes fearful. Therefore they stretch good expectations for too long and they become very pessimist than needed sometimes.
 
In fact, most of the times, the markets swing between these 2 extremes, according to Marks. That’s what he calls The Pendulum.
 
Markets don’t spend much time in the middle!
 
Therefore, as investors we can benefit from the irrational behaviour of others and be greedy when others are fearful as Buffet likes to say. Now that’s easier said than done. And as a true passive investor I ask myself: Isn’t this a form of market timing? Of course it is!
 
To an extent… Which is why “The Most Important Thing book” aims to teach us how to achieve superior returns, not just the average. I’ll tackle that point a bit later.
 
So yeah, investors are emotional animals and get excited (or depressed) too quickly. I quite liked this image from Forbes on investor’s emotions:
market-cycle-emotions
Market Cycle Emotions

This video by Ray Dalio (that I have linked in Gemfinder numerous times) explains the economics of market cycles very clearly.

Now you, like me, may be wondering: Where are we now?

4. Having a sense of where we stand in the market cycle

We may not know where we’re going but we know where we are. And that gives us a good-enough direction for the future. Nobody can predict the future but people can make educated guesses.
 
One way to understand where we are is to look around us. 
 
  • Are investors optimistic or pessimistic?
  • Are they pouring market into the markets or are they avoiding it?
Remember the Bitcoin frenzy in 2017? That reminds me what being optimistic means. “BTC can soon reach $100k and there’s only a limit to how many of them can exist”.
 
  • Are the current price-to-earnings metrics higher or lower compared to history?
  • What about yield spreads?

For example, as I’m writing this article in June 2019, the Shiller PE ratio sits around 30 – almost double its historical value! As we enter the 10th consecutive year of the bull market this metric tells us that the US market looks expensive compared to 100 years of history. The rest of the world looks fairly valued for now.

What about yield spreads? Currently, the US bonds offer a very low real return – around 2%. The spread between short-term lending (1 to 2-year bonds) and 10-year ones is very narrow.

That’s very strange as it means lenders want to lend for longer term which pushes the 10-year prices up and their yields down. They believe the 10-year yield will become lower in the future so better buy now. This usually happens in economic slowdowns or recessions.

US-treasury-yields-21-6-19
US Bond yields (21-6-19)

The UK yield curve is not much better – yielding 0.8% for 10-year gov bonds and 0.64% for 2-year ones. Another indicator of a low return environment is the dividends companies pay. For US companies (which represent around half of the global market nowadays) that’s around 1.86% at the time of writing. 

This is much lower compared to the historical 4-5% companies used to pay. That’s partly because companies today prefer to buy shares back (which as a result increases their share price) than pay out dividends. Also the high concentration of tech companies in the US stock market can partly explain why!

So if you’d ask me, where do we stand in the cycle? I’d say the 10-year recovery from the most recent financial crisis has had a great run. We’ve borrowed future returns and at some point, the music will stop. Obviously, this doesn’t mean we should not invest any more money.

We don’t really know when prices will become lower – Australia hasn’t had a recession for 28 years! But it means two things:

  1. we can invest more defensively than we otherwise would
  2. we should expect lower than average historical returns for similar portfolios
I’d focus on cutting down my exposure to lower quality assets (such as my p2p lending and/or junk bonds) that the business-friendly environment has allowed to perform well. I’m increasing my exposure to more defensive assets such as short-term global bonds, university accommodation rentals and cash.
 

5. Bargain Hunting

The Russians have a saying: “Stingy always pays twice”. When it comes to investing, I don’t fully agree with it. I like stingy! I like value and it’s my job as an investor to always pay less than what I’m buying. This is where the highest returns come from!

So many times we’ve heard:
 
– Look, that’s so cheap!
– Well, it’s cheap for a reason.
 
Being sceptical will save you from dropping off an aeroplane when someone says it’s safe. But being too skeptical makes you so pessimistic that you will miss out on some great opportunities that will come your way.

We make money not because an item is being loved by everyone, but because nobody wants it enough so that its price is now worth buying!

Therefore, when I see a flat trading at a -15% discount I buy – as I did recently on this Birmingham property.
 
And buying cheaper than its value will eventually pay off if I’m right. But finding underpriced assets is not easy. How do we go about finding value?
 
Marks suggests we focus on some certain characteristics such as:
  • Items not fully understood or known by everyone
  • Controversial buys
  • Not proper buys for “high-quality” portfolios
  • Unloved and unpopular
  • Poor historical returns

When I look at some great money-making investments in the past few years a lot of those characteristics come to mind! Everyone was afraid that renewable energy will take over oil plus OPEC disagreements brought its price down to 28$ a barrel in 2015.

Looking back, obviously we’re still using oil and that would’ve been a screaming buy.

Another one: Some areas in London like Peckham that were the least favourable a decade ago, only to appreciate so much lately. I’m looking at you unpopular Glasgow that you haven’t reached your 2008 house price levels yet.

Large amounts of money aren't made by buying what everybody likes. They're made by buying what everybody underestimates.

I’m also thinking of some more niche investments that I could have made.

For example, buying into AWS, the Amazon Web Services than now make more than half of Amazon’s operating income! I certainly spotted the trend of the whole IT industry trusting amazon to run its services back in 2014. That was probably little known to the world out of the IT sphere.
 
Now everyone knows about AWS and how Amazon has had some great success turning this product into a money-making machine for its business.

6. The most important thing is… Being a contrarian

Being a contrarian is quite a hard thing to do. Not only you have to do the opposite of what people are doing, but you also need to understand why they’re wrong. Plus psychologically, it’s double the effort to lose when most people are winning.
 
Selling when everyone around you is getting richer is easier said than done.
 
This ties up nicely with the bargain characteristics. Underestimated, unpopular areas turned out to be great places to invest a few years ago.
 
It’s not what we like that gives the best returns, but what is cheap compared to its future value.

7. Being patient

If we, as individual investors have an edge over professional managers, is that we have the option of doing nothing. For the majority of the time, doing nothing is the best course of action. And by the way, doing nothing itself is a course of action.
 
Professional managers have targets to meet, and activity to show. Doing nothing seems irresponsible, after all why are we paying you. To study all day and not take action?
 
But in investing, patient opportunism pays off well. Buffet used to sit on $100bn of cash for a long period of time recently until they started buying more AAPL. Usually, waiting for motivated people to sell than going out hunting for them is beneficial to the individual investor. Gives them the upper hand.
Best course of action most of the time
Best course of action, most of the time

8. Respecting luck

If I learned something from the book Thinking in Bets it’s that we, humans like to judge the correctness of a decision by its outcome. But this can be very misleading. Unfortunately, that’s how people assess our life decisions.

In poker, this is called reasoning. You may have made the perfect play given the facts and still lose in the end. This doesn’t mean that your play was wrong. It means that luck plays an important role too and we shall respect that. 
 
In life as well as in investing we never have all the facts before making a decision but we still need to make one. Call it chance, randomness whatever you want. It’s still something we cannot control but we have to factor in.
 
Some great ways to reduce the role of luck when investing are:
  • Have many years of history before trusting something
  • Judge by a longer time horizon
  • View the future as a probability distribution 
  • Invest defensively to minimise regret rather than maximise return
When times are good, the highest returns go to investors who take the most risk. But this doesn’t mean they’re the best investors. There are old investors and there are bold investors. But there are no old bold investors.

Final Thoughts

  • Price is what you pay, value is what you get
  • Understanding and recognising risk
  • Markets always move in cycles
  • Roughly know where we stand in the cycle
  • Being stingy pays off in investing
  • Being a contrarian gets rewarded but it's hard
  • Patience is gold
  • Not everything is skill - luck plays a role too!
I’m writing all these not as an advocate of market timing. Reading through The Most Important Thing book I’ve found myself tempted to time the market and go all out or all in which is obviously wrong if I want to succeed as an investor. No-one can time the market perfectly. That’s not the point.
 

But understanding risk, where we stand in the cycle and how markets have worked in the past allows us to be a little bit more conservative or more aggressive when needed. It also helps set our expectations and not be disappointed when “10% per year from stocks” are not delivered. 

For example, as we enter the 10th consecutive year of the bull market, maybe getting a sure return by overpaying our mortgage is better than investing the difference. One gives a sure return, the other relies on an expensive market to do so. 

But overall, “The Most Important Thing” is a book about achieving greater returns than the market. To achieve such returns, our perception about how much things are worth has to be better than the others. That in itself is a very hard thing to do.
 
If you’d rather invest every month into a global tracker (such as FTSE Global All Cap or Lifestrategy 60/40) and move on with life, I don’t blame you. That’s going to give the market returns which can certainly be enough. Money is not everything and percentages are as good as the stories we tell ourselves.
 
The book could easily be half the size and Marks is repeating himself at times. But overall, it was a pleasant read and I definitely learned from it.
 
Let me know your thoughts in the comments!
 
Disclaimer: This is not investment advice. As always, do your own research. This post may contain affiliate links.

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4 thoughts on “The Most Important Thing Book Review – Howard Marks”

  1. Hi Michael,

    Thanks for the post. Just gone through your thoughts, one thing you see here are all common sense thinking but not collated together in one place and, therefore, we forget in the heat of the moment.

    However, I do have issues with Howard Marks, Mark Mobius and some of the others in the ilk I would call perma bears and that results in a loss of credibility of them in my eyes. As the saying goes – a broken clock is right twice a day. So, if you had quit the market when they started warning of recessions and overvaluations as early as 2011, you would have lost out on a 300% S&P growth. So, assuming they would be right now and the market would go down over 50%, you would still be ahead if you stayed in the market for the whole time. This is where I feel listening to the so called experts is wrong. I do read these people’s commentary but in my mind I have a view of bottom up investing where I look at good companies in good sectors and invest in them periodically.

    In that sense, I believe in the following adage:

    Time in the Market is much more important that timing the market…..

    Thanks for all the good advice you are giving to people and all the best…

    Cheers,
    Aditya

    • Thanks for the very insightful comment, Aditya! I fully agree with you that Howard Marks is a perma bear. Reading his commentary is not very useful. Being eventually right after a very long period of time is the equivalent to being wrong. He even said it himself if I remember correctly.

      Now I don’t like following his forecasts that always “call for caution”. But I quite like reading his books as I find them much more balanced. There is some
      really good info in there such as how to understand risk, how price and value are not always moving together as well as behavioural lessons for the average investor. He treats defence and offence equally and he’s not biased towards safe assets. If something, he even says that in times of worry, being aggressive is a safe bet!

      It’s incredibly hard to time the market as you rightly said. Sure, Marks did very well building his distressed-debt fund empire but for the average
      investor, timing should be avoided. Buying consistently, being well-diversified, keeping the costs low and avoiding selling during market declines is the key to investment success.

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Hi! I’m Michael and I love writing about different ways to earn, save and invest our money. Coffee addict :)

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