Reviewing The Most Important Thing – How Do People Beat the Market?

As an investor, Howard Marks is an impressive but unglamorous fellow. Currently worth 2.2 billion USD (source), Marks has achieved his sizable pool of wealth through slow and steady accumulation rather than sudden bursts of income. As a writer, Marks is known for his memos, short notes containing valuable insights on the stock market. Warren Buffett himself has been quoted as saying, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something” (source). Does Howard Marks’ book live up to his impressive investing track record? Or should you save your time and go read a couple of memos online instead?

The long and short of it:

Howard Marks noticed that in many of his conversations with people who invest in his fund, he’s constantly saying “The most important thing is…”. Marks decided then to compile these “most important things” into a book, The Most Important Thing, in which he fully lays out these ideas and explains how they correlate. These are the most enlightening of Marks’ “most important things”:

To beat the market, you can’t be average

The market price of a stock is the aggregate evaluation of all stock investors. When most investors value a stock highly, the price soars, and when most investors feel the stock is worthless, the price is depressed. All investors have access to the same public information and investors are generally well-educated adults looking to make money in the stock market. Honestly ask yourself: are you truly better than the average investor? What is it about you that makes you better? Being able to give a good answer to these questions is key to achieving returns that surpass the market average.

To beat the market, you need superior insight

Insight comes with knowledge and doing your due diligence. You have to be able to assess the intrinsic value of a stock and you have to be aware of the current state of the market cycle. Marks thinks of the market as a pendulum: it swings from one extreme to the other and spends very little time in the middle. Investors have a short memory because market cycles occur over decades and up-and-coming 20 and 30 something investors regularly dismiss the patterns of history in favor of modern innovation. “It’ll be different this time!” is the frequent refrain, repeated in every economic boom before the inevitable collapse. To beat the market, you need to know the intrinsic value of your stock, know where you are in the pendulum swing, and follow through on your assessment.

Awareness of overall market fluctuations is only one aspect of being a good investor and finding good buys. No matter how good the company is, you will lose money if its stock is overpriced, and vice versa. Even poorly-run companies can be a good investment, provided the stocks are cheap enough. Of course, good bargains can be found in bull runs just as bad deals exist in bear markets. For less experienced stock pickers, however, what matters is that in a bull market, more companies are more frequently overpriced, while in a bear market, more companies are more frequently underpriced.

To beat the market, you need superior fortitude

You must be open to not buying what everyone says you should buy (FAANG comes to mind) and buying what everyone feels you shouldn’t (Howard Marks was known for purchasing the debt of nearly bankrupt companies). Of course, this doesn’t mean you should automatically forego Silicon Valley’s tech giants in favor of bad companies, it means that you must keep your mind open to the possibilities and be a contrarian. 

However, being a contrarian is uncomfortable because humans are built to be social and to make judgements based on what everyone around us is doing. If everyone says an overpriced stock is an excellent buy because the company will revolutionize communication, we feel a strong urge to join in or risk missing out. You purchased a value stock for $30 because you believe it’s worth $50, you should be glad to buy more as the market price drops from $30 to $25 to $17. Instead, you instinctively start to wonder if your initial assessment of the stock’s value is wrong and wonder if you should sell before the price hits zero. “Buy low sell high” is easy to say, but actually selling overpriced stocks even when it continues to go up and averaging down on bargains even as the price keeps dropping, is difficult and requires enormous mental discipline.

To beat the market, you need to give up on the short term

As Marks writes, “Being too far ahead of your time is indistinguishable from being wrong.” Sometimes you can be completely correct in your assessment of a company’s fundamentals and in your decision to buy but the market is not likely to promptly vindicate your decision. Selling a stock in a bull market frequently means watching from the sidelines as the stock goes to the moon and buying a stock in a bear market means watching your stock picks drop week after week, month after month. It may take months (or even years) before you see the true result of your fundamental analysis. To beat the market, you must accept that while you can’t anticipate the market, you can maximize your chances of making a profit by choosing companies with strong fundamentals, purchasing them for a reasonable price, and committing to long-term investments.

To beat the market, you must control risk

In the short-term, it’s difficult to see the importance of risk management but in the long-term, the value investors who can minimize risk really shines. There are many investors who have wildly successful but despairingly short careers because they took risks that paid off… until it stopped paying off. I like to think of it this way; the amount of risk involved is the amount of luck an investor needs to make money. If someone flipped a coin 20 times and got heads each time, would you bet your retirement fund on them getting another heads on the next coin flip? I should hope not. Yet this is exactly what we do when we give our money to mutual fund managers who don’t control for risk, or take on risky investments ourselves. 

However, unlike flipping a coin, the risk involved in investing is frequently concealed. Something that looks safe, for example mortgage debt, might in fact be dangerous. Make sure to do your research so you understand where the money comes from and how the value is generated. Do not take anything for granted, especially things everyone thinks is “risk free.”

Marks also notes the importance of accepting a certain degree of risk. Let’s say you got to know the coin flipper, and realized that their coin is heavier on one side, greatly increasing the probability of getting heads. Additionally, they offer you a risk premium; for every $1 you correctly bet on heads, you can get $2 in return, where if you’re wrong, you only lose the dollar. In this scenario, the risk is worth consideration. Such is the case with investing. Risk can never be fully avoided, but it can be controlled. Sometimes it’s okay to accept risk as long as you go into the deal with your eyes open and you can get it for the right price.

To beat the market, you need to manage all market conditions

Most investors have a style that they stick to. Some are aggressive growth investors looking to maximize their returns. Others are defensive value investors, looking to make a reasonable return and minimize losses. Different investment styles are suited to different market conditions. The aggressive investor will do well in a bull market, while the defensive investor will perform better in a bear market, but these results don’t tell us anything about these investors’ skill. All too often, the aggressive investor loses more than the market in a recession and the defensive investor fails to achieve average market returns in a bull run. What ends up happening is the additional return these investors gain in their ideal market condition is canceled out by them underperforming the market in less suitable conditions. Ultimately, neither the aggressive investor nor the defensive investor is able to beat the market. 

What really matters is asymmetry. Can the aggressive investor achieve superior returns during a bull run, and diminish losses during a bear market? Can the defensive investor effectively allocate capital in a bear market, and seize the market returns during a bull run? To beat the market, you must be able to keep more money than you give back, either by outperforming in a bull market or minimizing losses in a bear market. 

What makes The Most Important Thing unique?

As previously mentioned, Howard Marks is himself a successful money manager who frequently wrote memos that are both widely read and highly regarded amongst the investing elite. The Most Important Thing is in many ways a structured presentation of these memos. Marks frequently references his own memos when explaining his points. Aside from borrowing from his past self, Marks also borrowed the wisdom of other writers to supplement his points, primarily from Benjamin Graham, Warren Buffett, and Nassim Nicholas Taleb, author of Fooled by Randomness. Thus The Most Important Thing is something of a compilation, a mash-up of correlating investing ideas into a single product. For this reason, The Most Important Thing is a remarkably holistic approach to investing. Unlike The Intelligent Investor, which is unfortunately outdated in terms of specific applicability, and The Psychology of Money, which is more concerned with understanding money than making it, Howard Marks’ book stands out as an effective investment philosophy applicable to the modern market.

Final thoughts:

At just under 200 pages, The Most Important Thing is not a long book. But it is a dense book. Howard Marks has done his best to fully explain his own position as an investor in as few words as he could manage, and it shows. There is, compared to other finance books at least, little repetition in The Most Important Thing. The ideas Marks presents aren’t exactly revolutionary, but he has a way of presenting them that makes it feel like you’re finally understanding how the market works for the first time.

Should you read The Most Important Thing? 

Yes, definitely. It’s not very long and the various analogies Marks uses to illustrate his point can go a long way to clarifying a concept that is otherwise difficult to grasp.

I am not without criticism, however. In terms of investing philosophy, Marks leans more conservative, as is common for defensive value investors. While this is a perfectly legitimate investing approach, it doesn’t offer much leeway for those of us entering the stock market in midst of the longest bull market known to history (ahem). Marks emphasizes the importance of patience when the market is overheated, but as recent history proves, sometimes an overheated market can grow only more overheated as the years go on. It’s too much to expect individual investors to wait half a decade for the market to cool as their friends and family all make a fortune in the stock market. Although Marks has acknowledged that some allowances should be made with regard to investment standards during certain circumstances, he doesn’t offer any solid investment advice for new investors buying into a bull market. He also neglected to mention the importance of intangible assets (something Warren Buffet is known to value) and how it might be accounted for when evaluating a stock.

But looking past the flaws, The Most Important Thing provides a solid basis for investors of every stripe and creed. Just keep in mind that sometimes, especially during drawn out bull markets, you would be better served drawing your own conclusions about whether to invest in the stock market rather than unquestioningly following Marks’ recommendations.