Here is another interesting piece by the esteemed Howard Marks of Oaktree. His articles always make a lot of sense to me. His profound understanding of the economy and financial markets, coupled with his exceptional investment philosophy and approach, is remarkable to me.
In this article, Marks wrote about the role of sacrifice in investing that investors should not expect to make money without taking risk. On the other hand, investors should not expect to make money just for taking risk.
Here is section:
Because the future is inherently uncertain, we usually have to choose between (a) avoiding risk and having little or no return, (b) taking a modest risk and settling for a commensurately modest return, or (c) taking on a high degree of uncertainty in pursuit of substantial gain but accepting the possibility of substantial permanent loss.
Everyone would love a shot at earning big gains with little risk, but the “efficiency” of the market meaning the fact that the other participants in the market aren’t dummies usually precludes this possibility.
Most investors are capable of accomplishing “a” and most of “b.” The challenge in investing lies in the pursuit of some version of “c.” Earning high returns in absolute terms or relative to other investors in a market requires that you bear meaningful risk either the possibility of loss in the pursuit of absolute gain or the possibility of underperformance in the pursuit of outperformance. In each case, the two are inseparable.
The risk inherent in not taking enough risk is very real. Individual investors who eschew risk may end up with a return that is insufficient to support their cost of living. Professional investors who take too little risk may fail to keep up with their clients’ expectations or their benchmarks.
Like chess (and most card games), backgammon requires the calculation of when to take risk and when to avoid it. In backgammon, two players move their checkers around the board based on throws of a pair of dice. One player moves clockwise and the other counter-clockwise.
When players’ checkers come near each other, the player who’s moving often has a choice between (a) landing on one of the other player’s checkers, sending it back to the start (but at the risk of leaving the moving checker in a vulnerable position), and (b) avoiding doing so to play it safe. No one wants to be exposed and get hit. But most beginners play it too safe, and because they put so much emphasis on avoiding getting hit, they rarely win.
Relevant lessons from sports (included in past memos) are easily accessed and also very helpful:
“You miss 100% of the shots you don’t take.” – Wayne Gretzky, NHL Hall of Famer
“You have to give yourself a chance to fail.” – Kenny “The Jet” Smith, two-time NBA champion
Not having any losers isn’t a useful goal. The only sure way to achieve that is by not taking any risk. But 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.