Source: Smart investors.

Howard Marks, co-founder of Oaktree Capital, recently appeared on the interview program 'Global Money Talk', discussing some of the most important things in investing.

This is a South Korean program, so the host's questions are very different from the previous interview conversations.

This time Howard's words are truly most suitable for ordinary investors.

Especially in how to maintain a good mindset, how to make decisions based on one's own situation, tolerance, and preferences. He said there are no universally applicable principles, whether to take profits or stop losses, or to hold long term, all depend on each person's decision, depending on what they care about the most. Because when making decisions, there is no decision that is definitely right or wrong, the final result is also a probability.

1. It's difficult for ordinary people to make correct decisions based on market information.

Host: I would like to start with one of your recent memos, 'Mr. Market's Delusions'. In the memo, you mentioned that in the market, meaningless statements are often given too much weight, and a specific development can be interpreted positively or negatively based on the market's sentiment.

This reminds me of a quote by Amos Tversky: people accept any explanation that can fit the facts. In other words, price behavior can sometimes be a useful source of information.

So, could you please provide us with a "user manual" on how to use price behavior as a source of information?

Howard: Of course. But this is a complex issue, there are no simple answers in the investment world.

It is important that you quote Tversky's point of view. People always ask, why did that happen? Sometimes the answer is, there is no specific reason.

This is a kind of randomness, and also a kind of irrationality. You know, people often say, he's a good person, why did he die? Well, maybe there is no relevance.

This is a good company, why is the stock price falling? Sometimes, "who knows" is the right answer.

Not only in the investment world, but in general, people don't like to use "who knows" as an answer in their lives.

So as Tversky said, everyone tries to find an explanation, to give meaning to things.

Sometimes you can't explain it.

I wrote a memorandum titled 'What Does the Market Know?'. My conclusion is that the market knows nothing.

The market is not a genius with high IQ, but simply a collection of results voted on by all participants. Therefore, by definition, it is not smarter than average.

Nevertheless, sometimes price fluctuations are meaningful. You can consider it as a signal to think about issues and conduct research.

When you see a stock rising or falling significantly, you may try to find out if there is an obvious reason. Then try to determine whether the stock price's reaction to this reason is excessive or insufficient. This might tell you something worth doing.

However, I want to emphasize, and I will emphasize frequently, that arriving at these conclusions requires a very high level of professional knowledge, experience, and insight, which most people do not possess.

So, for the average person, seeing a stock rise by 20% in a week, then asking why did it rise? Is the 20% increase an excessive reaction or an insufficient one? Will it continue to rise? Should I buy? Most people do not have the ability to make such decisions.

If you try to do so, you are actually deceiving yourself.

2. Everyone needs to find the right strategy for themselves.

Host: In that memo, you also mentioned that there are no fixed rules in investing that can always be relied upon to produce the same results. However, investors often develop rules based on their own experiences, mainly to prevent repeating the same mistakes.

Do the rules are not perfect, but they can help investors maintain discipline. Do you have any rules you would like to share with everyone?

Howard: There is an old saying that rules are meant to be broken.

You can establish some general policies. But I think it's important to be prepared to break these rules when necessary.

For example, some people may adopt a rule like this: if you buy a stock and it drops by X percent, you should sell. This is called "stop loss."

Suppose you say, if I buy a stock and it drops by 10%, I sell. You need to consider, what does this mean? This means that if you sell every stock that drops by 10%, you will never lose 20%, 30%, or 40%.

But sometimes you run into a situation where you buy a stock, it drops by 10%, you sell, and then it goes up by 100%, you would miss out on all those opportunities.

No rule can help you deal with this situation. It's not that a 10% or 20% drop is fixed, there's no automatic rule that can both keep you safe and not let you miss opportunities at the same time.

You know, the approach I have always taken is that if you have made a lot of money, you should sell some. This way, if the peak is temporary, you won't give back all your profits.

The question is not whether the rule of taking partial profits is right or wrong, but whether it is suitable for you now.

Just like stop-loss actions, it can prevent large losses, but it may also make you miss some successful opportunities. You have to decide which point is more important to you.

This depends on your financial situation, your personality, and similar factors.

I will take partial profits, for example, sell some when it goes up by 30%, and sell some more when it goes up by another 30%.

So everyone needs to find the right strategy for themselves, it's impossible to be perfect.

Maintaining a calm mindset in both investment and life.

Dan: Recently, you had a conversation with your partner Bruce Karsh and chess grandmaster Maurice Ashley. In that conversation, Bruce talked about the importance of inner peace as an investor.

I completely agree with this point, it is indeed very important. Can you tell us how we can achieve this? This is also related to the question you mentioned about "what is right for yourself."

Howard: This is also related to my minor in Asian Studies during my college years.

In Asian Studies, there are many contents about satisfaction, inner peace, and acceptance.

Well, there is no instruction manual on how to achieve these goals. However, if you want to change your personality, which is what we are talking about, it requires deliberate practice.

You must ask yourself, how can you achieve greater tranquility? And one important point is, you cannot be a perfectionist. It is difficult to make investments perfect.

I used to have a friend with whom I often joked.

One day we decided to list all the ways you may go wrong. The first is you buy, and then the stock price drops; the second is you don't buy, and then the stock price goes up; the third is it goes up first, then you buy, and then it drops again; the fourth is you buy, it drops, you sell, and then it rises again; and the fifth scenario is it rises, you sell, and then it continues to rise.

There are countless ways to go wrong. There is only one right way, which is you buy, it goes up, you sell, and it never rises again.

But you can't always do that, right?

So you must achieve a peaceful mindset in all aspects of life, not just in investments.

You have to accept that some things you buy will fall, while others you buy will rise, and after you sell, it will continue to rise.

You can't drive yourself crazy pursuing absolute correctness, because it's simply not possible.

When I was young, I often heard John F. Kennedy quote this: "Give us the courage to change what can be changed, the serenity to accept what cannot be changed, and the wisdom to distinguish between the two."

I believe this is one of the greatest quotes.

Dan: It is very important for investors to have a conducive environment for achieving this inner peace. Have you established a culture that can maintain peace for the decision-makers of Oak Tree's investments?

Including which types of strategies you pursue, and which ones you deliberately choose not to pursue? How tolerant are you to losses and mistakes?

Howard: We are very lucky because we invest in the so-called "crediting" (credit).

The meaning of crediting is that we lend money to others, they sign a contract with us, promising to pay interest regularly, and then repay us at a certain point in time.

So our results are not entirely open, our results are defined by contracts.

Most of the time, people will keep their promises, pay interest on time, and we will also get the expected return. Sometimes they may not make payments, and as unpaid creditors, we have the right to seek solutions.

In most cases, this process can be resolved.

When you are a crediting investor or lender, the upside potential of returns is limited, unlike holding stocks like Nvidia, Microsoft, or Amazon to gain huge returns. But on the other hand, your losses are also minimal.

Well, we rarely have significant losses. So, this aligns well with my personality, as well as our company's culture and our clients' expectations.

When I joined the Citibank bond department 46 years ago, I discovered this investment approach that suited my personality, genes, and intellectual structure.

You just mentioned, how to establish this kind of culture?

I think the most important point in culture is not to blame. I hope everyone can make the right decisions, but I accept that no one can make only the right decisions.

For all of us, it's a matter of 'batting average'.

If a person supports an investment that loses money, first, this is not uncommon; second, this is understandable; third, it does not mean that this person is bad or lazy, and this person should not be criticized for it.

Imagine if you were a baseball pitcher, and every time you threw a bad pitch, or the opponent hit a base hit, you would be criticized, how would that be?

We try to avoid blame and shame, while understanding the limits of human behavior and what is achievable.

Of course, if someone repeatedly makes wrong decisions over a long period of time, then we can conclude that this person may not be suitable for the job, may not be suitable to work at Oaktree Capital.

Fourth, pursue a large number of reasonable successes and avoid major failures.

Dan: Is it more appropriate to apply this philosophy in bond investments than in stock investments?

Howard: Our philosophy is to pursue a large number of reasonable successes and avoid large failures. Debt investments are designed for this purpose. I wrote a memo titled 'Fewer Losers or More Winners,' which is the core of this philosophy.

Every viewer who wants to become an investor should ask: Is their goal to outperform the market, or can they accept the average level?

You know, the average level is actually quite good. In the USA, the S&P 500 index has grown at an average of about 10% per year in the past hundred years. This means that if you had $1 a hundred years ago, you would probably have about $15,000 now, which isn't bad, right?

And this is just the average level.

Most people won't live for a hundred years, nor can they invest for a hundred years, but even so, if your investment's annual rate of return is 10%, your funds double every 7 years. So if you can continue for 35 years, it will double 5 times, $1 becoming 2, 4, 8, 16, 32.

If you want to surpass the average level, I don't encourage amateur investors to pursue this goal because amateur investors usually do not have the ability to exceed the average level. They should willingly accept the average level.

The benefit is that with tools like index funds, you can ensure to achieve average level returns at a lower cost.

You may lose money, but you will not fall below the average level.

If someone says, "No, I am not satisfied with the average level, I want to exceed it, I know I may fail."

This leads to my memo: Which path to success will you choose? Do you want more success than the average investor, or do you want to reduce failures? Or both?

But this is difficult to achieve because a defensive mindset can reduce failures, while an offensive mindset is a necessary condition for you to achieve more success, it is hard to possess both mindsets at the same time.

So you should ask yourself, "What kind of person am I? Which strategy is more suitable for me?"

I like our way, both for myself and for my clients, it is much better than sometimes encountering complete failure after going all out.

But everyone has to face this problem. Look at Nvidia, it more than quadrupled last year. The question is, will you be upset because you didn't buy it?

Human nature may make you regret, but you must remind yourself, "Wait a minute, didn't I already say I want to reduce failures? I can accept missing out on all winners' results."

In human nature, there is a strong fear of missing out (FOMO). When we see others succeeding, we feel very uncomfortable, and this is harmful for investment.

There is a book about bubbles and crashes, where the author mentions that nothing hurts your mental health more than seeing your friends get rich.

Unfortunately, this is human nature. We must try our best to overcome it.

What constitutes a 'good decision' is difficult to attribute from a human nature perspective.

Dan: One of my favorite stories from your memo is about a friend of yours who wanted to buy all of Malibu like the Ringe family did in 1892 for 0.3 million USD. You mentioned that he would sell it when it reached 0.6 million USD.

I believe that holding stocks for long-term compound growth in stock investments is very challenging, just as challenging as finding a stock like that. The difficulty lies in the prudent practice of asset rebalancing. So, is it really just luck to significantly profit from long-term compounding stocks?

Howard: I wouldn't say it's just luck, but it does require a bit of luck.

Because you bought a stock and it doubled. Hmm hmm. You decide not to sell it. If it continues to appreciate, there is indeed a bit of luck involved.

You can never say, "Oh no, this will definitely happen. This is obviously a wise decision."

At every moment in the market, you will see the price of a stock, bond, or real estate and ask yourself, is it fair, too high, or too low. And there are no scientific tools to determine these things.

You have to make a determination.

The question is, is your judgment lucky? Well, luck sounds like it's all luck, like throwing dice. It is not.

Nevertheless, we are constantly assessing whether the price of something is reasonable, too high, or too low every day. The word "lucky" is not entirely appropriate.

When a decision succeeds, it is indeed a combination of making the right decision and having some luck. Life unfolds as expected, even better than expected, so you profit.

I mentioned Amazon in one of the memorandums, it was sold for $0.09 million in 1999, and dropped to $6000 in 2001.

The question is, if you buy at $6000, will you sell at $12000? Many people will sell when it doubles. Will you sell at $12000?

What about at $35,000? A fivefold increase. And $0.06 million? That's a tenfold increase.

When it rises to $0.6 million, you have already earned a hundredfold.

Isn't the prudent thing to do to sell some? Clearly, if you sell a portion, you can't let it all sit there and continue to grow.

When I wrote that memo, it had already risen to $0.33 million.

If you knew someone who bought Apple at $6, and still held it when it rose to $33,000, never selling a single share. You have to look at this person, they made 500 times profit, yet never sold. What if it crashes?

So, it goes back to that question: What is your mindset? What is your character? How would you feel if something went from $6 to $3,000 and then dropped back down?

For most of us mortals, we might sell some at $600, sell some more at $3,000, and then hope things move in a positive direction, right?

This brings us back to the issue of human nature. Human nature is a bit complex. Financially, you can see if a decision is a good one based on the outcome. But on a human level, describing a good decision may be very challenging.

Six, the market is currently in a neutral state, the economy will not decline tomorrow.

Dan: Understood. Let's switch topics a bit. How do you view the recession of 2020? Was it a real recession? Are we just in a normal economic cycle? Or was it just an interruption, so we are now beyond the usual cycle?

Howard: That's a great question. I've said rules are made to be broken.

There is a rule that a recession occurs every 8 to 10 years. If you don't count that as a normal recession, then we are already in the 15th or 16th year, right? Technically, we should be heading towards a recession tomorrow.

But I am pretty sure a recession will not happen tomorrow.

But no one can say whether it is a recession. Was it a normal experience? Did it reset the clock? Will it be 2008, 2028, or 2030? Nobody can say for sure. It would be foolish to blindly rely on the 8 to 10-year rule.

I would say, my perspective is, I don't know.

But when I observe the environment around me, I do not see any serious excesses in the economy. I do not see overly frenzied consumption, excessive inventory buildup, or a sky filled with numerous construction cranes indicating overbuilding.

When I read the newspaper, there are some good news and some bad news.

One day they say that we may face a resurgence of inflation, and the next day they say we may soon encounter an economic recession.

This tells me that the current situation is in a state of equilibrium.

In this state of equilibrium, there are no significant conclusions to be drawn. There are no high probability judgments about our economic situation.

So, I say nothing.

Dan: Usually in frenzied markets, there is what I call the "culprit", typically where frenzied behavior begins.

Howard: I would say that frenzy needs something to catalyze it.

I guess your question is, do you see the presence of these culprits?

Dan: According to what you just said, I guess the answer may be 'no,' you haven't seen any such situation. The biggest excess in the past decades was not in the economy, but in the financial markets.

Howard: During 1999-2000, we saw a bubble in technology stocks, overly optimistic. In 2008, we also saw a bubble in real estate and its related debts.

Although we did not have much excess in the real economy, we still experienced some severe recessions because the financial sector's investments overreactions caused harm, dragging down the economy.

So, you are right, currently I do not see that culprit.

By the way, I do not think the stock market is crazily soaring right now. It's a bit high, but far from crazy. I also do not think the crediting market is very unreasonable now, it's just (overly) a bit complacent.

Some contrarian investors like me are concerned about things that haven't reached a point of being impossible to move forward.

Dan: Can you share some?

Howard: It is now the third quarter of 2024, if you go back two years, the world was very pessimistic, which means high investment returns, as people felt very low, and asset prices were very reasonable.

Most people are quite optimistic now. The stock market has rebounded for almost two years.

You know, I like to buy when everyone else is pessimistic, without the price including any optimism. And today, most people are quite optimistic, not overly optimistic, but hardly any pessimism.

I prefer to buy when there is a lot of pessimism priced in, which is not the case today. It's okay to invest today, but it's not something to get excited about.

7. Thinking with probabilities will make your life happier.

Dan: Do most people consider investments from a right/wrong perspective, while you always look at things from a probabilities perspective? Or has this way of thinking evolved over time?

Howard: This is a great question, no one has asked me that before.

I believe it's a mature process.

I entered the investment industry in 1969 and switched to actual fund management in 1978, joining the bond department of Citibank. At some point between 1978 and 1988, I stopped thinking in terms of yes or no and strengthened my probabilistic thinking.

In 1963, there was a World's Fair in Flushing, New York, where IBM's pavilion showcased something interesting.

Two organic glass panels connected by a series of rods, with an opening at the top. They poured a pile of small balls from the top, and the balls came down like this. The balls hit the rods and when they reached the bottom, they formed a shape.

I was there at the scene, it was my first encounter with the concept of probability, I was 17 at the time.

Most things happen as expected, but there are also some things that happen in unexpected ways. Occasionally, things happen that you thought would never happen, which we call "tail events".

This is my view on life, it requires a high level of attention.

In a memo, I told a story. It was the 2016 Super Bowl (I am not very good at remembering football match dates), the Carolina Panthers against the Denver Broncos.

There was a former football player at the time, who had not been to the University of Chicago, nor obtained a PhD in investment, but he was asked, "Who do you think will win?" He gave a very clever answer, saying, "Out of 10 times, the Carolina Panthers will win 8 times." But he said a very important sentence: "This time might be one of the other two times."

Most people do not include this second half of the sentence. But in reality, there were two times Denver won. And sometimes, things do happen like that.

You must get rid of black and white thinking, I have always emphasized this point, whether in investing or in life.

When you are dealing with future events, you never know how the results will be, you must realize this. This way you will become a happier, more efficient person.

Editor/Rocky