How Howard Marks Thinks About Risk

Danial Jiwani is the author of Take Stock In This, which has been called “The Next Intelligent Investor” by readers. With the author’s books being read by Howard Marks and Bill Ackman, Jiwani is one of the leading thought leaders in the investment industry. Readers call it “the best book on investing since The Intelligent Investor,” according to Amazon reviews.

His new book Take Stock In This sheds some light on Howard Marks thinks about risk.

How Howard Marks Thinks About Risk

There are two ways to make money in the stock market: 

1. Pick winning companies.

2. Avoid loser companies. 

You would expect each of those to be equally important. But that isn’t the case. To beat the market, it’s more important to avoid losers than to pick winners . . .

In the mid-1980s, Howard Marks joined TCW Group. He was in charge of running the firm’s distressed debt fund. 

It was one of the first distressed debt funds from any major financial institution at the time. Just one issue. It’s hard to pick which distressed companies to invest in. 

After all, it’s not easy to predict the near-bankrupt ones that will recover. But Marks had an interesting strategy: don’t try to predict which distressed companies will succeed—just avoid investing in the ones that will fail. In other words, prioritize avoiding losers over picking winners. 

His strategy performed so well that the firm promoted him to Chief Investment Officer. He later went on to become one of the best distressed debt investors in the world. 

All that success came from avoiding losers, rather than trying to predict winners. 

Investing is a Loser’s Game

Have you ever heard of the concepts known as “a winner’s game” and “a loser’s game”? 

A winner’s game is when someone wins from “hitting winners.” For example, in a tennis match between two expert tennis players, the player who places the best shots that the opponent can’t return will win. 

A loser’s game is when is someone wins by avoiding losers. A tennis match between two amateurs is an example. The amateur who wins isn’t the one who places the best shots. It’s the one who avoids screwing up and just gets the ball back over the net. 

It turns out that the investing is actually a loser’s game rather than a winner’s game. The way you make money isn’t by finding the next hot stock. It’s by avoiding the duds.

That’s at least why Charlie Elllis, an investment consultant who founded Greenwich Associates, is successful: “Really strong defense makes the offense easy. Most of the trouble in investment management is not because you came just a little short of having superb investment results. It’s because you made a mistake. Knowing how to be selective, you avoid the mistakes.”

How To Avoid Losers

Buffett once said that “a long string of impressive numbers multiplied by a single zero always equals zero.” 

That quote illustrates the key to avoid losers: never invest in a company that exposed to tail risks. 

As Morgan Housel writes in The Phycology of Money, tails drive everything. All the returns, and the losses. So if you want to avoid major losses, you have to be focused on avoiding the tails.

You never want to take any risks that could potentially cause an investment to go to zero. You never want to be exposed to low probability risks, or high severity risks that can put you or your company out of business.

Don’t worry about non-tail risks–risks that can’t put a company out of business. Things like recessions, interest rates, and political events don’t really matter. For the most part, business never go out of business for those reasons. So they aren’t important risks to consider. 

But never invest in a company that’s exposed to even a little tail risk. 

Your bank account will thank you for it.