Finding Balance
Stock markets saw some volatility during the past week but ended without much change. The S&P 500 fell by about 0.16%, and the Nasdaq dropped by about 0.39%. The Dow eeked out a slight gain.
Last week also saw investor Howard Marks publish his latest memo. Marks discussed the balance between finding winners and avoiding losers and, if one is truly trying to achieve great long-term returns, how it’s inevitable to have some losers if you’re playing the game correctly:
Since (a) all but the most cautious investing entails risk and (b) the presence of risk means results will be unpredictable and inconsistent, very few (if any) investors are able to have only good years or to assemble portfolios that contain only winners. The question isn’t whether you’re going to have losers, but rather how many and how bad relative to your winners.
Warren Buffett – arguably the investor with the best long-term record (and certainly the longest long-term record) – is widely described as having had only twelve great winners in his career. His partner Charlie Munger told me the vast majority of his own wealth came not from twelve winners, but only four. I believe the ingredients of Warren’s and Charlie’s great performance are simple: (a) a lot of investments in which they did decently, (b) a relatively small number of big winners that they invested in heavily and held for decades, and (c) relatively few big losers. No one should expect to have – or expect their money managers to have – all big winners and no losers.
In fact, not having any losers isn’t a useful goal. The only sure way to achieve that is by not taking any risk. But, as I said earlier, risk avoidance is likely to result in return avoidance. There’s such a thing as the risk of taking too little risk. Most people understand this intellectually, but human nature makes it hard for many to accept the idea that the willingness to live with some losses is an essential ingredient in investment success.
We can see the balance in the case of Warren Buffett and Charlie Munger. First, they kept moving forward. They had a bunch of decent investments—some of which likely beat a comparable stock market return and some of which didn’t—that were positive and kept them going in the right direction.
Next, they had some big winners, and they put a significant portion of their capital into those winners when they saw that rare, golden opportunity to swing big. As Buffett has said, “When it's raining gold, reach for a bucket, not a thimble.”
And finally, when they were wrong and lost money, the losses were a small portion of their overall capital. They never had to go back to go, and they never took such a big step back that it was hard to recover.
They had balance which, as Marks continued, is important both to investing as well as the game of tennis in which he made comparisons in his memo:
To win – in tennis as in investing – you have to have a favorable relationship between winners and losers. You can win by having a few winners but fewer losers or by having a lot of losers but more winners. Neither maximizing winners nor minimizing losers is necessarily enough. It’s all in the balance.
In the highly-valued market we’re in today, which still has some speculative elements within it, there are plenty of opportunities to make mistakes that lead to losses.
But there are also plenty of opportunities for profit. Most of the stocks in the Russell 2000 are down for the year, for example, and many of the small and micro-cap investors we follow think this is one of the better opportunities they’ve ever seen in that space.
In most markets, but especially in the current environment, getting the balance between offense and defense approximately correct will make all the difference.
Tweets of the Week
In Case You Missed it…
Fewer Losers, or More Winners? - by Howard Marks
The Vigilant Investor’s Guide to Success in Stocks & Life w/ Chris Bloomstran (video)
Do Diligence: Navigating the Due Diligence Process to a Deal
Spinoffs Have Dramatically Underperformed. Here’s How to Profit from Them.
The 10-K Podcast: Berkshire Hathaway - 1976 Annual Report
Against the Rules: On Background Podcast: The Case Against Sam Bankman-Fried
The Social Radars Podcast: Brian Chesky, Co-Founder & CEO of Airbnb
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