Below is a continuation of portfolio management highlights from Howard Marks’ recent book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor, Chapter 2 “Understanding Market Efficiency (and It’s Limitation)”:

Risk

“I have my own reservations about the theory [efficient market hypothesis], and the biggest one has to do with the way it links return and risk…Once in a while we experience periods when everything goes well and riskier investments deliver the higher returns they seem to promise. Those halcyon periods lull people into believing that to get higher returns, all they have to do is make riskier investments. But they ignore something that is easily forgotten in good times: this can’t be true, because if riskier investments could be counted on to produce higher returns, they wouldn’t be riskier. Every once in a while, then, people learn an essential lesson. They realize that nothing – and certainly not the indiscriminate acceptance of risk – carries the promise of a free lunch, and they’re reminded of the limitations of investment theory.”

More Risk ≠ More Return

Psychology

“…one stands out as particularly tenuous: objectivity. Human beings are not clinical computing machines. Rather, most people are driven by greed, fear, envy and other emotions that render objectivity impossible and open the door for significant mistakes.”

Self-awareness. So important, yet again, so intangible – just like the creativity component.

I often tell people that half the investment battle actually takes place in your mind, not the marketplace. Controlling your bias, fears, vanity (my favorite, and most deadly investing original sin “I’m right, the market is just stupid.”), etc. takes an incredible amount of discipline. But before discipline can work its magic, self-awareness must first exist to identify the problem.