The Most Important Thing

This post appeared on Medium. Moving here for linking convenience.

When Ryan Holiday was asked about his favorite gadget he said “physical books, it’s the perfect technology.” He’s right. Where else can you study years of someone’s life for $20 and a few hours of time. Isn’t that amazing?

On example of this is Howard Marks’ book The Most Important Thing. While the title is deceptive — there are multiple important things — it’s full of wisdom.

I enjoyed the book, it’s one of the better per page books that I read this year. After reading it I boiled down the many lessons ever further, like good maple syrup. The big ideas are:

1. Outsized returns are not easy
2. Cyclical vs linear
3. Margin for error is important
4. Live to fight another day

1/ Outsized returns are not easy

Marks begins his book by explaining that the goal for an investor returns beyond the market average. Marks, along with other wise investors like Warren Buffett, suggest that people who don’t want to put in the time, effort, and risk to earn greater than the market return will be happy in index funds. In his commentary in The Intelligent Investor, Jason Zweig writes that investors could be much happier if they got comfortable saying “I don’t know and I don’t care.” While outsized returns sound great, they require a lot of work.

It takes a lot of effort to beat the market. You could have a hobby instead.

If you want to earn beyond the market return then you have to think beyond the market. Marks calls this second level thinking. This is not easy, it’s “deep, complex, and convoluted,” and “there’s no easy answer.”

Take any stock du jour. Microsoft in the 1990’s, Google in the 2000’s, or Facebook in the 2010’s. Each was only a good investments for a sliver of time. Their value was largest when their popularity smallest.  If you hear about something at a cocktail party, suggests Marks, know it’s too late.

Second level thinking isn’t all you need. That’s one of many obstacles.

Another is moral hazard. “The risk-is-gone myth,” writes Marks, “is one of the most dangerous sources of risk.” It’s the thinking that because the Titanic had innovative bulkheads it was unsinkable. It’s thinking you have things Foolproof.

Another obstacle to outsized returns is that it’s hard to be different. To summarize Marks in one sentence, you have to be different and you have to be right, but difference is uncomfortable. When Katherine Graham took over the Washington Post she was the only women in an industry dominated by men. Not only that, but she took a different strategy. Her decisions led to many successes, but they weren’t easy to make.

A final challenge for the investor is that it takes regular work, everyday, to show up, roll up your sleeves, and do the work. Consistency of work trumps intensity six days a week and twice on Sundays. Angela Duckworth wrote “Greatness is many, many individual feats and each of them is doable.”

If it were easy everyone would be doing it. (This was a dorm room poster I had in college).

2/ Cycles

Thinking in cycles rather than lines has been a major shift for me. At the same time I read The Most Important Thing, I watched this video from Simon Wardley:

Before I thought only in lines, now I think in cycles and maps. Marks writes, “it’s essential to recognize the conditions of the marketplace.” Survival schools teach a similar concept, warning people not to “bend the map,” to see things as you wish not as they are.

Even though Marks came up through the Booth School of Business in Chicago, he doesn’t believe entirely in the Efficient Market Hypothesis. “I do not believe the consensus view is necessarily correct.” (Ditto for fellow Alum Richard Thaler)

Instead, Marks sees the market like a cycle/pendulum, “At the extremes, which are created by ‘most people’ believe, most people are wrong.”

Adoption of this model isn’t the only thing. You must have the right model and know where you are in it.  “Being too far ahead of your time is indistinguishable from being wrong,” writes Marks. That means at certain points you need to, as Barry Ritholtz says, “don’t just do something, sit there.” Marks writes, “Sometimes we maximize our contributions by being discerning and relatively inactive.”

Warren Buffett says to be greedy when others are fearful and fearful when others are greedy. Bill Belichick rolls out different formations in the second half, so teams can’t adjust at halftime. There are optimum times to act and other times to wait. Bill Simmons recalled this exchange in his 2010 trade value column.

Before we hit the last two groups of players, I have a quick All-Star Weekend story for you …

So it’s 2:45 in the morning on Friday night. All the Dallas bars and parties have either closed down or stopped letting people in. I’m standing on Main Street with a bunch of people, including Worldwide Wes, the renowned NBA power broker who’s really a cross between Confucius, a benevolent uncle and The Wolf in “Pulp Fiction” to assorted NBA superstars and up-and-coming stars. Known as “Uncle Wes” to the players, he carries more weight within the league than basically anybody. Because he keeps such a low profile, I could never figure out why. Which is why I went out of my way to spend some time with him on Friday night.

Back to Main Street: We’re standing with a young player who wants the night to keep going. The young player pushes to find another bar even though the odds are against it. Uncle Wes makes a face. He’s squashing this right now.

“Nothing good can happen at this point,” Wes explains simply. “You can’t chase the night. When the night is over, the night is over. That’s just the way it is. You just gotta wake up tomorrow and hope for a better day.”

Uncle Wes had spoken. I am not exaggerating by saying it’s a strangely profound moment. Within 15 seconds, our group splinters in three directions to look for cabs. I find one with my friend Connor. We climb in. We look at each other.

You can’t chase the night.

Marks writes that before they do anything, “We’d better have a good idea where we are.” Before action requires location. John Boyd’s OODA loops emphasize this; observe, orient, decide, act (rinse, repeat, and rock).

Know where you are on the line, map, or cycle, and only then act. 

3/ Margin for error

Because it’s hard to do well (#1) and accurate cycle timing is difficult  (#2), Marks builds in a cushion for mistakes. Margin of error equals value minus price.

Margin for error = Value -price

Marks writes that value, “is the indispensable starting point.” But price is important too, “There’s no such thing as a good or bad idea regardless of price.”

If there’s enough of a difference — enough margin for error — it’s worth buying. Rarely is this a clear choice. If it’s an obvious investment, say, one you overheard at a cocktail party, then something is off in the value & price calculations.

The Bill Gurley story about missing out on Google because it was too expensive was one of the most shared anecdotes I wrote up. Gurley said his mistake was in not thinking how things could go right and too much about price. If we think about the equation above, Gurley ranked price as too high and value as too low.

I got the impression that venture capitalists need to be optimists when it comes to values. Chris Sacca said much the same thing about passing on AirBnb. He thought about what could wrong not what could go right.

That’s not to say that Sacca, Gurley, and Marks should have similar investments. Marks looks for a hearty margins that is computable with second level thinking. He tries to be a six foot person crossing a five foot river.*

That margin for error is important because no matter how focused the value calculations, reality can diverge from that, and often does. Life is full of possible, yet unrealized outcomes.

Marks joins Nassim Taleb’s choir about possible futures and writes, “risk may have been present even though loss didn’t occur” and “much of risk is subjective, hidden, unquantifiable.”

Each decision we approach is like a tree. We start on the trunk, and move down branches. Each fork in the road our decision is influenced by the Two-Jar model of skill and luck.  “The truth is,” writes Marks, “much of investing is ruled by luck.”

This feels squishy but Marks gives us some guidance for figuring things out.

1. For things that are too difficult we should adopt Charlie Munger’s mindset and move on.
2. For things you can know, know them as much as possible.
3. Don’t suffer attribution substitution and confuse good profits with good process. Some people were ducks on a rising pond or had a tailwind.

So much is hard to figure out, acknowledge your weaknesses and build in redundancies. 

4/ Live to fight another day

“If we avoid the losers the winners will take care of themselves.” — Howard Marks

To win the game you have to stay in the game. Sports provides a nice analogy for this. No matter how well you’re playing at the moment, no matter the competition, or your teammates — if you get a red card you’re done.

In finance this is called permanent loss of capital. In other areas it’s reputation loss. For the riskiest ones it’s your life.

“If this decision is wrong, will it be painful or fatal?” – Matt Barrett, former chairman Bank of Montreal

NFL analyst Michael Lombardi says teams that aren’t complete let opponents hang around too long. They don’t finish them. Lombardi’s former employer, Bill Belichick and the New England Patriots emphasize this. “We talk a lot that before you win you have to learn not to lose,” said assistant coach Matt Patricia.

“The man who wishes to keep at the problem long enough to really learn anything positively must not take dangerous risks. Carelessness and overconfidence are usually more dangerous than deliberately accepted risks.” — Wilbur Wright

Stay in the game, some take a long time to win/enjoy. Live to fight another day. 

Thank you for reading.

*As the comments below note, I didn’t explain fully about the margin for error in the river analogy. Marks writes that outcomes are based on skill and luck. You should try to do anything you can to improve your skill. That includes the acknowledgement that rivers 5 feet deep on average can be much deeper in spots. Thanks Patrick for pointing this out. 10/27/16