1. “It is simple to see what is necessary, but not easy to be willing or able to do it.” Howard Marks’ wife has said that his annual letters “are all pretty much the same.” Jason Zweig similarly wrote once that his job was to write the same column about investing over and over again in new ways. In this series you have heard the great investors repeatedly say that investing is mostly about controlling your emotions and avoiding mistakes. A range of dysfunctional heuristics makes this task far harder than people imagine. Value investing is a simple system designed to remove decisions from the process which may lead the investor to make mistakes. Decisions for a value investor are sorted into three baskets: “yes”, “no” and “too hard.” The “yes” basket is tiny compared to the other two baskets.
2. “It is utterly imperative that you know your limitations as well as your strengths and weaknesses. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely must not manage your own money. On the other hand, if you have patience, a decent pain threshold, an ability to withstand herd mentality, perhaps one credit of college-level math and a reputation for common sense, then go for it. In my opinion, you hold enough cards and will beat most professionals (which is sadly, but realistically, a relatively modest hurdle) and may even do very well indeed.” Only 2-5% of investors have the qualities that Grantham describes. “Many are called” to investing but few are genuinely capable of achieving success, especially emotionally.
3. “Financial markets are very inefficient, and capable of extremes of being completely dysfunctional. I learned that in 1974, ’82, ’87, ’2000 and definitely not excluding 2008.” Academics who claim that markets are always efficient are not paying attention. Confusing (1) the inability of investors to beat markets due to emotional instability with (2) market efficiency, is a deeply broken thought.
4. “You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.” Much of the job of the value investor is to tune out the noise. Risk is something an investor should retire rather than “dial-up”.
5. “The only things that really matter in investing are the bubbles and the busts. And here or there, in some country or in some asset class, there is usually something interesting going on in the bubble business.”
6. “The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority ‘go with the flow,’ either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest. It explains the discrepancy between a remarkably volatile stock market and a remarkably stable GDP growth, together with an equally stable growth in ‘fair value’ for the stock market.” Incentives are powerful things and the incentives of people who manage money for a living can have some seriously ugly consequences for the poorly informed. For the value investor wild market swings actually are a source of opportunity. Opportunities to generate investment gains arrive in a lumpy fashion. Much of the time of a value investor is spent reading and thinking. The time of greatest activity for a value investor is when people are fearful.
7. “The central idea … in the stock market is patience and value and mean reversion. …We have a shockingly short horizon in the stock market, as witnessed in the Internet bubble.” Good things come to the value investor who is willing to wait for the fat pitch which always arrives but not on a fixed schedule. But people have the investing equivalent of attention deficit disorder. They want to get rich now. The idea that one gets rich slowly (but with opportunities arriving in a lumpy fashion) is a hard sell to the general public.
8. “All bubbles break; all investment frenzies pass. The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.” Something that cannot go on forever will eventually stop. “Reversion to the mean” should be the value investor’s mantra.
9. “Wait for the good cards. This will be your margin of safety.” Investors in this series have repeatedly made analogies to playing cards since investing is inherently a probabilistic process.
10. “Ridiculous as our market volatility might seem to an intelligent Martian, it is our reality and everyone loves to trot out the ‘quote’ attributed to Keynes (but never documented): ‘The market can stay irrational longer than the investor can stay solvent.’ For us agents, he might better have said ‘The market can stay irrational longer than the client can stay patient.’”
11. “The more investments you have and the more different they are, the more likely you are to survive those critical periods when your big bets move against you.” Especially for the “know-nothing” investor, diversification is the closest thing there is to a free lunch.
12. “Leverage reduces the investor’s critical asset: patience. It encourages financial aggressiveness, recklessness and greed. It has proven so seductive that individuals en masse have shown themselves incapable of resisting it, as if it were a drug.” The only thing that seduces more investors than leverage is easy leverage.