Source: IN Coffee
Author: Smart Investors

The latest memo issued by Howard Max on April 17 talks again about risk.

He said understanding risk is essential.

In fact, if you look at Howard's many years of memorandums and speeches, you'll find that he spent more time discussing risk and how to limit risk than discussing how to achieve a return on investment.

As Howard himself said, “In my opinion, risk is one of the most interesting and challenging aspects of investing.”

Including “The Most Important Thing About Investing,” which he wrote, which is regarded as a must-read book by investment circles, there are three chapters that talk about risk.

Oak Capital, founded by Howard, regards risk control as the only one. In fact, there is his consistent strong logic behind it: at the end of the day, the investor's job is to take risks wisely for profit.

Being able to do this excellently is what distinguishes the best investors from others.

This is also an important background for understanding Howard's 3,000-word essay “Risk is Inevitable.” It is worth mentioning that

Smart Investors (Capital-Nature) sorted out 30 golden sentences of Howard Marx's views on risk over the years and shared them with everyone.

At the same time, we have also carefully translated the full text of this memorandum. The reason is very simple, but the thinking logic is very interesting, so I recommend reading it carefully.

01 Volatility is not a risk per se

1. Risk is the possibility of loss.

2. If we avoid losses, profits will come uninvited.

3. Investment risks are largely unobservable in advance, except for those with extraordinary insight, even after they have withdrawn from the investment. Because of this, many of the financial catastrophes we have seen have not been successfully predicted, and people have failed to manage risk well.

4. The cornerstone of an excellent portfolio is risk control, which is a great and hidden achievement.

5. The biggest challenge in investing is to control uncertainty while still maintaining huge potential for growth.

6. I don't think risk is measurable, and I don't think it was absolutely applicable in the past.

7. Investing is about only one thing, coping with the future. No one can accurately predict the future, so risk is unavoidable, and dealing with risk is an essential (I think most fundamental) element in investing.

8. When considering an investment, investors must first determine the risk nature of the investment and their own tolerance for absolute risk; secondly, determine whether the return on investment is commensurate with the risk they bear; third, they must clearly understand the concept of “risk-adjusted return.”

9. If a riskier investment can reliably produce higher returns, then it's not really risky!

10. Higher risk investments are only associated with increased uncertainty and increased probability of loss, leading to more uncertain results.

11. Volatility is not a risk per se. Risk is the probability of an adverse outcome, and volatility is at best an indicator of the presence of risk.

02 The biggest risk is thinking there is no risk

12. The greatest investment risk lies where it is least easily detected, and vice versa.

13. The riskiest thing in the world is that people feel there is no risk, because when people think there is no risk, they risk doing many things, thus making the world a risky place.

14. When others engage in high-risk behavior, we need to act more carefully.

15. When everyone believes that something is risk-free, the price is usually driven up to the point where it contains huge risks.

16. When everyone believes something is risky, their unwillingness to buy usually lowers the price to the point where there is no risk at all. Widespread negative opinions can minimize risk because all the optimism in the price has been removed.

17. What determines whether your investment is risky is not what you buy, but at what price. A good investment isn't about “buying good”; it's about “buying well.”

18. Only in difficult times can we discover which investments are risky and which are not.

19. “This time is different” are the 5 most dangerous words in the investment world. In particular, when market prices reach extreme valuation levels in history, they are even more dangerous, but at this time, there are a lot of people who say “this time is different.”

20. Risk is best assessed through subjective judgment rather than modelling; risk cannot be measured through measurement. This must be the field of experts.

One way of saying it is to prefer vague accuracy over exact mistakes.

21. Think about it, if you have a car and your car is insured, and nothing happened in the past year, would you feel like you've wasted money on insurance? If you have a brain, you must always have insurance, but hopefully you'll never need to use it.

The same goes for risk control, in my opinion.

03 Taking too little risk itself is also a risk

22. The reason why outstanding investors stand out is simple. They have an excellent sense of the probability distribution that governs future events, so that potential returns can compensate for potential risks, thus achieving “asymmetry.”

23. Understanding the difference between risk control and risk aversion is critical for investors.

24. Risk aversion basically means not doing anything that has uncertain results and may have negative effects. Essentially, however, investing is about seeking attractive returns while withstanding uncertainty.

25. Risks you are aware of, risks you can analyze, risks you can diversify, and risks that will be richly rewarded... Risks like these don't have to be avoided.

If you have real insight, you can be careful to take such risks and profit from them.

26. If your serve never goes out of bounds, then your serve may be too careful and difficult to win. The same goes for investments.

27. Risk avoidance is likely to lead to avoidance of reward. Taking too little risk is also a risk in itself. Most people understand this intellectually, but due to human nature, few people can accept the view that being willing to bear some losses is the only way to invest successfully.

28. Risk-averse individual investors may ultimately receive insufficient returns to support their cost of living. Professional investors, on the other hand, may not be able to meet customer expectations or benchmarks if they take too little risk.

29. The more we trust our own judgment, the more confident we are in our ability to make decisions. The courage to take risks is worth pursuing in itself.

30. The bottom line for pursuing a return on excess investment is clear: you can't expect to make money without taking risks, but you can't expect to make money just by taking risks; you have to sacrifice certainty, but you must do it with skill and wisdom, and remember to control your emotions.

Attached is the latest memorandum:

“Risk is indispensable”

By Howard Marks

Many times, through analogies, we can better understand what interests us and clarify the point by relating it to other parts of our lives.

That's why in the 40 years I wrote the memo, I linked investment to sports every year. In the 200 memo, I also compared investing to playing cards.

I was inspired to write this memo by my partner Bruce Karsh (Bruce Karsh) of an article published in the Wall Street Journal on April 12, entitled “Chess Teaches People the Power of Sacrifice.”

The writer is chess master Maurice Ashley (Maurice Ashley), who was inducted into the US Chess Hall of Fame.

Few people know Bruce is a chess player; I've forgotten this for years. But this article gave me a good reminder to write down this memo.

As you can clearly see from the title of the article, this post is mainly about the role of “sacrifice.”

Ashley said, “If you don't give up something of value, you can't win or keep many situations, such as humble little boys and powerful queens.

By “sacrifice,” Ashley refers to the deliberate loss of pieces as part of a chess game plan.

He described some sacrifices as “false” sacrifices (a term coined by chess master Rudolf Spielman in his book “The Art of Sacrifice in Chess”).

In other words, “it is easy for people to see that discarded pieces will bring specific benefits that can be clearly calculated”.

There are also some that are considered “real” sacrifices.

In other words, “the benefits of abandoning a piece are neither immediate nor visible to the naked eye. The return on investment may be controlling more space, creating an attackable weakness in the opponent's position, or having more pawns in a critical attack area”.

In this way, we can clearly compare it to an investment.

Buying 10-year US Treasury bonds is a modest or “false” sacrifice. You gave up the right to use the funds for 10 years, but this is only an opportunity cost, and accepting that it also brings a definite interest income.

However, most other investments involve real sacrifices, risking losses in pursuit of “neither direct nor tangible benefits.”

Ashley went on to talk about sacrifice in risk/benefit terms that investors are familiar with.

He talks about his mother's decision to leave him and his two younger siblings and go to Jamaica and the US at the age of two in order to have a better life for herself and her two younger siblings. After 10 years, she achieved her goals, brought her kids to America, and achieved success in all walks of life:

This doesn't have to be the case. This is because she is willing to accept the key element of making real sacrifices: willing to take risks.

For chess players, risk is both intuitive and calculated. Due to the intrinsic complexity of chess games, it is almost impossible to assess with certainty whether a step of adventure will ultimately pay off. It depends on whether players are equipped enough to take risks.

We know that the famous phrase “no risk, no reward” is true in many situations.

Highly skilled opponents are usually able to handle steady and conservative punches, so they can take away the opportunities inherent in our situation. As five-time world chess champion Magnus Carlsen (Magnus Carlsen) said, “Being unwilling to take risks is also an extremely dangerous strategy.”

This is: the indispensability of risk.

01 Risk of not taking risks

Because the future itself is uncertain, we usually have to choose between the following situations:

1. Risk avoidance, but there is little or no benefit;

2. Take moderate risks, but only obtain corresponding moderate benefits;

3. Undertake a high level of uncertainty to pursue significant gains, but accept the possibility of permanent major losses.

Everyone wants to get huge returns with very little risk, but the “efficiency” of the market, that is, no other players in the market are fools. So this possibility is minimal.

Most investors can do “a” and most “b.” The challenge of investing is to pursue some version of “c.”

To obtain high returns, whether in absolute terms or in relation to other investors in the market, you must take a meaningful risk: either you may lose money in pursuit of absolute returns, or you may not perform well in pursuit of excess returns.

In every situation, the two are inseparable.

As Ashley said, without risk, there is no reward. Without pain, there is no gain.

The risk inherent in not taking enough risk is very real.

Risk-averse individual investors may end up receiving returns insufficient to support their cost of living. Professional investors, on the other hand, may not be able to meet customer expectations or benchmarks if they take too little risk.

Like chess (and most card games), backgammon also involves calculating when to take risks and when to take refuge.

In backgammon, two players move pieces on the board based on a pair of dice thrown. One side moves clockwise and the other side counterclockwise. When players' pieces are close to each other, players who move the pieces often have to choose between the following two situations:

(a) Land on the opponent's piece and return it to the starting point (although it may leave moving the piece in a vulnerable position); (b) avoid doing this for safety.

No one wants to expose themselves and get hit on. But most beginners are too safe to play because they put too much emphasis on avoiding getting hit, so they rarely win.

Relevant experience in sports (including in past memos) is easy to obtain and very helpful:

“You'll make a mistake with 100% of your shots.” —Wayne Gretzky, National Hockey League Hall of Fame Member

“You have to give yourself a chance to fail.” ——Two-time NBA champion, “Jets” Kenny Smith

In my September memo “Reduce Losses or Increase Profits” in September of last year, I stated the true meaning of sacrifice and risk:

“Not investing in any losers is not a viable goal. The only surefire way to achieve this goal is to not take any risk.

But as I mentioned earlier, risk avoidance is likely to lead to avoidance of reward. Taking too little risk is a risk in itself. Most people understand this intellectually, but due to human nature, few people can accept the view that being willing to bear some losses is the only way to invest successfully.”

02 How to view adventure

The risk-taking paradox is unavoidable. You have to take risks to succeed in a highly competitive and highly motivated field. But taking a risk doesn't mean you'll succeed, which is why people call it risk.

Paradoxically, a long-term high rate of return does not always necessarily mean a consistent record of success. More commonly, it stems from significant and well-founded investments, some of which have had good results.

In “Reducing Losses or Increasing Profits”, I also wrote:

“The reason Warren and Charlie are doing so well is simple: (i) they did a good job with many of their investments; (ii) they invested heavily and held relatively few big winners for decades; and (3) they invested relatively little in big losers.

No one should expect themselves—or their fund managers—to only invest in big winners and avoid losers.”

Investors must be aware that success is likely to come from large investments; you invest all of them because you expect them to be successful, but you know that some of them won't.

You have to do your best to hit it off.

Not every effort will be highly rewarded, but hopefully it will pay off enough to achieve long-term success.

Ultimately, this success will depend on the ratio of wins and losses, and how much the losses are compared to gains. However, in the process, refusing to take risks is unlikely to achieve the goals you want.

Finally, I'd like to close with another quote from Ashley:

Taking risks doesn't mean there will be successful results, and there's no need to pursue them. If we have good reason, we should instinctively take risks.

The more we trust our judgment, the more confident we are in our ability to make decisions. The courage to take risks is worth pursuing in itself.

The bottom line for pursuing excessive return on investment is clear:

You can't expect to make money without taking risks, but you can't expect to make money just by taking risks;

You have to sacrifice certainty, but you must do it with skill, wisdom, and remember to control your emotions.

Editor/Somer