03 – THE REGULARITY OF CYCLES – Mastering The Market Cycle

The world is full of randomness and people behave differently at different times so that it is difficult to predict the exact future. If we study the science and mathematics cycles then those have predictable sets of rules and moves in a regular way. But economics, companies, and participants are relying on the psychological influences so that they do not behave in a regular way. When emotions have an involvement then things become more difficult to predict.

So that Greed and Fear of the investors remain regular in every cycle. This affects the prices of the assets.

As per the Cambridge dictionary, the definition of cycle “a group of events that happen in a particular order, one following the other, and are often repeated.”

We can see that many factors affect the occurrence of the events and that makes it difficult to predict the exact for the future. Current global scenario, we have an ample number of factors that can affect the cycle such as crude, the decision of the USA, domestic economic conditions, etc.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

Mastering The Market Cycle – 01 – WHY STUDY CYCLES?

After the completion of the Bibliophile series on the book “The Intelligent Investors” by Mr. Benjamin Graham; I am hereby starting a series on the book “Mastering Market Cycle” by Mr. Howard Marks. I have already completed bibliophile series on his first book – “The Most Important Things”. He is one of the investors to whom I admire and learn about the cycle and always get to protect my wealth while nobody thinks about it.

As the cycle getting change, our odds also start getting change. It is mainly depending on our position to the cycle at where we stand to the cycle. If we are standing in a favorable position then we can increase our bets and reap the benefits of the cycle. Similarly, in unfavorable situations, we can protect ourselves from unfavorable changes in the cycle. If we are standing at unfavorable situations then we can adjust our position.

If we have the same information as others have and we analyze as similar to them then we cannot outperform the mass. Consistently outperform the mass is already a difficult task to perform.

Mr. Buffett has mentioned regarding the desirable piece of information – it has to be important, and it has to be knowable. Macro definitely affects the market so knowing it helps. But for consistently outperforming through knowing macro is difficult.

When we are constructing the portfolio then we generally look at the difference between price and value. Also, we bought the company which has the highest value I. E. Company available at a discount to its value.

So, does it not look at the quality of the company?

Yes, it is right that for successful investing, we need to identify the company which understates the value proposition. Higher the upside, we can take a position accordingly. But if we adjust our position as per the upcoming market storm then it can be more profitable and can add further value to our investment journey. This estimation of the upcoming market situation helps us with the decision making to remain aggressive or to be defensive in our portfolio. We only make an aggressive /defensive decision when we know the investment environment and where we stand in a cycle. When we get investment opportunity at cheaper, discounts to value then we should be aggressive and when getting expensive, then we should be defensive.

Similar we can do for the midcap and small-cap universe. And prepare ourselves from an upcoming cyclone.

We all talk about the risk but what actually risk mean? It can be loss of capital, academic says the risk is volatility in the price of assets. So, Mr. Marks has explained the types of risks in a good manner.

Opportunity loss, this is a missing out a potential gain, our investment has underperformed compared to what we missed and things do not happen the way we want it.

Risk means the occurrence of more things than we have predicted. If we know what is going to happen then there will be no uncertainty or not any risk. And if things are certain then we also get certain returns such as bank deposits. We cannot surely know the outcome of the events but we can assume the probability of the occurrence of the events. We assume the probability of the events that does not mean that we know the occurrence of the events. Anyone event can occur out of the many events. When we do not know the occurrence of the events, then we do not have an edge and we have to stay depended on luck. When we have the knowledge of the occurrence of the events then we have an edge and winning probability will increase with lower down losing probability.

Superior investors are attentive to cycles and they capture the cycle for reaping profits.

When a cycle is in our favor, we can earn good profits by taking benefits of it and visa Versa, when the cycle does not favorable to us then we can protect ourselves for loss of capital.

When cycle at extreme of Greed then we have to protect ourselves from capital loss. There will be a higher chance of incurring losses rather than earning profits.

If we look at the P/E of Midcap and Small Cap index during the year 2017-18 then on the closing basis it was 37.22x and 86.19x respectively and high P/E of both during the same period was ~47x and ~114x respectively. At such valuation, we are not ready to buy a few growing large caps but having a huge hope of getting a return at such high valuation and transformation of small-cap as a future large cap. So that such a scenario is for protecting capital rather than chasing high returns. I had parked ~73% of my portfolio in the liquid fund during the same period which has helped me to survive in such cyclone. We need to focus on the cycle, pendulum where it is moving and where we stand in the cycle.

When in a similar cycle economy, corporate profits and prospects remain the same but pessimism among the participants provides an excellent opportunity to make an investment, increase our position to be more aggressive. And when the economy, corporate profits, and prospects remain the same but having a huge optimism among the participants then we should adjust our position as a defensive investor.

When our position in the cycle changes, our odds also get change and if we do not change our investment accordingly then we miss the opportunity to enhance return or protect capital.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

One of the books which have influenced me and my investment journey is “The Most Important Thing by Howard Marks”. This book teaches us the most important thing which we need to develop for becoming a wise investor.

“The Most Important Thing” has many concepts which can help us to our investment journey. I have posted articles on the book. Now, I have compiled different articles into the one file for the ease of reading.

For, All in One Article click – BIBLIOPHILE THE MOST IMPORTANT THING BY HOWARD MARKS

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “ADDING VALUE”

If our target is to achieve returns similar to the market returns with the similar risk & reward scenario then it’s not a difficult task. We just need to buy an index fund. But if we want to add a value to our targeted returns, different risk & reward scenario then we require a superior investment skill, superior insights which we have seen in second level thinking.

For the understanding, what actually mean for skillful investors to add value, we need to understand Beta – portfolio’s relative sensitivity to market movements. And Alpha – ability to generate performance unrelated to the movement of the market (I.e. personal skills).

While we are active investors then we have a number of options available to us.

1) We can decide that whether to build aggressive or defensive portfolio compared to the index, such characteristics of the portfolio is for temporary situations or for permanent. If we build an aggressive portfolio then it will increase a systematic risk of the portfolio that is beta.

2) We can make a decision to get deviate from the index. We may buy few index stocks and exclude others or add stocks which are not the part of the index. As such portfolio gets diverted from the index so that return of portfolio also get deviate from the index. But in a long-term, the return of investors with superior insights will cover index return and can able to add value in terms of risk-reward scenario.

If we are managing our portfolio actively then we require having a second level thinking skill. If we do not have such superior insights then it is advisable to go with a passive investment. We need to shift a portfolio from aggressive or defensive as per the surrounding situation and need to avoid a frequent trades with the belief of generating a higher returns.

Different active investors hold different portfolios, some of those portfolios perform better than others portfolio, and some of the portfolios perform well during some particular time period. In a longer-term, active investors with superior insights can able to generate an above average risk-adjusted return. Combination of all different active portfolio reflects market behavior but in fact, all of those portfolios having different features.

Aggressive investor’s portfolio can able to generate a higher returns compared index in a good time and lose more compared to the market in a bad time. This volatility is measured by beta.

If the Investors who generate higher returns with risky portfolio compared to other investors who generate average returns with low-risk portfolio then always we need to put more emphasis on the risk-adjusted return. But we cannot quantify each and every risk involves the portfolio. So that we need to accept that investment skills having an existence though everyone does not possess it.

If we don’t have any investment skill then we can able to achieve index return by making an investment in the index fund. Some of the investor’s portfolio fluctuates more compared to benchmark and few of the investor’s portfolio moves near to benchmark returns and few others can able to control risk and fall less. We get a different result at the different market scenario but our core focus should be on controlling risk and able to generate a risk-adjusted return.

In bad years, defensive investor’s lossless and in good years, aggressive investors make more money. So can we say that they are adding value? We cannot able to say anything about the value added by just seeing to the one-year performance of any investor. We can able to see the value added in a long term only.

Mr.Buffett, Mr.Howard Marks have mentioned that they like to increase average in good years and fall less in bad years. This provides them an advantage to adding value over a longer period of time. Protecting ourselves against the worst period is essential compared to the beat into the good period.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AVOIDING PITFALLS”

We have seen in all article series of “The Most Important Thing” that Mr. Howard Marks is always keeping focusing on the avoiding losses. If we can able to avoid losses then our investment success will come to us.

When we are going to focus on the risk and avoidance of risk then there is a chance of under-performance of our investment portfolio during the bull phase of the market. But also we can able to get protected from the worst situations coming into the future. We can able to get survived into the market for a longer period of time.

For avoiding losses, we need to avoid the pitfalls which invite the losses. And sources of pitfalls can be analytical/intellectual or psychological/emotional.

Looking at the analytical/intellectual error – such error occurs while we collect too less information, uses wrong analytical methods, wrong approach, computational error, etc. Such errors wrongly direct the result and tend us to make a wrong decision.

One type of analytical error which is called by Mr. Howard Marks is “Failure of imagination”. This error means we cannot able to imagine or little in imagine full range of outcomes or not understanding consequences of occurrence of the extreme events.

“Failure of imagination” is the inability to understand the different range of outcomes in advance. In investing, we need to be dealing with the future and many a time, we try to assume that future will be similar to the recent past.

Most of the time future looks like the past so assuming it does not harmful to us. But what happens while future will not repeat the scenario as similar as happens in the past, either we have to lose huge money or no money made by us.

Events might occur or might not occur or it take times to occur compared to what we have assumed.

While we largely depend on the certain outcomes to happen in our investment then not occurrence of those events can kill our investment. So that we should always try to focus that if certain events do not occur then also we should not lose our huge money. We should focus on controlling our risk.

During sub-prime crisis also things do not work as it should work which resulted in a global meltdown. During sub-prime also investors believe that risky situations do not go to happens and securities are backed by assets based mortgage which encourages the risky behavior of investors. Majority of the investors did not expect that value of backed assets also can befall.

We should make an investment which can protect us against deflation and hyperinflation situations. We should not always a stick to the cash, treasury or gold to avoid pitfalls. But as a when requires, we should shift from defensive to offensive and offensive to defensive.

It is important to avoid pitfalls but there must be a limit which differs from each and every investor.

Psychological factors are most interesting sources of investment error. These factors tend to extremely high or low prices of an asset, sometimes very irrational. (My Article on Psychological errors – BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “COMBATING NEGATIVE INFLUENCES”)

One of the psychological factors is GREED. Excess of greed tends to be higher security prices. We want to make a more money and for that, we keep on buying an asset though it’s price trading at a higher range. We believe that assets will keep on appreciating into the future.

The second psychological error can be an error of not noticing. Sometimes we have a plan to steadily invest in the stock market. And we ignore the undisciplined buying by others has created a boom.

The third error can be not consistent with doing a wrong thing but failing to do a right thing. Average investors just being a fortunate enough by avoiding pitfalls. While superior investors avoid it and also take an advantage of it.

Our psychology resists us from accepting novel rationale and keep believing that “It’s different this time.”

The way pendulum swings, people forget to be skeptical every time rather believe that things keep on doing well.

The combination of Greed and optimism lead us towards the adoption of strategies which provides a higher returns without taking a higher risk. Pay higher prices for the securities with the hope of still left with an appreciation.

Just knowing about the pitfalls provide helps to us to some extent but the implementation of it leads towards success.

We should always learn the lesson and remember it throughout our journey. Mr. Howard Marks pointed out eleven lessons such as –

We should always be focusing on the things surrounding us. Excess supply of investment funds will lead to the situation called – “too much money chasing too few ideas”. Such situations can be dangerous for our financial health and we need to be careful during such situations.

When people become careless, investors not worried or skeptical about events, everyone becoming more bullish, increasing leverage. But we have to always keep in mind that such scenario will be going to reverse, it will never remain forever of the same magnitude.

It is near to impossible to avoid downfall but we can able to reduce our pain.

When we loss less than others then it provides a benefit to us such as we can able to maintain equanimity with others, able to avoid a psychological pressure and can able to generate higher profit by buying at a lower price.

Surviving during the declines provides us an opportunity to buying an asset at the low price. But for achieving success through this formula, we need to avoid pitfalls.

The way errors can appear to us is infinite but some of them are quoted by Mr. Howard Marks. Such as data or calculation error in the analytical process, ignoring the full range of outcomes or probability of occurrence of events, psychological factors (I.e. greed, fear, envy, ego, etc.), extreme risk-taking or risk avoidance behavior, etc. The second level thinkers can able to understand errors and also can able to detect over or underpriced assets. They can take a proper benefit of it and also take benefits of errors from others.

Errors are moves around us, sometimes assets prices reach a higher level or reach the lower level, sometimes such extreme scenario happens with entire market, sometimes to individual securities. Sometimes an error occurs while we do something and sometimes doing nothing leads to an error. So that error is around us and without any errors, there will be no occurrence of any events.

All above-discussed points don’t indicate rules for avoiding pitfalls but it provides us an awareness, flexibility, adaptability, and mindset to take the cue from our surrounding environment. There are times where few of our acts resulted in errors.

And sometimes reverse to such acts.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “INVESTING DEFENSIVELY”

Whenever someone asks us for an investment advice, then our first step must be an understanding his attitude towards the risk and return. We need to ask a question to him that what his choice – making money or avoiding losses is.

We cannot able to do both the things simultaneously in each and every situation.

If we provide an advice or we make an own investment without knowing attitude towards risk and return then we will not able to provide a proper solution. This is as similar as an asking for a cure from a doctor without disclosing our diseases to him. Investing is a full of bad bounces, uncertainty and random events which challenge us every time. So that such uncertainty requires knowing our risk-reward attitude for long-term survival into the market.

While we hit fewer losers then our probability to win the game is much higher. We need to choose how to play the game of investment – Offensive or Defensive.

We just need to do is to protect our wealth by not picking wrong opportunities. In investing, only avoiding losers is in our control, not everything else. We do not know what will happen in the future, our best investment can be turnout as the worst investment. But we have to be ready for it. We have to focus on missing wrong shots so that can protect game if our best turnouts as a worst.

If we look at the sports, many a time we need to protect our wicket rather play aggressively to make scores. Staying on a pitch provide us an opportunity for making a score while we get a good hitting opportunity. Investing also having many points which are similar to the game either positive or negative. As in cricket, Dhoni, Sachin, Rahul Dravid, Virat all having a different style to play a game. Some play defensive, some play aggressive and some make the balance of it. We cannot able to judge any players by looking towards his one match. Successful players perform well over a longer period of time with consistency.

Sometimes even a good players overestimate short-term success and forget to focus on the consistency of performance over a longer period of time.

As all players cannot be a Sachin, Dhoni, Dravid. As similarly, all investors cannot be a Warren Buffett, Charlie Munger, Howard Marks, etc. We just need to focus on our game in our comfort zone.

We are not able to know what will the result of the game we played, any uncertainty can affect it. We cannot only focus on one single investment ideas, we need to work on a selective group of ideas.

Negative side – If we keep on playing an aggressive investment game then we might not able to stick for the longest period of time in the game. Many uncertain events work as bounces for us.

Many a time, short-term investment success can become a reason to ignore the durable and consistent track record of investors. And few get attracted towards shine without checking its durability.

When opponents try to keep on throwing bounces then referee blows the whistle to give warning sign to opponents but in investing, there is no one who blows the whistle, we cannot able to get protected. Also in sports, we get notifications for the change of turn from our to opponents. But in investing, there is no notifications are available to us. We have to decide ourselves for changing the game from offensive to defensive.

We need to focus on the outperform into the bad time rather focus on outperforming into the good & best time. In good time, everyone can able to generate a good return but skill comes when we can able to outperform into the bad time. Doubled your Money in Last 3 Years? Skill or Luck?

Every player can able to play well against a weak team but a good player who can able to play well against strong opponents.

We should focus on either making more score or stay on the pitch for a longer period of time. We cannot say that only one way is the right way and we just need to select it. Selection of way can be based on our experience, learning, market environments in which we operate, etc.

We require a different kind of mindset for doing a right thing and avoiding doing the wrong thing.

Defense is focused on avoiding bad outcomes. It can help us to generate a higher returns but more through avoiding bad outcomes, through missing bounces, through managing risk.

If we bought an asset at Rs.100 and it falls to Rs.50; it falls by 50% but for reaching to Rs.100, that asset has to rise by 100% to just reach break-even.

When we play offensive and if it works then it will add additional returns to our investment. BUT if not works then it creates a damage to our investment and to our wealth.

Defensive game help us to stay in the game during a tough time also, it helps us to survive for a longer period of time.

Majority of a time, financial markets works in an average manner but it shows one abnormal day which has reason to destroy our financial health. We need to prepare for that worst day. We just can prepare for the worst day but cannot predict how worst it can be or when that worst day will come. But it’s sure that worst day will come.

It is hard to say in investing that whether our investment becomes successful or not and it works in the future as we have expected, economy /industries / Companies moves in a certain way and we prove to be right every time. We need to take care of the unforeseen future events which can go against us and can meltdown us. Warren Buffett has given concept which can protect us from such unforeseen events that called “Margin of Safety”.

When we buy Rs.100 worth of an investment for Rs.90 then we have a chance to gain. But when we buy that same thing at Rs.70 then we have very less chance of loss and if odds will be in our favor then we can able to make a good return. So that buying cheaper provide us a “Margin of Safety” when our assumptions go wrong.

In the over-optimistic scenario, people buy Rs.100 worth of investment avenue for more than its worth (I.e. Rs.150, Rs.160) and then find a greater fool who will buy at the higher price from him.

When we need an above-fixed returns then we need to go for more uncertainty but how to balance the defensive game with the inclusion of offense is the key area to focus. We cannot get higher returns with the exclusion of offensive game. We cannot able to win the match by just keep on making a single run. We need to hit 4 & 6 but with also focus on not losing a wicket.

Our first focus is to play a defensive game for staying on the pitch and then the inclusion of offense to the game for generating higher returns. Such approach provides us a consistency for a longer period of time.

If we take out a history of investment managers, investors then we will come to know that very few get survival for the longer period of time. Not due to their inability to make a 4 & 6 but to lose wickets in many matches. Many investors come and performed well in a good time but worst time make them disappears.

The managers who do not get survived for a longer period, the majority of them have built up their portfolio on based of favorable scenario and with the hope of likelihood of outcomes without keeping a room for the occurrence of an error.

Aggressive investors require competitive technical skills with fortitude, patient mindset, and capital. The investment might have potential to work well in a long-term but above quality provides a support to stay in a game for a long term.

We should focus on controlling risk, avoiding losses rather than try to focus on gaining again and again.

Simply defensive investing means being scared while making an investment decision. Worrying about losses, bad luck, worrying about something we don’t know, bounces etc.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “APPRECIATING THE ROLE OF LUCK”

While we involve into any of the investment decisions then those decisions are having dependencies on the future. As we know that future is uncertain and it is difficult to predict it. In such uncertain investment environments, luck plays an important role and we have to recognize the role of luck in our investment journey.

When we get some result or looking at the result then we must have to think the role of randomness in that generated result.

Many outcomes are visible to us but we have to think those outcomes with different viewpoints. If someone has made a risky & uncertain investment and he gets a good outcome from it. We can say that such outcome happens due to luck not due to skill. But people take such outcome as their skill, not consider a role of luck.

For example, baller throw ball towards stump for capturing a wicket of the batsman and that becomes the wrong throw and ball has touch boundary line then it is not a skill of batsman but the role of luck.

Many times, people get the return on investment by just being in the right place at a right time. Not due to their skill.

If someone has invested his fund during the year 2013 with just making a portfolio with random stocks then also that person generated a good return. Doubled your Money in Last 3 Years? Skill or Luck?

In short term, we can able to generate a good return and many a time achieved an abnormal return by just being in the right place at a right time. But what about the long-term result? How we can say that luck always keeps on favoring us.

Generally, during a boom period, the person who takes a higher risk get highest returns. But that is not the reason to consider them as the best investors. Very few people appreciate the role of randomness or luck in the life or in investment journey.

Mr. Taleb has mentioned the list of things which are generally mistaken by us.

We should understand that when things going right, luck looks like a skill and people misinterpret lucky investors as skillful investors. Many a time, we get an extremely good reward by chance and we make a mistake to consider such result as our skill.

That means batsman hit ball for six and that ball also declared “No ball” and batsman get free hit and he again hit another six on a free hit.

In short run, we can win and make good returns by an occurrence of chances but in a long run, our wise decision provides us a good reward.

When we realize that investment outcomes get an influenced by the randomness then we can able to focus on every event with the different perspective. Otherwise, we just thought that such outcomes happen due to our skills only.

We have made a list of assumption for the occurrence of events but we also should focus on the occurrence of other different events; which we may not have assumed. It might be possible that sometimes all other events have collectively more probability to occurred compared to the single event on which we have put the huge focus. Such ignorance becomes dangerous for our financial health.

Investing something like a mixture of both skills as well as luck. Investing is not a pure luck like a snake and ladder game or not a purely skilled by the game of chase.

While we play chase then we require a skill to protect ourselves from moves of an opponent’s. We cannot able to win chase just by waiting for the favor of luck and mistake made by an opponent. We have to create a scene where opponent commits a mistake and we can able to win a game.

Whereas, there is not a requirement of a skill in throwing a dice while playing a snake and ladder game.

But we generally consider our winning as our skill while we should recognize that we are winning a snake and ladder just due to a support of a luck. While we should reach towards 100, we should not forget that there is a snake on 99 number which can bring us towards number 7. And transform our success into failure due to highly dependencies luck. Similar happens to us while we play an investment game on the base of pure luck. We may win till number 98 and maybe that our fortune transforms into failure by destruction in our wealth. We climb many ladders, get many multifold return generator stocks but we forget that such occurrence is due to luck. If we do not have our skill involve in it, then our wealth get destroy. We should not forget that investment requires a luck but also it requires a skill. If we fully dependence on the luck then we should never forget a snake on number 99.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “HAVING A SENSE FOR WHERE WE STAND”

Some category of people does not accept that cycle is unpredictable and largely unknowable, and those people put efforts for predicting the future. Few people ignore the cycle and adopt the buy & hold approach. They do not get aggressive or defensive with their investments in the cycle. Many people have wrongly understood the statement of Mr. Warren Buffett – “Our favorite holding period is forever.”

And the last category which is an appropriate approach for the investment. Such category of people accepts that cycle will occur. Everything moves in a cycle. Fundamental, psychology, prices, etc all moves in a cycle. We cannot able to know when existing trend will go, get the stop and start getting reversed. But we need to be confident enough that trend will stop sooner or later. No trend continuously keeps on going forever.

So that we should try to know where we are standing in the cycle rather than to predict timing and extension of the cycle.

By knowing where we are standing at the cycle, we cannot able to know what will be going to happen in the coming future. But we can prepare ourselves with a probability of occurrence of events.

I can’t change the direction of the wind, but I can adjust my sails to always reach my destination. – Jimmy Dean

Knowing present environment is not much hard compared to knowing future. We can come to know the present environment by observing the behaviour of participants around us, by observing our surrounding environment.

We have to focus on everyday events prevailing to the market. Such events provide us a rough idea of our position at the cycle.

When everyone is aggressive in buying a particular asset then we must have to take care and be aware of the upcoming risk. We should be aggressive in buying a particular asset while everyone is in panic and selling particular assets.

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” ― Warren Buffett

We have to look around and think it by ourselves regarding present situations and make a decision that where we are standing in the cycle. What is market participants doing? What media is talking? Such questions need to be answered by looking at situations around us.

When too much money getting deployed into few assets then huge liquidity drives prices of an asset, such price momentum is not due to its actual fundamental. And also at the higher valuation people are ready to buy an asset aggressively. People are ready to buy Rs.100 worth of asset at Rs.200-300-400…. With the bright future expectations.

We cannot predict when huge liquidity gets dry but as a contrarian investor, we can prepare ourselves for upcoming risk.

We need to check which side majority of our answers falls and as per it, we can make an estimation of the present situation. And can able to prepare ourselves for the situations. When a majority of our answers falls at the happy situation then we have to be cautious towards the present scenario and vice-versa.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “KNOWING WHAT YOU DON’T KNOW”

When we concentrate on the small part of the things then we acquire more knowledge regarding particular aspects. We need to work harder and harder to develop our skills by which we can able to know more than another person. Enhancing knowledge will be work like an edge for us to knowing our positions better than others.

Also, we try to identify that where we currently stand, what’s our actual position so that we can prepare ourselves for the further development.

When we predict upcoming changes then we can able to earn money from participating in that changes. But if we have predicted something which is not going to change then it will be near to impossible to earn money. If things do not go to change then we cannot able to earn money by taking benefits of those changes.

It’s very difficult to forecast future and people generally forecast future with regard to what has happened in the past.

So that forecast can get right some of the time but it should be consistent in the getting right every time which can be very difficult.

Some of the people stick to always bullish or always bearish view and keep that view for a longer period. So that sometimes they get right with their forecast. It does not mean that their forecast will be right all the time. If you toss coin 100 times then there are a half of the possibilities to get the head of the coin. We cannot say such outcomes as a consistent outcome.

We have to check that how many forecasters have predicted meltdown of subprime crisis or again boom was driven due to huge domestic liquidity currently.

Forecasters are called as “I know” school of investors. They are more confident about the future and the things will work out as per their assumptions.

“I don’t know” group of people can able to guard themselves while they have to deal with the future at the macro level.

We never want to invest for the future which is largely unknowable and on the other hand, we need to face unforeseen future without forecasting the future.

The biggest problems arise when we forget the difference between probability and outcomes. We cannot surely know the occurrence of future events but we can know the probability of the occurrence of the events. When we forget the difference between probability and outcomes then we start predicting future events with surety.

Investors who ignored such limitations then they make mistakes in their portfolio and also incurred huge losses. Events do not always occur as per our assumptions and we have to be ready for it.

When we do not know the future then we act in a different manner such as we diversify, hedge to the position, taking less leverage, focus on today’s value over a future growth, etc. On the other hand, while we feel that we know the future or future event will occur as per our assumption then we start taking more risk, taking more leverage, play on making an assumption of bright future. If we know the future then we play an aggressive game. We not take a diversification and take a huge leverage.

When we know that there will be no obstacle comes to our way while we are driving then speed, carelessness will increase. And on the other hand, when we know that our way is clear but any obstacle can come on the road anytime then we drive the vehicle more carefully with a speed which we can able to control. Similarly with the investment, when we believe that future is knowable then we behave for investment in a different way and when we believe that future is unknowable then also we behave for investment in a different way.

As the road is clear while we are driving but anytime any vehicle can come to that road and we can able to meet an accident if we do not have a control over our driving. Similarly, if we do not have a control over our investment then any unforeseen event can destroy our wealth. We need to wear a helmet while driving for controlling risk and also take proactive steps while making an investment for guard ourselves against unforeseen accident.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “PATIENT OPPORTUNISM”

We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment.

We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment. We should not be going for chasing an investment rather we should wait for investment opportunities to come to us. When we are chasing an investment then it might happen that we might not get an opportunity at a bargain. We only get bargain where the seller is motivated to sell and such opportunities provide us a bargain.

Every time a great bargain will not be available, cycle – pendulum not at an extreme where we can go against it. Many a time, Market situations are balanced and fairly priced. In that case, we have to make an investment decision from what is available to us.

In cricket, we do not try to hit each and every ball. We try to identify proper pitch to hit and till that opportunities, we just need to wait for a proper pitch or just keeps on rotating strikes.

Same with the investment, we should always wait for the proper pitch which is in our competence area and then needs to hit on it.

In investing, the penalty is the loss of our capital. And if we try to eliminate such possibilities of getting penalized then, of course, we only remain with the rewarding investment opportunities. But many a time, we also need to miss some winning opportunities for getting our perfect pitch. And that can be bearable compared to the penalty of losing our capital. Staying on the pitch is more important compared to sitting at the stadium and seeing dreams of playing well for winning the match.

We should wait for the profit-making opportunities with the control on risk. If we lost our focus on protecting our capital then huge waiting period and higher returns also might not be able to provide us above average returns.

Many a time, we get lucrative profit-making opportunities but for getting those opportunities, we need to take a higher risk and sometimes, we do not even know that we are taking a higher risk.

Generally, people shift towards higher risk investments while they do not get desire returns from the safer investments.

Before the credit crisis occurs, people tend to take borrowing at a cheaper cost and make an investment into the high return opportunities with the belief of low risk.

When prices are keeps on going higher and higher than, we cannot refuse to have a lower returns with the higher risk. Mr.Howard Marks mentioned few aspects while lower returns environments exist.

There is no easy way to cope up with such situations. One major mistake people make is reaching for the returns and forgetting the risk. Always seeing dreams for making a century in every match and forget the risk of losing a wicket before hitting a century.

When there is a low return environment then we need an exceptional skill, high risk bearing capabilities and huge luck for generating higher returns.

The major opportunities for buying an investment comes where the holder of an asset are forced to sell it. Such situations create a bargain opportunities for us. When baller is frustrated and then only there will be a chance of occurring a mistake by him and that creates an opportunity for a batsman to hit six. But for hitting a six, we need to protect our wicket and need to stay on the pitch. We get a good opportunity to make a good score when baller is frustrated and throwing lousy balls; not when he is sharply bowling and chance to lose our wicket is higher. Or batsman is frustrated and want to make score then he will lose his wicket. Similarly with the investment; we do not get good investment returns while we are frustrated and want to make an investment or all our friends are earning & we have missed out opportunities. We get good investment returns while all are negative or frustrated and we have the capability to capture the opportunity.

Sometimes question raised in our mind that seller can be well informed and rational also then why he sell something at the bargain price?

When forced sellers come to sell their assets then market requires a liquidity to buy assets at a bargain price. So that the person who is waiting for an opportunity those only can capture such opportunities.

Read for more detail: The Most Important Thing Illuminated by Howard Marks