Today, I am going to share with you 5 important investing lessons from Howard Marks that will prevent you from making terrible losses in a bear market.
Howard Marks is an investing legend who co-founded Oaktree Capital Management – which manages assets worth $164 Billion. His lessons are timeless and if you implement them, they will help you in both bull and bear markets.
Unfortunately, people tend to forget the basic tenets of investing – which leads to terrible losses.
Your Behavior In A Bull Market Leads To Your Losses In A Bear Market
The lessons that we are going to learn today will help you:
- Become a wiser investor.
- Remain calm in a bear market.
- Find gold dust when it’s carnage everywhere.
- Avoid making rash mistakes that destroy capital.
Let’s dive in.
1: The Future Is Uncertain
Even after spending decades in the industry, Howard Marks accepts that he doesn’t know what the future will hold.
But as investors in a bull market, we tend to think that it will continue indefinitely. This is exactly what happened post covid when tech stocks saw a sharp rise.
People added to their positions thinking they will continue to grow. Then, new investors joined the bull market and they pumped even more money thinking that the bull market will make them rich.
The year 2022 has made people realize that markets can be highly unpredictable and a bull market can never be indefinite.
2: Second-Level Thinking
First-level thinkers look for simple answers and formulas to invest their money in. They may look at a company that’s growing at >25% annually and think that’s a sound investment. This simplistic approach made people invest billions of dollars in hyper-growth companies in 2021, but today, most of them are down 70-90% from their highs.
On the other hand, second-level thinking is more complex and insightful. It makes you look beyond the obvious and easy answers and ask deep questions like:
- Will this company continue to grow by >25% for the next 10 years?
- What are things fueling its growth, and what scenarios can prevent it from growing fast in the future?
- What happens if the competitors apply the same growth strategy?
In his book The Most Important Thing, Howard Marks explains:
“First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first-level thinker needs is an opinion about the future, as in “The outlook for the company is favorable, meaning the stock will go up.” Second-level thinking is deep, complex and convoluted.”
3: High Margin Of Safety
The margin of safety is the difference between the fundamental value of the company and the price you pay for it. If you pay significantly lesser than the fundamental value of the company, your chances of losing money when the company goes down are less.
Here’s what Howard Marks has to say about the margin of safety:
“Margin for error is a critical element in defensive investing. Whereas most investments will be successful if the future unfolds as hoped, it takes margin for error to render outcomes tolerable when the future doesn’t oblige. An investor can obtain margin for error by insisting on tangible, lasting value in the here and now: buying only when price is well below value; eschewing leverage, and diversifying.”
4: Focus On Avoiding Risk
This idea was an eye-opener for me when I read The Most Important Thing. In a bull market, every investor goes after high returns because everyone else is making money. Twitter is filled with people screaming about how much they gained this week, this month, or this year.
People undertake high-risk gambles thinking that it will lead to even higher returns (cough, Crypto, cough).
“Especially in good times, far too many people can be overheard saying ‘riskier investments provide higher returns. If you want to make more money, the answer is to take more risk’. But riskier investments absolutely cannot be counted on to deliver higher returns. Why not? It’s simple; if riskier investments reliably produced higher returns, they wouldn’t be riskier!”
If you focus on avoiding risky decision-making, you will be much happier when the tide runs out.
Yes, you may not make a lot of money like other aggressive investors – but your portfolio will look healthy when you enter bear territory while theirs will bleed red.
5: Luck Plays An Important Role
Investing is that one field where many things are out of your control. Things like:
- Management decisions
- Competition performance
- Macro scenarios like inflation, interest rates, govt policies etc
In the 2020-21 bull market, the internet was filled with people selling their stock advisory services because their portfolio was rising. They confused their luck with their skills.
The same can happen in bear markets where your stocks are getting hammered even though they are fundamentally sound.
Luck can go both ways. So you must be able to differentiate between luck and skill.