The Most Important …. Man for All Markets
Top lessons from two of the greatest investment minds of our time.
This summer’s investment curriculum included two books which I was very excited to read.
The Most Important Thing by Howard Marks
To start with Marks, I am amazed it took me this long in my career to read this book. (Side note: the version I bought is The Most Important Thing Illuminated, which features commentary from other investors. I found most of the commentary worthless and skipped the majority of it. I would recommend buying the original version.) It really is a staple in the investment cannon and ranks right up there with The Intelligent Investor by Ben Graham and Random Walk Down Wall Street by Burton Malkiel as must reads.
The book is laid out as 21 chapters each titled as “The most important thing is ….” Suggesting that each of the points Marks lays out is, in itself, the most important thing. He outlays the importance of things like finding value, identifying cycles, contrarianism, among others. The book is short and concise, and it took me a long time to get through simply because I took a ton of notes and reread entire sections to make sure I retained as much as possible.
A Man for All Markets, is the autobiography of one on the most successful investors that no one has ever heard of. (I hope this book, and his subsequent appearances on popular podcasts, has helped to change that). It is a great look into how his mind works and the thinking that went into everything from beating blackjack to creating an insanely successful hedge-fund. His telling of this journey uncovers a ton of gems about how to assess risk, size bets, and think systematically.
I highly recommend anyone interested in investing to read both of these books but here are some ideas that are key takeaways.
Risk and Probability
Thorp – “(Academic Theorists) described stock prices using a distribution of probabilities with the esoteric name lognormal. This did a good job of fitting historical price changes that ranged from small to rather large, but greatly underestimated the likelihood of very large changes.”
Marks – Howard quotes his friend Bruce Newburg “There is a big difference between probability and outcome. Probable things fail to happen – and improbable things happen – all the time”
Lesson – calculate the odds, but also calculate the cost if your wrong. I liken it to being dealt pocket aces in a game of Texas Hold’em poker. It is statistically the best hand, but just because you have great odds of winning does not mean you should bet the whole stack of chips. Bad beats happen all the time, not just in Hold’em but in investing and in life as well. You have to be able to survive those bad beats.
Risk and Leverage
Thorp – “The lesson of leverage is this: Assume the worst imaginable outcome will occur and ask whether you can tolerate it. If the answer is no, then reduce your borrowing”
Marks – “The Financial Crisis occurred largely because never-before-seen events collided with risky, levered structures that weren’t engineered to withstand them.”
Lesson – If you are seeking to increase your returns through leverage, remember your risk will also be magnified. Nothing leads to financial destruction faster or more often than over-borrowing.
Sizing Bets and Making Bets
Thorp – Explaining the Kelly Criterion method for sizing bets “…for a favorable bet that pays odds of $A for a bet of $1, the optimal Kelly bet is the percent of your capital equal to your edge, divided by the odds.” – Thorp tells the story of going to Vegas to apply his blackjack method and starting with risking a very small amount compared to his overall bankroll. As he counted cards and would evaluate a favorable deck, he would increase the size of his bets as his edge increased and reduce them as it went down. “I planned to play conservatively, betting twice my lowest bet when the advantage for me was 1 percent, four times as much with a 2 percent edge, and finally leveling off at ten times my small bets when the game was 5 percent or more in my favor.”
Marks – “When there’s nothing particularly clever to do, the potential pitfall lies in insisting on being clever.”
Lesson – You should only put on an active bet when you have an edge, and even then, you should size your bet according to the odds.
Thorp – What it takes to beat the market, 1) Get good information early. 2) Be a disciplined rational investor. 3) Find a superior method of analysis. 4) Invest ahead of the crowd.
Marks – “To achieve superior results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently, or do a better job analyzing – ideally all three.”
These lessons just barely scratch the surface of what is offered in these books. I definitely recommend both, but if you need one or the other, I would say if you are serious about learning the craft of investing, you have to go Marks. If your interests are more worldly, than go with Thorp. Either way you can’t go wrong.
Until next time…..
“The most important thing is the relationship between price and value….Since buying from a forced seller is the best thing in our world, being a forced seller is the worst. That means it’s essential to arrange your affairs so you’ll be able to hold on – and not sell – at the worst of times. This requires both long-term capital and strong psychological resources.” – Howard Marks.
Further reading –