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Risk, Volatility, and Investing: 5 Big Lessons from Howard Marks’s Latest Memo

“If you were to read just five books in your life to become a sensible investor,” I often suggest people seeking my view, “…they have to be Warren Buffett’s letters, Poor Charlie’s Almanack, Peter Lynch’s One Up on Wall Street, Ben Graham’s Intelligent Investor, and Howard Marks’s memos.”

Well, if you don’t know who Howard Marks is, let me tell you he is the CEO of Oaktree Capital and is one of the most famous investors who manages to keep a low profile, despite managing almost US$ 90 billion.

Marks is also the author of an amazing book – The Most Important Thing: Uncommon Sense for the Thoughtful Investor. In its ultimate praise, Warren Buffett writes, “This is that rarity, a useful book”.

Apart from the investing gems he has shared through this book, Marks also writes regular memos for investors where he outlines his investment philosophy, in line with what Buffett does via his annual letters to shareholders.

Here is what Buffett has to say about Marks’s memos – “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something…”

From whatever I have read in his memos, Marks focuses a lot on risk control and seeks to exploit market cycles. He prefers judgment to mechanical quantification, and believes in the power of checklists.

Marks’s latest memo is a masterpiece in itself. One particular reason it touches a chord with me is because it talks about a pain-point – the concept of ‘risk’ – that I feel as an investor each day, and maybe you do too.

Here are 5 big ideas I have pulled out from the memo. If you wish to learn anything and everything about investment risk, this one memo will help you do that.

In fact, reading this memo would provide you with all the big lessons that even a one-year MBA in Investment Risk won’t provide.

So, let’s get going with 5 big lessons from Howard Marks’s latest memo (the emphasis is mine).

1. Volatility Vs. Permanent Loss

…while volatility is quantifiable and machinable – and can also be an indicator or symptom of riskiness and even a specific form of risk – I think it falls far short as “the” definition of investment risk.

In thinking about risk, we want to identify the thing that investors worry about and thus demand compensation for bearing. I don’t think most investors fear volatility. In fact, I’ve never heard anyone say, “The prospective return isn’t high enough to warrant bearing all that volatility.” What they fear is the possibility of permanent loss.

Permanent loss is very different from volatility or fluctuation. A downward fluctuation – which by definition is temporary – doesn’t present a big problem if the investor is able to hold on and come out the other side.

A permanent loss – from which there won’t be a rebound – can occur for either of two reasons: (a) an otherwise-temporary dip is locked in when the investor sells during a downswing – whether because of a loss of conviction; requirements stemming from his timeframe; financial exigency; or emotional pressures, or (b) the investment itself is unable to recover for fundamental reasons.

We can ride out volatility, but we never get a chance to undo a permanent loss.

2. Future is Unpredictable. Period.

It seems most people in the prediction business think the future is knowable, and all they have to do is be among the ones who know it. Alternatively, they may understand (consciously or unconsciously) that it’s not knowable but believe they have to act as if it is in order to make a living as an economist or investment manager.

On the other hand, I’m solidly convinced the future isn’t knowable. I side with John Kenneth Galbraith who said, “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

There are several reasons for this inability to predict:

  • We’re well aware of many factors that can influence future events, such as governmental actions, individuals’ spending decisions and changes in commodity prices. But these things are hard to predict, and I doubt anyone is capable of taking all of them into account at once. (People have suggested a parallel between this categorization and that of Donald Rumsfeld, who might have called these things “known unknowns”: the things we know we don’t know.)
  • The future can also be influenced by events that aren’t on anyone’s radar today, such as calamities – natural or man-made – that can have great impact. The 9/11 attacks and the Fukushima disaster are two examples of things no one knew to think about. (These would be “unknown unknowns”: the things we don’t know we don’t know.)
  • There’s far too much randomness at work in the world for future events to be predictable. As 2014 began, forecasters were sure the U.S. economy was gaining steam, but they were confounded when record cold weather caused GDP to fall 2.9% in the first quarter.
  • And importantly, the connections between contributing influences and future outcomes are far too imprecise and variable for the results to be dependable.

Given the near-infinite number of factors that influence the future, the great deal of randomness present, and the weakness of the linkages, it’s my solid belief that future events cannot be predicted with any consistency.

3. Dealing with Uncertainty

Here’s the essential conundrum: investing requires us to decide how to position a portfolio for future developments, but the future isn’t knowable.

How can investors deal with the limitations on their ability to know the future? The answer lies in the fact that not being able to know the future doesn’t mean we can’t deal with it.

It’s one thing to know what’s going to happen and something very different to have a feeling for the range of possible outcomes and the likelihood of each one happening. Saying we can’t do the former doesn’t mean we can’t do the latter.

We can’t know what will happen. We can know something about the possible outcomes (and how likely they are). People who have more insight into these things than others are likely to make superior investors.

As I said in the last paragraph of The Most Important Thing

Only investors with unusual insight can regularly divine the probability distribution that governs future events and sense when the potential returns compensate for the risks that lurk in the distribution’s negative left-hand tail.

In other words, in order to achieve superior results, an investor must be able – with some regularity – to find asymmetries: instances when the upside potential exceeds the downside risk. That’s what successful investing is all about.

4. Risk Now is Driven By Fear of Losing Money

These days, the fear of losing money seems to have receded (since the crisis is all of six years in the past), and the fear of missing opportunities is riding high, given the paltry returns available on safe, mundane

Thus a new risk has arisen: FOMO risk, or the risk that comes from excessive fear of missing out.

It’s important to worry about missing opportunities, since people who don’t can invest too conservatively. But when that worry becomes excessive, FOMO can drive an investor to do things he shouldn’t do and often doesn’t understand, just because others are doing them: if he doesn’t jump on the bandwagon, he may be left behind to live with envy.

5. Start Paying Attention to Loss Prevention

Warren Buffett put it best, and I regularly return to his statement on the subject: “…the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”

While investor behavior hasn’t sunk to the depths seen just before the crisis (and, in my opinion, that contributed greatly to it), in many ways it has entered the zone of imprudence.

To borrow a metaphor from Chuck Prince, Citigroup’s CEO from 2003 to 2007, anyone who’s totally unwilling to dance to today’s fast-paced music can find it challenging to put money to work.

It’s the job of investors to strike a proper balance between offense and defense, and between worrying about losing money and worrying about missing opportunity.

Today I feel it’s important to pay more attention to loss prevention than to the pursuit of gain.

What you read above was just a tiny chunk of the amazing wisdom Marks has shared through his latest letter. I suggest you read the complete memo right away.

Believe me, this is the most important investment letter you would read now, and especially in these times when imprudence has started to set in.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. Madhusudan R says:

    Hi Vishal,

    Thanks for this post!

    Do you know where I could download all Howard Marks’ memos till date? Or if you have them all, could you share it?


  2. We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know. Wonderful line very informative post

  3. Thank you.
    His memo’s undoubtedly are masterpieces and lucid.

  4. Very interesting and insightful.

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