In his latest memo titled The Indispensability of Risk, Howard Marks explains why investors should approach their portfolio with the expectation that not all investments will succeed, but a well-calculated risk can lead to overall success. This success is influenced by the balance and impact of both winning and losing investments. Thus, avoiding risk altogether can hinder achieving substantial returns.
Moreover, taking risks should be a thoughtful, almost reflexive decision made on solid grounds, building confidence and decision-making skills over time. The ultimate takeaway is that while bearing risk is necessary for earning returns, simply taking risks without strategic consideration is insufficient. Success in investing requires skillfully managing risks with a controlled and intelligent approach. Here’s an excerpt from the memo:
The paradox of risk-taking is inescapable. You have to take it to be successful in competitive, high-aspiration arenas. But taking it doesn’t mean you’ll be successful; that’s why they call it risk.
Equally paradoxical, earning a high rate of return over a long time period doesn’t have to – and usually doesn’t – connote a record of consistent success. More often it results from having made a lot of well-reasoned investments, some subset of which worked out well. Here’s how I described the basis for the success of Berkshire Hathaway in Fewer Losers, or More Winners?:
I believe the ingredients of Warren [Buffett]’s and Charlie [Munger]’s great performance are simple: (a) a lot of investments in which they did decently, (b) a relatively small number of big winners that they invested in heavily and held for decades, and (c) relatively few big losers. No one should expect to have – or expect their money managers to have – all big winners and no losers.
Investors must accept that success is likely to stem from making a large number of investments, all of which you make because you expect them to succeed, but some portion of which you know won’t. You have to put it all out there. You have to take a shot.
Not every effort will be rewarded with high returns, but hopefully enough will do so to produce success over the long term. That success will ultimately be a function of the ratio of winners to losers, and of the magnitude of the losses relative to the gains. But refusal to take risk in this process is unlikely to get you where you want to go.
I’ll conclude with another good paragraph from [Maurice] Ashley:
Taking a chance doesn’t mean there will be a successful outcome, nor does it require it. If the reasons are sound, the risk should be taken almost reflexively. The more often we trust our judgment, the more confidence we gain in our decision-making capacity. The courage to take risks becomes a worthwhile end in itself.
The bottom line on the quest for superior investment returns is clear: You shouldn’t expect to make money without bearing risk, but you shouldn’t expect to make money just for taking risk. You have to sacrifice certainty, but it has to be done skillfully and intelligently, and with emotion under control.
You can read the entire memo here:
Howard Marks Memo – The Indispensability of Risk
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