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The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor Columbia Business School Publishing

The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor Columbia Business School Publishing

Date read: 2021-01-18
How strongly I recommend it: 9.48/10
(See my list of books, for more.)

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The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor Columbia Business School Publishing

Cycles and optimism

“Understanding that cycles are eventually self-correcting is one way to maintain some optimism when bargain hunting after large market drops.”

Discomfort and bargains

“by the time the knife has stopped falling, the dust has settled and the uncertainty has been resolved, there’ll be no great bargains left.”

“a hugely profitable investment that doesn’t begin with discomfort is usually an oxymoron”

Foreign exchange is a bad investment

“Take foreign exchange, for example. What are the things that determine the movements of one currency versus another? Future growth rates and inflation rates. Is it possible for any one person to systematically know much more about these things than everyone else? Probably not. And if not, then no one should be able to regularly achieve above-average risk-adjusted returns through currency trading.”

* The implication is to achieve above average return, one must systematically know more about some investment than the rest of the world.

2 things to know in investments

The more we concentrate on smaller-picture things, the more it’s possible to gain a knowledge advantage. With hard work and skill, we can consistently know more than the next person about individual companies and securities, but that’s much less likely with regard to markets and economies. Thus, I suggest people try to “know the knowable.”

•   An exception comes in the form of my suggestion, on which I elaborate in the next chapter, that investors should make an effort to figure out where they stand at a moment in time in terms of cycles and pendulums. That won’t render the future twists and turns knowable, but it can help one prepare for likely developments.”

Unknowns in investment cycle

“But just like the oscillation of cycles, we never know:

•   how far the pendulum will swing in its arc,

•   what might cause the swing to stop and turn back,

•   when this reversal will occur, or

•   how far it will then swing in the opposite direction.”

Investment as doing nothing

“At any particular point in time, the investment environment is a given, and we have no alternative other than to accept it and invest within it. There isn’t always a pendulum or cycle extreme to bet against. Sometimes greed and fear, optimism and pessimism, and credulousness and skepticism are balanced, and thus clear mistakes aren’t being made. Rather than obviously overpriced or underpriced, most things may seem roughly fairly priced. In that case, there may not be great bargains to buy or compelling sales to make.”

“JOEL GREENBLATT: This is one of the hardest things to master for professional investors: coming in each day for work and doing nothing.”

Risk and loss

“loss is what happens when risk meets adversity. Risk is the potential for loss if things go wrong. As long as things go well, loss does not arise. Risk gives rise to loss only when negative events occur in the environment.”

No recipe for investment success

“There’s no surefire recipe for investment success

investing can’t be reduced to an algorithm and turned over to a computer. Even the best investors don’t get it right every time.

The reasons are simple. No rule always works. The environment isn’t controllable, and circumstances rarely repeat exactly.”

Cycles and trends

“Ignoring cycles and extrapolating trends is one of the most dangerous things an investor can do.”

Inconsistent forecast is worthless

“So the key question isn’t “are forecasters sometimes right?” but rather “are forecasts as a whole—or any one person’s forecasts—consistently actionable and valuable?”

“That’s the trouble with inconsistent forecasters: not that they’re never right, but that the record isn’t positive enough to inspire action on their occasional brainstorms.”

Identifying market bottom

“The bottom” is the point at which the price of an asset stops going down and gets ready to start going up. It can be identified only in retrospect.”

Cause of investment mistakes

“Why do mistakes occur? Because investing is an action undertaken by human beings, most of whom are at the mercy of their psyches and emotions.”

“And not only their psyches and emotions—perverse incentives can influence institutional investors’ decision making in negative ways.”

Investment knowable and unknowable

“We should spend our time trying to find value among the knowable—industries, companies and securities—rather than base our decisions on what we expect from the less-knowable macro world of economies and broad market performance.”

Occurrence of investment pendulum

“The occurrence of this pendulum-like pattern in most market phenomena is extremely dependable

“There are a few things of which we can be sure, and this is one: Extreme market behavior will reverse. Those who believe that the pendulum will move in one direction forever—or reside at an extreme forever—eventually will lose huge sums. Those who understand the pendulum’s behavior can benefit enormously.”

Short-term gains and losses

Short-term gains and short-term losses are potential impostors, as neither is necessarily indicative of real investment ability (or the lack thereof).”

Investment opportunities and pendulum

“In theory with regard to polarities such as fear and greed, the pendulum should reside mostly at a midpoint between the extremes. But it doesn’t for long.”

“This means markets will always create opportunities, whether now or later. In markets with few opportunities, it’s important to be patient. Value opportunities will eventually present themselves, usually after no more than a year or two.”

Consistent performance and exploiting mistakes

“Inefficiencies—mispricings, misperceptions, mistakes that other people make—provide potential opportunities for superior performance. Exploiting them is, in fact, the only road to consistent outperformance. To distinguish yourself from the others, you need to be on the right side of those mistakes.”

Alternate history

“Most people acknowledge the uncertainty that surrounds the future, but they feel that at least the past is known and fixed. After all, the past is history, absolute and unchanging. But Taleb points out that the things that happened are only a small subset of the things that could have happened. Thus, the fact that a stratagem or action worked—under the circumstances that unfolded—doesn’t necessarily prove the decision behind it was wise.”

Intuitive and adaptive investment approach

“Because investing is at least as much art as it is science, it’s never my goal—in this book or elsewhere—to suggest it can be routinized. In fact, one of the things I most want to emphasize is how essential it is that one’s investment approach be intuitive and adaptive rather than be fixed and mechanistic.”

Buying strategy

“So here’s a tip: You’ll do better if you wait for investments to come to you rather than go chasing after them. You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own. An opportunist buys things because they’re offered at bargain prices. There’s nothing special about buying when prices aren’t low.”

Decision quality and outcome

“One of the first things I remember learning after entering Wharton in 1963 was that the quality of a decision is not determined by the outcome.”

“A good decision is one that a logical, intelligent and informed person would have made under the circumstances as they appeared at the time, before the outcome was known.”

Best time to buy

“There are three times to buy an asset that has been declining: on the way down, at the bottom, or on the way up. I don’t believe we ever know when the bottom has been reached, and even if we did, there might not be much for sale there.

If we wait until the bottom has been passed and the price has started to rise, the rising price often causes others to buy, just as it emboldens holders and discourages them from selling. Supply dries up and it becomes hard to buy in size. The would-be buyer finds it’s too late.

That leaves buying on the way down, which we should be glad to do. The good news is that if we buy while the price is collapsing, that fact alone often causes others to hide behind the excuse that “it’s not our job to catch falling knives.” After all, it’s when knives are falling that the greatest bargains are available.

Salesman and economist

“In addition to “Is it too good to be true,” just ask “Why me?” When the salesman on the phone offers you a guaranteed route to profit, you should wonder what made him offer it to you rather than hog it for himself. Likewise, but a little more subtly, if an economist or strategist offers a sure-to-be-right view of the future, you should wonder why he or she is still working for a living, since derivatives can be used to turn correct forecasts into vast profits without requiring much capital.

Builders and earthquakes

“A good builder is able to avoid construction flaws, while a poor builder incorporates construction flaws. When there are no earthquakes, you can’t tell the difference.”

capital and psychology

“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.”

Dealng with the future

“in dealing with the future, we must think about two things: (a) what might happen and (b) the probability that it will happen.”

Think differently to outperform

“To outperform the average investor, you have to be able to outthink the consensus

You can’t do the same things others do and expect to outperform. …

Unconventionality shouldn’t be a goal in itself, but rather a way of thinking. In order to distinguish yourself from others, it helps to have ideas that are different and to process those ideas differently.”

Good assets and good buys

“Our goal isn’t to find good assets, but good buys. Thus, it’s not what you buy; it’s what you pay for it.”

Edge of investment

“Second-level thinkers know that, to achieve superior results, they have to have an edge in either information or analysis, or both. They are on the alert for instances of misperception. My son Andrew is a budding investor, and he comes up with lots of appealing investment ideas based on today’s facts and the outlook for tomorrow. But he’s been well trained. His first test is always the same: “And who doesn’t know that?

Defensive investing

“We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.”

How wrong decision is made

“The tendency toward self-doubt combines with news of other people’s successes to form a powerful force that makes investors do the wrong thing, and it gains additional strength as these trends go on longer.”

Bargains and quality

“Investment bargains needn’t have anything to do with high quality. In fact, things tend to be cheaper if low quality has scared people away.”

Invest scared

Worry about the possibility of loss. Worry that there’s something you don’t know. Worry that you can make high-quality decisions but still be hit by bad luck or surprise events. Investing scared will prevent hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong. And if nothing does go wrong, surely the winners will take care of themselves.”

Spend more time in buying cheap

“we don’t spend a lot of time thinking about what price we’re going to be able to sell a holding for, or when, or to whom, or through what mechanism. If you’ve bought it cheap, eventually those questions will answer themselves.”

economics and science

“One of the most important things to bear in mind today is that economics isn’t an exact science. It may not even be much of a science at all, in the sense that in science, controlled experiments can be conducted, past results can be replicated with confidence, and cause-and-effect relationships can be depended on to hold.”

A principle of portfolio design

“The suboptimizers of the “I don’t know” school, on the other hand, put their emphasis on constructing portfolios that will do well in the scenarios they consider likely and not too poorly in the rest.”

Changing investment approaches

An investment approach may work for a while, but eventually the actions it calls for will change the environment, meaning a new approach is needed. And if others emulate an approach, that will blunt its effectiveness.”

Avoiding losses

“trying to avoid losses is more important than striving for great investment successes”

Successful investment criteria

“no investment activity is likely to be successful unless the return goal is (a) explicit and (b) reasonable in the absolute and relative to the risk entailed”

“Every investment effort should begin with a statement of what you’re trying to accomplish. The key questions are what your return goal is, how much risk you can tolerate, and how much liquidity you’re likely to require in the interim.”

Investment pendulum

The pendulum cannot continue to swing toward an extreme, or reside at an extreme, forever

“Like a pendulum, the swing of investor psychology toward an extreme causes energy to build up that eventually will contribute to the swing back in the other direction”

The swing back from the extreme is usually more rapid—and thus takes much less time—than the swing to the extreme. (Or as my partner Sheldon Stone likes to say, “The air goes out of the balloon much faster than it went in.”)”

Psychology and market variability

Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable."

Checklist on market status

“Are investors optimistic or pessimistic?

Do the media talking heads say the markets should be piled into or avoided?

Are novel investment schemes readily accepted or dismissed out of hand?

Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls?

Are price/earnings ratios high or low in the context of history?”

“All of these things are important, and yet none of them entails forecasting. We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.

The key is to take note of things like these and let them tell you what to do. While the markets don’t cry out for action along these lines every day, they do at the extremes, when their pronouncements are highly important.”

Contrarian and investment success

“To improve our chances of success, we have to emphasize acting contrary to the herd when it’s at extremes, being aggressive when the market is low and cautious when it’s high

Price is a key factor of an investment

“no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheap enough.”

“When people say flatly, “we only buy A” or “A is a superior asset class,” that sounds a lot like “we’d buy A at any price … and we’d buy it before B, C or D at any price.” That just has to be a mistake. No asset class or investment has the birthright of a high return. It’s only attractive if it’s priced right.”

High-return environments

“High-return environments, on the other hand, offer opportunities for generous returns through purchases at low prices, and typically these can be earned with low risk. In the crises of 1990, 2002 and 2008, for example, not only did our funds earn unusually high returns, but we feel they did it through investments where loss was unlikely.”

“The absolute best buying opportunities come when asset holders are forced to sell, and in those crises they were present in large numbers. From time to time, holders become forced sellers for reasons like these:

•   The funds they manage experience withdrawals.

•   Their portfolio holdings violate investment guidelines such as minimum credit ratings or position maximums.

•   They receive margin calls because the value of their assets fails to satisfy requirements agreed to in contracts with their lenders.”


“For each pair, check off the one you think is most descriptive of today. And if you find that most of your checkmarks are in the left-hand column, as I do, hold on to your wallet.”

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profit in meltdowns

“To satisfy those criteria, an investor needs the following things: staunch reliance on value, little or no use of leverage, long-term capital and a strong stomach. Patient opportunism, buttressed by a contrarian attitude and a strong balance sheet, can yield amazing profits during meltdowns.”

Strategies and results

“Given the highly indeterminate nature of outcomes, we must view strategies and their results—both good and bad—with suspicion until proved out over a large number of trials.”

Avoid losses and recognize pitfalls

“To avoid losses, we need to understand and avoid the pitfalls that create them...

I think of the sources of error as being primarily analytical/intellectual or psychological/emotional.”

“we collect too little information or incorrect information. Or perhaps we apply the wrong analytical processes, make errors in our computations or omit ones we should have performed”

failure to recognize market cycles and manias and move in the opposite direction”

“The power of herd psychology to compel conformity and capitulation is nearly irresistible, making it essential that investors resist them.”

Buy the cheap today

“if we find something attractive, we never say, “It’s cheap today, but we think it’ll be cheaper in six months, so we’ll wait.” It’s just not realistic to expect to be able to buy at the bottom.”

React opportunistically

“At Oaktree, one of our mottos is “we don’t look for our investments; they find us.” We try to sit on our hands. We don’t go out with a “buy list”; rather, we wait for the phone to ring. If we call the owner and say, “You own X and we want to buy it,” the price will go up. But if the owner calls us and says, “We’re stuck with X and we’re looking for an exit,” the price will go down. Thus, rather than initiating transactions, we prefer to react opportunistically.”

Market extreme and action

“no formula that will tell you when the market has gone to an irrational extreme, no foolproof tool that will keep you on the right side of these decisions, no magic pill that will protect you against destructive emotions”

“What weapons might you marshal on your side to increase your odds? Here are the ones that work for Oaktree:

•   a strongly held sense of intrinsic value,

•   insistence on acting as you should when price diverges from value,

•   enough conversance with past cycles—gained at first from reading and talking to veteran investors, and later through experience—to know that market excesses are ultimately punished, not rewarded,

•   a thorough understanding of the insidious effect of psychology on the investing process at market extremes,

•   a promise to remember that when things seem “too good to be true,” they usually are,

•   willingness to look wrong while the market goes from misvalued to more misvalued (as it invariably will), and

•   like-minded friends and colleagues from whom to gain support (and for you to support).”

Mujo and investment

“mujo means cycles will rise and fall, things will come and go, and our environment will change in ways beyond our control. Thus we must recognize, accept, cope and respond.”

The perfect is the enemy of the good

“There’s an important saying attributed to Voltaire: “The perfect is the enemy of the good.” This is especially applicable to investing, where insisting on participating only when conditions are perfect—for example, buying only at the bottom—can cause you to miss out on a lot. Perfection in investing is generally unobtainable; the best we can hope for is to make a lot of good investments and exclude most of the bad ones.”

The best time to learn investment lessons

“Good times teach only bad lessons: that investing is easy, that you know its secrets, and that you needn’t worry about risk. The most valuable lessons are learned in tough times

Intrinsic value and catching falling knives

“It’s our job as contrarians to catch falling knives, ”

“That’s why the concept of intrinsic value is so important. If we hold a view of value that enables us to buy when everyone else is selling—and if our view turns out to be right—that’s the route to the greatest rewards earned with the least risk.”

Knowing where we are

“In the world of investing, … nothing is as dependable as cycles. Fundamentals, psychology, prices and returns will rise and fall, presenting opportunities to make mistakes or to profit from the mistakes of others. They are the givens”

We may never know where we’re going, but we’d better have a good idea where we are.”

Being ahead of your time vs being wrong

“But don’t expect immediate success. In fact, you’ll often find that you’ve bought in the midst of a decline that continues. Pretty soon you’ll be looking at losses. And as one of the greatest investment adages reminds us, “Being too far ahead of your time is indistinguishable from being wrong.”

Judgement and behavior

“Only if your behavior is unconventional is your performance likely to be unconventional, and only if your judgments are superior is your performance likely to be above average.”

Investment secrete of market cycle

“Nothing goes in one direction forever.”

“In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, circumstances can change and “sure things” can fail. However, there are two concepts we can hold to with confidence:

•   Rule number one: most things will prove to be cyclical.

•   Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.”

Probability and outcome

“There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time.”

Reasons for market cycle

“The basic reason for the cyclicality in our world is the involvement of humans. Mechanical things can go in a straight line. Time moves ahead continuously. So can a machine when it’s adequately powered. But processes in fields like history and economics involve people, and when people are involved, the results are variable and cyclical. The main reason for this, I think, is that people are emotional and inconsistent, not steady and clinical.”

Time for the market to get it right

“In my experience with the U.S. stock markets, two or three years is generally enough time for the market to get it “right.” If you read the newspaper every day, this is often a tougher wait than it sounds.”