The Tim Ferriss Show - #338: Howard Marks — How to Invest with Clear Thinking

Starting point is 00:00:00 At this altitude, I can run flat out for a half mile before my hands start shaking. Can I ask you a personal question? Now would have seen a perfect time. What if I did the opposite? I'm a cybernetic organism, living tissue over metal endoskeleton. The Tim Ferriss Show. This episode is brought to you by Inktel. And I've used them personally. Ever since I wrote the 4-Hour Workweek, I've been asked over and over again how I choose to delegate tasks,

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Starting point is 00:04:25 that you can apply and test for yourself. This episode features someone who is very, very well known in the world of investing. But studying what he says is really a study in clearer thinking. And it transcends investing in business in so many different ways. Howard S. Marks is co-chairman and co-founder of Oak Tree Capital Management, a leading investment manager with more than $120 billion in assets. He is the author of the new book, Mastering the Market Cycle, subtitled Getting the Odds on Your Side, and his previous book on investing, The Most Important Thing, subtitled Uncommon Sense for the Thoughtful Investor,

Starting point is 00:05:03 was a critically acclaimed bestseller. To give you an idea of who reads his memos and his writing, Warren Buffett has written of Howard, quote, when I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something, end quote. I'm going to keep this short because it covers a lot of ground. We talk about the three stages of a bull market, newsletters he reads, thoughts on Bitcoin and crypto, his thoughts on understanding market cycles for making better decisions, how his firm was poised to capitalize on the bubble in 2008 and put massive amounts of capital to work, and more and more and more and more. We really cover a lot of ground and I had a lot of fun. So without further ado, maybe I've already said that, here is Howard Marks.

Starting point is 00:05:49 Howard, welcome to the show. Thank you, Tim. I've been looking forward to being here. I am thrilled to be sitting here with you because I have so many fans of your work and thinking in my friend circles. Well, that's great to hear. When I went out to a handful to ask for potential topics or questions, they were very, very forthcoming. But what I thought I would do in this particular episode, I've never done in a podcast episode before, which is to start with a poem. This is always risky, risky business, but this was

Starting point is 00:06:15 suggested by a friend. And he said, I would use an A.E. Hausman poem. This captures effectively the, I think that what he views as the spirit of much of your writing. And you can agree or disagree. Here we go. I, to my perils of cheat and charmer, come clad in armor, by stars benign. Hope lies to mortals, and most believe her, but man's deceiver was never mine. The thoughts of others were light and fleeting, of lovers meeting, or luck or fame. Mine were of trouble, and mine were steady, so I was ready when trouble came. And that is a Shropshire Lad, the name of the poem. research for this conversation, I discovered that you had studied not only finance and what you might look at as vocational subjects when you were an undergrad, but also seems like Japanese. And that there was this concept of mucho that popped up when I was doing my reading.

Starting point is 00:07:17 Would you mind describing that time and that concept? Well, I went to Wharton at an enlightened time when you were required to have a non-business minor and then a semester of the literature of a foreign country in English. I never learned Japanese. But I started off for some reason, which it's interesting, that I have no recollection of what motivated me, but I decided not French literature or English, but Japanese literature. It must have been the exoticism. And I liked it so much that I turned Japanese studies into my minor and took 15 credits at the graduate level. And that's what turned me from an indifferent teenager into a student, really. But the professor for most of those courses, a guy named E. Dale Saunders, was an inspirational speaker and Oxford Don, an esthete. And so I took this course in Japanese philosophy and we came across Mujo.

Starting point is 00:08:27 Mujo literally means the turning of the wheel of the law. In other words, the operation of life. And the essence is impermanence because the wheel does turn. And also the unpredictability of the future and these were really formative for me and they have in unconsciously informed everything i've done and i think that personally that in the investment business and also in life, you are better off if you realize, number one, that life is always going to change on you and there will always be new things coming down the pike and you can't control it.

Starting point is 00:09:16 And what we have to do is live with it. In the course of the reading, I've done prep for this, which is not only the new book, but also many of your letters, which I'd already been a fan of, but went back to revisit. I came across many people who had tried to select favorite quotes, and one that came up a lot, so you could certainly correct this if it's not accurate, is something along the lines of you can't predict, you can prepare. And that leads me to 2008. And we're going to bounce around chronologically quite a lot, I suspect. But during the 2008 bubble, which of course was a time in which many investors were pulling out of the market, Oaktree did exactly the opposite.

Starting point is 00:10:10 And you put more than a half a billion dollars a week to work over 15 weeks. Why did you do that? Were you predicting? Were you prepared? What led to that type of decision? Sure. Well, you mentioned the memos. I've been writing the memos since 1990.

Starting point is 00:10:31 And I wrote one about 20 years ago, late 90s, called You Can't Predict, You Can't Prepare. I stole the tagline from an ad from Northwestern Mutual Life Insurance. But I think that's true of life. Now, it sounds like an oxymoron, because how can you prepare if you can't predict? But the answer is, we never know what's going to happen. But we can consider the likely scenarios and prepare for some of them. You can't, by definition, prepare for every eventuality. But I would say that we did have a sense, my partner Bruce Karsh and I, had a sense in 05 and 06 that the world wasn't running right. And the main thing that made us conclude that was the crappy deals that were getting done.

Starting point is 00:11:32 And he and I would spend the day walking into each other's office saying, look at this piece of crap that got issued yesterday. There's something wrong. A deal like this should not be doable. The fact that investors are buying this tells me that they're not being skeptical. They're not being demanding. They're not applying standards. And Buffett has a saying, the less prudence with which others conduct their affairs,

Starting point is 00:11:59 the greater the prudence with which we must conduct our own affairs. And it's absolutely true. And so we knew that the market was dangerous because of the behavior of others. Now, you can't – so we were prepared. We sold a lot of assets. We liquidated large funds. We replaced them with small funds. We became very selective in our buying. We raised a very large fund for investment if a crisis bursting would come into being. Was this for a distressed debt?

Starting point is 00:12:36 For distressed debt. Now, the interesting thing, though, so you can't prepare. You can't predict. The thing that caused the bubble to burst was the unsubstantiality of mortgage-backed securities and especially subprime. If you read the memos, you won't find a word about it. We didn't predict that. We didn't even know about it. It was occurring in an odd corner of the securities market. Most of us didn't know about it. But it is what brought the house down. And we had no idea. But we were prepared because we knew simply that we were on dangerous ground. And that required cautious preparation. Let me ask, and I may embarrass myself with questions that display my ignorance about many topics in this interview, but when you raised money for a

Starting point is 00:13:36 distraught debt fund, did you emphasize to the LPs or whoever gave you those funds that you had a specific timeline in mind for deploying those funds? Or did you emphasize the importance of patience with those people and that you'd be looking for indicators and that they needed to look at it as a long-term investment? How did you manage the question of when from those people? The question of when is one of the hardest ones in our business. And I always say that we may have an idea of what's going to happen, but we never know when it's going to happen. You can't call these things. As one of my partners says, if you name a price, don't name a date. And if you name a date, don't name a price. And then you can't be wrong. But

Starting point is 00:14:19 we never did name a date. We probably, I can't even remember, we probably had a limit. In other words, if we hadn't deployed it within X years, then it got canceled, the commitments. But I think there was an understanding that we thought it was coming within the next one, book, of course, the title Mastering the Markets, it's the subtitle Getting the Odds on Your Side. Why this book? And how does one, and this is, of course, something we could discuss for many, many hours on end, but why this book and how does someone in this context get the odds on their side? So I started writing the memos in 1990. I wrote them for 20 years. I always concluded that I would write a book and pull them together into a philosophy when I retired. And then I got a letter from Warren Buffett in 2010 saying, if you'll write a book, I'll give you a blurb for the jacket. So that was enough to get me off my ass and get me to do it in real time. I wrote a book called The Most Important Thing, because I found myself sitting in clients' offices saying the most important thing is buying cheap. And then 10 minutes later, I would say the most important thing is not losing money. And then 10 minutes later, I would say that the most important thing is contrarian behavior. So I wrote a book called The Most Important Thing, which has 21 chapters,

Starting point is 00:15:46 and each one starts off, the title is, The Most Important Thing Is, and then it's a different thing. One of those most important things is knowing where we stand in the cycle. And as I say, I don't believe in forecasts. I always say, we never know where we're going, but we sure as hell ought to know where we are. I mean, I can't tell you what's going to happen tomorrow, but I should be able to assess the current environment. And that's the kind of thinking that helped us prepare for the crisis.

Starting point is 00:16:15 I think that the two most important things are where we stand in the cycle and the broad subject of risk. And in fact, where we stand in the cycle is the primary determinant of risk. So I think that this is really an important topic and it can really help you do better. Getting the odds on your side what that means is we don't know what's going to happen nobody can tell you but there are times when the future is the outlook is better and there are times when it's worse and it's largely determined by where we stand in the cycle when we are low in the cycle that is to say we're coming off a bust. The economy is starting to warm up. Investors are just barely starting to switch from pessimism to optimism. And prices are starting to rise. Clearly, the odds are in your favor. The outlook is better.

Starting point is 00:17:21 It doesn't mean you're going to make money, but the chances are good. On the other hand, when the cycle has gone on, the up cycle has gone on for a long time, when valuations are high, when optimism is rampant, when everybody thinks everything's going to get better forever, when the economy's been moving ahead for 10 years and it looks like it's never going to stop, then usually the enthusiasm has carried the prices to such a high level that the odds are against you. And just knowing that is a huge advantage in investing. You should know that when we're low in the up cycle, that's a time to be aggressive and put a lot of money to work and buy more aggressive things. And when the cycle has gone on for a long time and we're elevated, that's the time to take some money off the table and behave more cautiously.

Starting point is 00:18:13 Question about 2008. Or you could pick another period, a bus cycle that you're familiar with, whether from firsthand experience or from research that you've done. You raise these funds, and I want to revisit the question of when, from a personal standpoint, and I'll admit it very freely. I think I've had a very fear-based mentality when it comes to public markets. I've done reasonably well in privately held technology startups because I lived in the middle of the switchbox in San Francisco. And that's the only thing I paid attention to. And it protected me in a way from

Starting point is 00:18:49 my lesser behaviors because I wasn't allowed to sell. Uh, but in the public markets, I've almost always held onto cash waiting for some cataclysmic event, but then lost my nerve in some fashion. I'd be, I'd love to hear, and maybe the catching falling knives is a way to segue into this. I don't know that I found that very, very interesting to read about. But how do you think about sitting on a position like that and timing? What, what, what determines the go command for deploying? You have really touched on an extremely important topic. Most of us have an inherent bias. Most of us are essentially cautious or essentially aggressive. Probably more people are essentially cautious than aggressive. Probably more people are essentially cautious than aggressive. So one of the most important things is to assess ourselves, understand our biases, and try to overcome them. Now,

Starting point is 00:19:55 the Tim Ferriss that I heard you describe, I take that to mean that maybe you were lucky or smart enough to turn cautious leading up to the bubble. The markets fell apart. You're sitting on cash. You patted yourself on the back for being so smart as to not get caught, and you watched. What you didn't do is you didn't turn aggressive at the bottom. That's right. And it's common not to do so. It's common to, as you say,

Starting point is 00:20:28 for people to say, I'm not going to jump in while this thing's collapsing down. I'm going to wait till the dust has settled and the future is clear. I'm not going to try to catch a falling knife. But it is when the knives are falling that the people are most terrified that the best bargains are available. So if you wait until the dust settles, the bargains are gone. And that's what happened at the end of 08. You mentioned that we, in distressed debt, we put $500 million a week to work in the last 15 weeks following the bankruptcy of Lehman Brothers and across the firm, something like 650 million a week for 15 weeks. That's $10 billion. But the key is, it was at a time when essentially nobody else would, you get great bargains. By the

Starting point is 00:21:17 time the end of 08 rolled around, the hedge funds that were getting withdrawals had either satisfied their withdrawals or gated. What does gated mean? Told clients they couldn't have their money back for a while. Gotcha. And so the selling abated. A few people saw the great values, and with the selling and thus the fear having reduced, they were able to

Starting point is 00:21:47 come forward. Prices started to move up. Then it's too late. Because if you're trying to buy in a falling market, you can buy all you want at successively lower prices. But if you're trying to buy large amounts in a rising market, your own buying puts the price up. You're your own worst enemy. You can't get much at low prices. So, you know, one of the keys to successful investing is to either be unemotional or at minimum act like you are. You know, the great investors I know are – behave in an unemotional fashion. You know, Warren Buffett couldn't care less. David Tepper couldn't care less, and so forth. My own partner, Bruce Karsh, very stalwart.

Starting point is 00:22:34 But part of it is that we support each other at the bottom. It's not easy. You know, and I say in the book that I recount some of the things we've done right with regard to cycled extremes. But I absolutely don't want to give the impression that it's easy. It's terrifying. Others are terrified. That's why they're selling.

Starting point is 00:22:55 That's why they're saying, I don't care what the price is. Just get me out. That's when you want to buy. But the things that terrify them into selling will also terrify you. You have to overcome it. How much of that stoic resilience or stoic composure is nature versus nurture, born versus trained from what you've observed and experienced? And if a portion of it is trained, how would you suggest to someone that they develop that ability? from what you've observed and experienced. And, and if, if a portion of it is trained, how,

Starting point is 00:23:26 how would you suggest to someone that they develop that ability? I don't want to answer categorically. I think it's a hell of a lot easier if you're born that way, you know, to, to, to teach yourself to be unemotional is to, is to counter human nature.

Starting point is 00:23:42 And by definition, it can't be easy. This is other than as to, you know, where are we in the cycle and what's going to happen in the coming six months? This is probably the question I get the most often. How can you teach yourself to be unemotional, to be contrarian, to be a second level thinker. And there is no easy answer. In the first book, on the subject of what I call second-level thinking, I say, in basketball, they say you can't coach height. All the coaching in the world will not make your team taller.

Starting point is 00:24:17 So I don't know, frankly, whether people can teach themselves to be unemotional. But clearly, if you are as emotional as others, you will probably succumb to the same errors. I'd love to back into this type of, not psychological profiling, but an examination of this type of resilience, maybe indirectly, maybe it'll come up, maybe it won't. And I might get the total duration incorrect, but you mentioned a name, Bruce Karsh,

Starting point is 00:24:54 that I'd love to bring up yet again, and he may come up repeatedly. 23-year partnership, is that right? Or 20-plus year? 31 now. 31, okay. Because Oak Tree is 23 years old but we worked together for eight years before that prior to that all right so if you were trying to hire a

Starting point is 00:25:11 say 25 year old version of bruce what would you be looking for well i'll tell you what he is let's Let's do that. He's super smart. That goes without saying. He is highly competitive. He's a chess player. And most of the people that, again, that I know who are good investors are games players, either backgammon or chess or something like that. We are inherently competitive. He's also very analytical, and he's kind of a grinder. And I would describe myself as being intuitive and a quick decider, thinking slow and fast, Kahneman. I'm a fast thinker. You tell me a

Starting point is 00:26:08 problem, I tell you my answer in short order, and I'm done with it for the most part. Bruce will think about it longer, come to his conclusion, and then he'll come back the next day and say, you know, I was thinking about it last night. I don't think that's right and here's why. Or I don't think you were right and here's why. And he'll grind on it for hours and days. I think this is part of the secret to our success. Again, something I once wrote on the subject of a good partnership. I said shared values and complementary skills.

Starting point is 00:26:45 If you have a partner who has different values than you do, for example, Bob wants to make the most money possible and Ed wants to operate with integrity. Those are largely contradictory. So I think it's very important to share values but i also think it's it's important to not be the same person a copy of yourself if you're if it's a copy of yourself you don't need it it the person should bring skills that you don't bring and maybe operate in ways you don't and i think it's it's probably helpful that I'm intuitive and he's analytical.

Starting point is 00:27:29 I've heard, well heard, that's not the right verb. I've read, I believe it was Buffett who said that Charlie Munger has the something along the lines of the best 60 second mind he's ever encountered. It sounds like you also have a very highly developed, fast-thinking capacity. How is it similar or different from Charlie Munger's 60 Seconds? Well, first of all, it's a daunting comparison. I would never put myself in the category with Charlie. He's brilliant and one of the best thinkers there is. But, you know, I mean the main thing is that he has read more broadly. He's had another 22 years to read further and he was probably always a broader reader than I was. And so it's his ability to call on these references,

Starting point is 00:28:27 you know, in a way, it's kind of silly to think we have to, or that we can reinvent all the wisdom in the world. It's great to borrow from others. And, and, and Charlie does that broadly and I try to do it, but he just knows more. I think. I think we'll almost certainly come back to Morin and Charlie more in this conversation. But I want to return to Bruce, because you mentioned the complementary skill sets. And you've written about him, of course, quite a bit, mentioned him quite a bit. And I want to pull up quickly, just a few lines in the new book. So Bruce and I have exchanged ideas and backed each other up almost daily over that period. This is a preceding text. And my give and take with him, especially in the most difficult of times, has played a particularly indispensable part in the development of the approaches to cycles on which this book is based.

Starting point is 00:29:17 Could you share an example of back and forth or disagreement during a difficult time or with a particular decision. Is that possible? Just so that we have a real world example of the interplay between the two of you? We normally don't debate individual investments because he operates more at that level and I operate more at the big picture level within Oaktree. But, I mean, I think a good example is in the period we've been talking about a couple of times now. We've mentioned the last 15 weeks of 08. You know, it was really a very tough period because Lehman Brothers had gone bankrupt and Bear Stearns had disappeared and Merrill Lynch had been absorbed by Bank of America, and Washington Mutual, and Wachovia Bank,

Starting point is 00:30:07 and it looked like falling dominoes. And people were talking about the fact that Morgan Stanley was next, and Goldman was right behind that. And so you just had to conclude that the financial world was either going to end or it wasn't. You couldn't analyze it. You couldn't prove anything about the future. And so it required an almost gamesman-like approach

Starting point is 00:30:32 to whether you buy or not. And, you know, we would talk about that in that sense, and we were both very comfortable talking about it in that sense. And what we concluded was that if the world ended, it didn't matter what we did. But if the world didn't end and we hadn't bought, we hadn't done our job. So buck up and do your job. Now, the great thing is that half the days, Bruce would come to me because he would be lying in bed at night thinking about this stuff. And he would come to me and he would say, you know what? I think we're going too fast.

Starting point is 00:31:13 I think we should slow down. And half the days, he would say, I think we're going too slow. So I would play devil's advocate and support his decision but try to show him the other side. And he would do that with me. And that's why we got it done. But as I say in the introduction to the book from which you read, I think that – I don't think either of us could have done as good a job alone. I think that the devil's advocacy, but in a supportive way, really held the key. In one of my memos, I wrote about a reporter, and he called me up a few days after the bankruptcy of Lehman, and he said, what are you doing? I said, we're buying.

Starting point is 00:32:06 He said, you are? Like it was the craziest thing he ever heard. And, you know, my reaction was, if we're not buying now, when will we? But, you know, it's been a great partnership, as you say, 31 years. Never an argument. Never an argument. Never an argument. I mean, intellectual disagreements, but never an argument never an argument never an argument i mean intellectual disagreements

Starting point is 00:32:26 but never an emotional argument and never and the key is respect even when we disagree we respect and the great thing about that is you sit down you disagree you maybe you don't come to a conclusion and then you go back to your corners and he says, well, you know what, maybe Howard's right. And I say, maybe Bruce is right. And then you can have a productive discussion. If your reaction is that moron, then you can't benefit from what he has to say. For people who are hoping to exhibit that type of poise and respect for someone else, are there any tactical recommendations you might have? And the reason I ask that is, I no longer live in Silicon Valley, but I was there for 17 years, and you see co-founders

Starting point is 00:33:18 all the time. Some of them go the distance, but a lot of them end up fatalities. And you can almost see the writing on the wall when the respect goes out the window. And it's just a matter of time for a lot of these guys. For people who are in partnership, let's just for the time being, assume it's in a business capacity or an investing capacity. What are some of the tools of the trades that it doesn't escalate? Do you walk out of the room if you're starting to get heated there? Or do you avoid in some systems way, given policies of the firm, any types of sort of mission critical,

Starting point is 00:33:57 single decisions from becoming an object of argument, if that makes any sense. Because when the stakes are high, what are some recommendations you would have when perhaps emotions are starting to escalate? Well, the only issue I would take, Tim, is you started with assume you're in partnership. I think you have to start sooner.

Starting point is 00:34:19 Okay. Who do you get in partnership with? And you have to share values and you shouldn't be partners with somebody you're not going to like, enjoy spending time with, and be able to work with constructively when the stuff hits the fan. That's really the key. So I mean, I believe that, that most solving most personnel or managerial problems start at the beginning with the hiring decision or the combination decision. So just don't get into business with somebody you're not going to be able to live with. It's kind of like a marriage.

Starting point is 00:34:56 Do you stress test their ability to handle potential high-stress situations in some real or simulated fashion? Do you look back at, in say hiring decision, do you look back at their history and reference checks to assess that? How do you assess whether someone is going to keep their cool or not? Well, we don't do simulations or war games or anything like that, but we do, you know, I mean, that's an important part of reference checking. You have to, you have to person is smart and whether the person is a moneymaker. You know, we have a no assholes rule at Oak Tree. And I think that solves a lot of problems. And, you know, there are lots of people in the world who can make you a lot of money.

Starting point is 00:35:41 But you may not want to be in business with them, and it may not be viable long term. Now, it's hard to absolutely follow that rule, because really smart money makers are very tempting, but I think it's really important. But then, you know, once you are in business together, and you have the inevitable disagreement, I think one of the most important things is to, number one, acknowledge the limits on what you know. If you go in with some humility, then you're unlikely to have a fight to the death, that is to the death of your partnership over an issue. And it's great to say, I mean, people should wake up in the morning and start the day by practicing, I don't know. I don't know. It's a great thing to say and not enough people say it.

Starting point is 00:36:41 And the flip side of I don't know is what I said before about our discussions. Maybe he's right. You know? And so I think that's important, humility. Number two, again, control of emotion. Don't get into fights just to show who's more manly or equate winning the argument with success. Because if you're in a business situation and you're fighting for something that ultimately proves out to be a mistake, your success in winning the argument will lead to a failure. So don't confuse winning the argument with coming to the best decision. And, you know, again, try to limit the testosterone. I think that really gets in the way. One of the many things that I really enjoy about your writing is that it serves for me, at least, as a reflection on clear thinking that transcends investing. I mean, it applies to so many, if not all areas

Starting point is 00:37:55 of life, at least those governed by anything in the prefrontal cortex. And one that caught my eye when I was reading, which is page 15 in the new book, is the following. And I'd just like to read it. It's not very long. In addition to an opinion regarding what's going to happen, people should have a view on the likelihood that their opinion will prove correct. Some events can be predicted with substantial confidence. Example given, will a given investment grade bond pay the interest it promises? Some are uncertain. Example, will Amazon still be the leader in online retailing in 10 years? And some are entirely unpredictable. Example, will the stock market go up or down next month? It's my point here that not all predictions should be treated as equally

Starting point is 00:38:36 likely to be correct, and thus they shouldn't be relied on equally. I don't think most people are as aware of this as they should be. Could you expand on this a bit, if that's possible? Maybe give some examples of how you or other people you respect use that type of heuristic when making decisions or just, I suppose, reflecting reality in their own minds or perceiving things. Sure. You know, we all have opinions and we hold our opinions because we believe in them. Nobody ever says, you know, my opinion is X and I think I'm wrong. We all think that our opinions are correct. But, and again, the world becomes a better place, an easier place to navigate if we admit that even though there are opinions, they may be wrong. And, you know, how does an investor like me opinions on all these subjects, but I say it's one thing to have an opinion and it's another to believe and act as if it's right. And if you just say, maybe I'm wrong, the world gets easier, in my opinion. Easier to succeed, less easy to navigate day to day. You know, and a big theme of the book is that we have to view the future not as an event which is predetermined and predictable,

Starting point is 00:40:17 or, you know, determined already, but as a range of possibilities, as a probability distribution. And, you know, I went to the World's Fair in Flushing in 1964, I think it was. And I stood before an exhibit that IBM had. And it was, you know, typical of technology 50-odd years ago. It was the most simplistic thing you could imagine. They had a slot at the top and a bunch of balls. And the balls came through the slot. And then top and a bunch of balls, and the balls came through the slot, and then there were a bunch of pegs in a grid. And when the balls hit the pegs, they started to diffuse. And by the time they got to the bottom, they were in a bell-shaped

Starting point is 00:40:59 distribution. And I think that was probably my first exposure to a distribution, but it's beautiful. And that's how life is. The future is a distribution of possibilities. And if we're really smart, we know what the possibilities are, and we may have an idea of which are more likely and less likely. But we still don't know what's going to happen. And I think we have to behave that way. Now, some things we know more, some things we know less. We shouldn't get confused.

Starting point is 00:41:33 But the most important single thing is to not have the same degree of conviction about all of our opinions. Do you apply a 1 to 10 numerical value? Is it more of a light, medium, strong? How do you think about that yourself? Yeah, well, I think it's certainly not, you know, I'm not, for the most part, a quantifier. If you read the book, I would hope you would be struck by how few numbers there are in it. And, you know, one of the great quotes, which is broadly attributed to Einstein, I don't think it was Einstein, is that not everything that can be counted counts and not everything that counts can be counted. So the most important insights to life are non-quantitative. But I try to be conscious of when I have an opinion of howinflations, 15%, 16%, 17% a year, nobody could figure out how to stop it. And the world was really a very difficult place to live.

Starting point is 00:43:14 Kaufman, there was two guys, Kaufman and Al Wolgenlauer, first boss, and they were called Dr. Gloom and Dr. Doom. But Kaufman said two kinds of people lose a lot of money, the people who know nothing and the people who know everything. And it's – very few of us know nothing, but it's really important to assume – to not assume we know everything is there any reading you've done or maybe it's just real life experience in the trenches of doing this day in day out but if for people who want to develop that uh i i saw that you're it seems like a reader or fan of some of what nasim talib has put out and He talks about epistemological arrogance quite a bit. It's thinking that we are believing we know it all or more than we actually know. How would you suggest, are there any resources, letters, books, memos, talks that you might recommend to people

Starting point is 00:43:55 who want to really cultivate that awareness of limited knowledge? Well, when you started to ask that question, I did fast forward to Nassim Nicholas Taleb and his book, Fooled by Randomness. I think it's a really important book in terms of its ideas. And it's really about how much randomness

Starting point is 00:44:23 there is in our world. Now, it's primarily about investing, not the general world, but the world of investing. And his example is that if you're a dentist, he picks on the dentist a lot in the book. But if you're a dentist- Picks on economists too. Yes. And you always fill a tooth the same way you always get a successful filling. Whereas in the investment business, there's nothing that you can do that if you do it the same every time, you're going to get a successful outcome because of the changeability and randomness in the world.

Starting point is 00:45:01 And this is extremely important. And, you know, we have to think about the world as a probability distribution. When we, you know, one of the things that interests me most is when you look at history, you say, well, I don't know so much about the future, but the history, that's done, that's settled. We know what happened. We know what the truth was. But Taleb uses a concept called alternative histories. The other things that reasonably probably could have happened but didn't. And so when you look at a historical event, you have to say, was that outcome inevitable? In which case it demonstrates a truth, or was it subject to randomness,

Starting point is 00:45:49 and could other things have happened just as well? You know, I wrote a memo, in a memo around 06, I talked about the Rose Bowl game between USC and University of Texas, and USC was highly touted as the best team in the history of college football. And I won't go through all of it. I hope readers will take a look at it. But in the end, they lost on one play. And so nobody talked about them as being the best football team in history.

Starting point is 00:46:20 My point was, and I entitled this section, What's Real? Maybe they were the best team in history. My point was, and I entitled this section, What's Real? Maybe they were the best team in history. And maybe the fact that they weren't successful on that one play that the whole game done, maybe it was because the wind was blowing left to right rather than right to left at that moment. And so we should not be too firm in our conclusions. I guess the recurrent theme is a lack of certainty. But I really would push people to fooled by randomness. There's a little book by John Kenneth Galbraith called The Short History of Financial Euphoria, and a great quote. He said, we have two kinds of forecasters, the ones who don't know, and the ones who don't know, they don't know. And that has been very inspirational for me. I don't think this was attributed to you, but I came across it in looking at some highlights of your memos in prep for this conversation.

Starting point is 00:47:22 And I don't think it's attributed to you, but someone said dumb money can become smart money if it accepts its limitations. I don't know if you would agree with that, but it's, it's stuck with me as maybe not necessarily forecasters, but at least people who cultivate becoming aware of what they don't know. Sure. Well, that I think, first of all, knowing what you don't know is one of the keys to success in anything. You know, Dirty Harry said a man should know his limitations. I wouldn't say, it's not my quote, I wouldn't necessarily say that dumb money can be smart money. But I would say that one of the ways to avoid being dumb money is to not act as if you know things you don't know.

Starting point is 00:48:07 Maybe by the time I get done giving the quote, I'll be able to remember who said it. But somebody very wise said, Mark Twain, that's it. It's not what you don't know that gets you into trouble. It's what you know for certain that just ain't true. That is so important. There's nothing more dangerous in life than being sure you know something that you don't know. If you have excess certitude, you will do things boldly in dangerous ways and to dangerous extents that have the ability to get you into trouble, get you killed.

Starting point is 00:48:52 But a sentence that starts off with, I'm not sure, but is unlikely to lead to fatal action. The distinction to me is so clear and so unarguable that I think this is one of the most important things for life. Know your limitations. You mentioned a little bit earlier how you could potentially say to yourself in the morning, you know, I don't know. I don't know. Maybe he or she is right. Maybe he or she is right. It makes me think of some of these memento mori type quotes that maybe apocryphal from ancient Rome where they'd have someone behind the emperor when he's being paraded through the streets saying, you're just a man, you're just a man, something like that. I know this is seemingly maybe not on the same topic, but nonetheless, I want to ask about it. Do you have any particular routines or habits in the first, say, hour or two of your day,

Starting point is 00:49:42 whether it's now or whether you were kind of, if there were a particularly productive period in your professional life where you feel like those routines or habits in the morning were important, does anything come to mind? I don't have stylized routines. I mean, I would just say that my life is pretty calm, and I try to keep it that way. What would be a symptom of it not being calm, and how would you respond to that? Well, watching too much political TV and getting exercised about what you see on TV would be a good example. I mean, that's negative energy. That's not going to contribute to your

Starting point is 00:50:25 effectiveness in the day. Now, the fact that I don't get exercised about what I see on the news shows is not purposeful. So up to this point, we've talked a fair amount about the importance of avoiding hubris, of understanding your limitations, the incompleteness of your knowledge. How do you balance that with perhaps knowing your strengths well enough or having conviction in evidence to the extent that you can then take action? Sure. Well, that's a great question, Tim. And clearly, it's essential to balance. You don't want to be the person who thinks he knows everything,

Starting point is 00:51:04 but you can't be very successful in life, and especially not in investing, if you think you're the person who knows nothing. There is no magic in it. There is no rule, no method. It's just an awareness. But we have to feel we know enough to take action. Now, most successful people, most smart people, don't have a problem in that area. They have a history of having their ideas validated, for the most part. But I think it's, I mean, it is one of the great conundrums, which is unanswerable methodologically. You know, you buy a stock at 80, it falls to 60. You say, well, I think it's cheaper now. I like it more.

Starting point is 00:51:57 I'm going to buy more. You buy more, now it falls to 40. Is there a point at which you say, well, maybe I'm wrong and maybe the market's right? If you throw in the towel and sell every stock you buy, when it goes down a little, you can never be successful. But if you ignore the possibility that you're wrong, you can never be successful. And you have to strike a balance. So when you buy a stock and it goes down a little, you take another look at your analysis. Is there anything you missed?

Starting point is 00:52:32 Did your analysis hold water? And so forth. Maybe you talk to some people that you respect to get their opinions. But, you know, again, if you're too sure, you're in trouble. And if you're too too sure you're in trouble and if you're too unsure, you're in trouble, uh, you have to strike a balance. If we come back to the, the hypothetical example you gave someone buying at 60 drops to 40

Starting point is 00:52:56 drops to 30 drops to 20 to avoid being in that position where you are offering yourself the option of buying or selling at each of those check-in points, what are you deciding in advance so that you don't make those interim mistakes or you don't even make those decisions or look at them to begin with? That's not my approach or Oak Tree's approach. We don't have preset rules. Everybody says, says well why don't you just set a rule there are things called stop loss orders you buy something goes down 20 you sell it every time there is no rule that will ever work in every case uh you have a you have a rule that goes down 20 you're out so it goes down 21 you sell then it goes up 100. Or it goes down 10, you don't sell, and it never goes up again. There can't be a rule that always works. One day, just before the publication of my other book,

Starting point is 00:53:58 I had lunch with Charlie Munger. And at the end of the lunch, when I got up to go, he said, just remember, none of this is meant to be easy. Anybody who thinks it's easy is stupid. These things cannot be reduced to a rule. The market operates so as to confound rule makers. And I wrote a memo five years ago called It's Not Easy. It all comes down to judgment. We have to have, if we're going to have superior investment performance, we have to have superior judgment.

Starting point is 00:54:36 And you, I mean, you can work on your processes, both intellectual and emotionally, But you can't, I mean, superior judgment isn't something you can order up, and not everybody can necessarily attain it. But I mean, I think that one of the most important things is to dismiss the concept of a process or a rule that always works in the absence of superior judgment. Is the judgment the decision to take a certain path versus another? In other words, and I know I'm going to be bastardizing this, but if an advantage could take the form of access to better information, better analysis of that information, making a better decision with this with that information that is available having the courage to act on it and then the emotional fortitude to either act on

Starting point is 00:55:32 it or also sit with that decision and there may be other behavioral psychological advantages or disadvantages i'm sure there are when you talk about judgment is that a particular link in that chain? I think judgment is everything. For example, just to follow your taxonomy, judgment is knowing when you have information that others don't. And if you think you know something that others don't, it's knowing when yours is likely to be valid and knowing whether you're likely to be offbeat.

Starting point is 00:56:09 It's understanding how to analyze it. Judgment is the reaching of conclusions based on your analysis, and judgment is all we have to tell us when something goes against us whether we should hang in or give up. So, as I say, I think it's all judgment. I would imagine a lot of people read your memos and your writing to develop, in hopes of developing, better judgment. and that while there is no one rule that will work for all circumstances, all cases, there may be certain questions or tools that prove helpful in a greater percentage of cases than others. And to that, I would love to refer to a few things that I have in front of me. One is a letter that you sent to me along

Starting point is 00:57:06 with the book. And towards the end of the letter, it says, I draw on my 50 years of investing experience to provide an orientation to the usual cycles in the economy, corporate profits, the availability of credit, and the securities markets, as well as some of the less ordinary ones. For example, in distressed debt, investor psychology, and even in success. But I think potentially, I think potentially the most useful chapter, the most useful is the chapter on the cycle and attitudes towards risk, how investors are thinking about risk and behaving toward it at a point in time might be the single most influential determinant of markets position in the cycle. And that's the best indicator of how we should behave with regard to. And I read that chapter, I believe I had the right chapter. And there's a point in this chapter that has a few lines bolded,

Starting point is 00:57:55 which I really appreciate, by the way. And it is, if I could ask only one question regarding each investment I had under consideration, it would be simple. How much optimism is factored into the price? Could you talk about this question and perhaps give some examples of using it or how people might use it? Sure. You know, I started in the business in a summer job at Citibank, summer of 68, 50 years ago. And the bank was an investor in what was called the nifty 50, the 50 best and fastest growing companies in America. And if you bought the stocks the year I showed up and held them five years, you lost almost all your money in the best companies in America. Then 10 years later, I switched to the so-called junk bond business, high yield bonds. Now I'm lending money to the worst companies in America,

Starting point is 00:58:45 and I'm making money steadily and consistently. So clearly, buying good things can't be the secret to success in investing and avoiding bad things. It has to be the price you pay. It's not what you buy. It's what you pay. And there's no asset which is so good that it can't become overpriced this is of course something that people have to bear in mind when they look at the fang

Starting point is 00:59:13 stocks and on the other hand for those who don't know could fang facebook uh amazon netflix google Google, and they throw in Alphabet, too. And so there is no asset which is so good that it can't be overpriced. There are very few assets which are so bad that they can't be underpriced and thus a bargain. So what we have to look for if we're going to be successful investors, now my school, which is called Value value investing, puts more emphasis than perhaps venture capital or growth investing, which largely looks for brilliant futures. But the key is paying a low price relative to something called intrinsic value. If you pay a high price relative to the value, you're unlikely to do well and you probably have to get lucky to have a good return. But if you pay a low price relative to the intrinsic value, then the odds, again, like my book says, are on your side.

Starting point is 01:00:16 So we want low price to value. How do you get low price to value? And the answer is low optimism. There are other ways to describe it. You mean looking for low overall optimism? Right. In short, the things that everybody feels good about are likely to be the things that are high priced and the things that everybody feels bad about are likely to be low price. So if you could find out that here's a stock, nobody thinks this company can ever have a good day. Maybe there's a chance that it'll produce some favorable surprises and make you a lot of money. If there's a company like the Nifty

Starting point is 01:01:00 50 back in 68, everybody assumed literally, Tim, nothing bad could ever happen to these stocks. Then clearly there has to be so much optimism in the price that there can never be a favorable surprise. We make money from favorable surprises. And if the positive conviction is so high, then by definition, there can never be a favorable surprise. So I think that this is a number one concept. You mentioned, I think you said the word never in this sort of hypothetical exuberant enthusiasm,

Starting point is 01:01:43 what someone might say. And I believe there are certain words you dislike using or pay attention to when they come up. It's all part of this lack of intellectual hubris. Right. We should never say, never, always,

Starting point is 01:02:03 has to, can't. You know, these expressions are far too absolute to be winners in a world beset by uncertainty and randomness. And when you use those words, you tend to get into big trouble. When assessing, uh, public sentiment, it could be really wide. Let's say anyone participating in the S&P 500, it could be narrower, but let's, let's assume we're looking at the, the, the broad, uh, the broadest collection of market participants, at least let's just say S&P 500.

Starting point is 01:02:49 I was texting with a friend of mine who's a successful investor, very different stylistically than yourself. And I asked him, I said, what would people use or what do investing pros use or what do some of them use to measure how fearful or greedy, and then in quotation marks, the market is is are their go-to indices or polls and he said people use the vix as a measure of fear vix and then he said some people might use something like yield

Starting point is 01:03:17 on junk bonds as a measure in other words low yield equals complacent market. What are, let's say, it seems so difficult to keep track of the media as a whole, although certainly it becomes obvious at some point if it's all negative or all positive. Are there particular indicators that you like to pay attention to or your firm likes to at least keep an eye on? In the old book, there's a chapter that talks about the importance of taking the temperature of the market, knowing where we stand. And it has a, it includes with a checklist, largely tongue-in-cheek, called the Poor Man's Guide to Market Assessment. And basically it asks some simple questions. What's going on?

Starting point is 01:04:07 If a new fund comes out, does it sell out immediately or does it struggle? If an investor goes to a cocktail party, yeah, there you are. It's also in the new book. Oh, it's also in the new book. No, it's good. Yeah. If an investor like me goes to a cocktail party, is he the center of attention that everybody wants to talk to? Well, that's probably a sign that interest in the market is too high.

Starting point is 01:04:33 Or is he pushed into a corner and everybody wants to talk to the athletes and the venture capital guys? And that's probably an indication that interest in my part of the market is too low and that bargains may be available. You know, when you turn on TV, is it all they want to talk about is the good news or the bad news? And I have some cartoons in the new book, old cartoons dredged up from my files. But, you know, it just, they demonstrate that virtually everything in the world and in the markets is subject to either a positive or negative interpretation. And if everybody is interpreting everything positively, that tells me that the spirits are too high and perhaps ready to be dashed and vice versa.

Starting point is 01:05:27 You know, the greatest thing I was ever taught was back around 73, 74. Somebody said, I'm going to tell you about the three stages of the bull market. And in the first stage, just a few incredibly insightful people understand that there could be improvement. And in the second stage, most people recognize that improvement is actually taking place. And in the third stage, everybody and his brother believes that things will only get better forever. Now, I think this is, number one, this is a very accurate description of the world. Number two, clearly, if you buy in the first stage, when only a few people understand the potential for improvement, you're going to pay a low price because there isn't much optimism in the price.

Starting point is 01:06:19 Then, as you progress to the second and third stage, the unanticipated improvement takes place. That gives the market a favorable surprise. The stock prices or the asset prices rise in response to those favorable surprises. But you eventually reach a point where the good news convinces people that it's going to go on forever. And when everybody believes that things will get better forever, clearly it's likely that so much optimism is in the stock price that it's dangerous and unlikely to yield a profit. So I think that the three stages of the bull market, and conversely, of the bear market, are really important, not as a money-making rule, but as something to bear in mind and watch out for. I'm going to ask you a few questions that you may not like, but that my fans will kill me for if I don't ask.

Starting point is 01:07:26 So where, I guess number one is, where do you think we are at the moment? And of course, this has to be timestamped. And we're talking in August 2018. And what has you worried? What has you optimistic, if you're optimistic about anything? Sure. Well, where are we? For the last 10 years, ever since the crisis, people have been asking that question in the form of what inning are we in? When they asked it in late 08, what they really meant was, how much longer will the pain go on? Now what they're asking is, how much longer will the pleasure go on and the bull market and

Starting point is 01:08:06 the economic recovery? I think we're in the eighth inning. Now you don't have to timestamp it because I've been saying this for a while and I'm likely to continue to do so. But about a year ago, I came to realization that that observation, even if accurate, is of limited use because unlike baseball, we don't know how many innings there are in a game. This is a big distinction. In a normal baseball game, we know there are nine innings. If I say we're in the eighth and if I say it accurately, that means the good times are about to end. But in economies and markets, there is no fixed duration. So the bull market, this is the 10th year. That's a long time. In the economic recovery this month, we have begun the 10th year. The longest economic recovery in recent history is 10 years. So these observations start to tell you,

Starting point is 01:09:06 not that it's going to end, but that the likelihood of its continuing is declining. The odds are not on your side. When you're in the 10th year, the odds of having 10 more years of recovery seemingly are not good. We don't know if there's some reason why there has never been a recovery of more than 10 years,

Starting point is 01:09:23 but we have to wonder if there is. But on the other hand, we can't be too sure. Now, I believe that this economic recovery for many years was the slowest on record. That is probably helpful because that kept excesses from coming into existence that have to be corrected with a downturn. So you asked about the good news. The good news is that the economy is functioning at a high level.

Starting point is 01:09:53 We just had a quarter of unusually rapid growth. Unemployment is declining. Our economy is the envy of the world. Stock prices, which were very high when measured by price-earnings ratio last year, are not so expensive this year because the earnings have been supercharged by the tax bill. The projected earnings of the S&P 500 are way up this year, 23%, I think, which is unusual. And higher earnings, everything else being equal, means a lower price-earnings ratio.

Starting point is 01:10:29 So by most measures, stocks are only slightly expensive at this point in time. So that's the good news. The bad news is, number one, interest rates are likely to increase, and interest rates increase the burden of debt on companies. And when bonds yield more, they offer more competition for stocks. Clearly, there are a lot of uncertainties in the macro world, in the geopolitical world and in the political world, the greatest of which is the possibility of a trade war, which almost everybody thinks would be extremely negative, not only for the U.S. and for the people who engage in the trade war, but for everyone.

Starting point is 01:11:18 And I think that, interestingly, what we've been talking about is assessing the level of investor psychology. I don't believe that investor psychology is terribly frothy. The way I've put it in the past is that people are not thinking bullish, but they're acting bullish. A lot of people have moved into higher risk investments in order to get the returns they want because right now safe investments, treasuries and high-grade bonds and cash and money markets, offer so little. So people have been forced to move out the risk curve and take more risk, and that makes the world a riskier place for you and me.

Starting point is 01:12:01 I borrowed a phrase from my late father-in-law who said that those people could be described as handcuffed volunteers. They're doing things not because they want to, but because they have to. But the effect on the market is the same. When people move to riskier actions, it makes the market riskier for everyone. So if we were to consider all of that, if you had, say, three people come to you, and you had to give them some response, because it's like a mother-in-law,, $1 million, $10 million to invest. So $100K, $1 million, and $10 million, they make $100,000 a year. That is going to remain stable and predictable. Let's just assume that on the income side. They are very cautious.

Starting point is 01:12:59 I think like a lot of people, the loss aversion and pain of losing $100 hurts much more than the joy they derive from making $100. And they have their investable funds, in this case $100K, $1 million, $10 million in cash or cash-like equivalents or some of these safe vehicles currently. And they say, Howard, I don't know what to do. What are your thoughts? I think that one of the most important things in investing is to make people comfortable. It's a mistake to sit there and say, you should do this, you should do that, regardless of people's comfort level. Because if you violate their comfort level, if you force them into things that are too risky for them and then things go bad,

Starting point is 01:13:44 they're unlikely to do the right thing. They're more likely to panic and sell on the lows, which is the cardinal sin of investing. So it's very important to assess people's needs and ability to withstand tough times. Clearly, the person who makes $100 and has a hundred doesn't have a big margin of, uh, of safety for tough times. And, and, and they should invest, uh, more conservatively. The person with 10 million, um, uh, depending on his psychology, uh, or her psychology, probably would be willing to stomach some losses in the pursuit of big gains. Now, people always overestimate in advance the equanimity with which they would greet losses. You know, back in 1997, 8, 9, when the stock market and the tech stocks were rocketing along, what a lot of people

Starting point is 01:14:47 I think said is, well, my 401k has been doing so great, I wouldn't mind if I lost a third of my money. It's okay. Believe me, when they lost a third of their money, they weren't okay. But our mantra, my mantra for the last few years has been move forward but with caution. And so in varying degrees to those three people, I would say we are investing every day. We are endeavoring to be fully invested today other than in funds that are strictly designated as standby funds for the crisis. We are definitely taking risk, but with caution. We're a cautious firm. We invest in risky asset classes, high-yield bonds, distressed debt, real estate, emerging market stocks and bonds, et cetera, these are risky assets. And Oaktree has always taken a low-risk approach, a controlled risk approach to those asset classes.

Starting point is 01:15:51 So when I say with caution, I mean with more caution than usual. I think this is a time for more caution than usual. And that's what I would tell those people. But I don't – so I think that the outlook is not so bad and the prices are not so high that you have to practice maximum defensiveness and go to cash and suffer a 1 percent return on cash. But I think the outlook is not so good and prices are not so low that this is time for aggressiveness. And I wouldn't be aggressive. I think one way that I help myself make these decisions, and it might be helpful to your listeners, is I constantly remind myself and others that as an investor, there are really two key risks that we face every day. Now, the first one is obvious, and everybody knows that. It's the risk of losing money. What's the second?

Starting point is 01:16:49 Not so obvious, a little more subtle. It's the risk of missing opportunity. And most people, if reminded of the twin risks, they would say, well, I think that's right. And the truth is that I don't want to lose a lot of money. But on the other hand, I don't want to miss all the opportunities. So I'm going to compromise. I'm going to balance the two. I'm going to do a lot of money, but on the other hand, I don't want to miss all the opportunities. So I'm going to compromise. I'm going to balance the two. I'm going to do something kind of in the middle. And that makes sense.

Starting point is 01:17:10 Everybody, you know, other than daredevils and scaredy cats, everybody should do something in the middle. Exactly where in the middle is debatable and should be tailored to their own psyche and financial position. So the interesting question is, okay, what about today? Today, should you be in your normal balance between the twin risks, or should it be different? Should you be in a higher risk position because so many things yield so little, or should you be in a lower risk position because there are so many uncertainties?

Starting point is 01:17:46 And I actually think the latter. So fully invested and being cautious does not mean being in cash, but everything you want to do in the investment business, there are higher and lower risk ways to do it. And I think today is a time for the lower risk ways. So I, you know, this is not the first time I've asked a question like this. But the last time I asked the first part of that, which was making 100 grand a year, I've someone has 100 grand to spend was actually at the Berkshire Hathaway shareholder meeting a long, long time ago,

Starting point is 01:18:21 and is my my, my first and only time there. And I was so excited to be there. I mean, it's Woodstock for investor nerds. And it was, there's so much excitement. People were camped out, out front to be in line. I was part of that. And I asked someone working there where the microphone was that was hardest to get to. And then I sprinted over there and I was able to ask Warren and Charlie this question. And of course, you know them and the responses can be very short. And I said, if someone hypothetically were making $100,000 a year, they had $100,000 to deploy in some way, how would you suggest they invest that capital? And it was along the lines of invest in the S&P 500 or a low-cost index fund in the S&P 500 and get back to work.

Starting point is 01:19:09 And I found that very dissatisfying, but in retrospect, certainly not the worst advice that you could give someone. How do you, what do you disagree with Warren most on? What do you guys not see eye to eye on? You know, Tim, there's a book out called The Warren Buffett Way, and I was asked to write the forward for the latest edition. And I wrote something called What Wakes Warren Buffett, Warren Buffett. And I listed the things that characterize him. Extremely high IQ, unemotional, great analyst, understand what's

Starting point is 01:19:46 important, looks at the things that are important and figures out their import, ignores the things that are unimportant, and on and on like that. And the last one was the most, one of the most important. He's not afraid of getting fired. He doesn't have to worry about the interim consequences of error. Most people do. And so, you know, okay, so you say your advice is, or his advice is, invest in an index fund. Fine as far as it goes, but how much? Should the person who has $100,000 put the whole $100,000 in the stock market?

Starting point is 01:20:25 Right. And especially should they do it today? And if they do it all today, we're confident that 20 years from now, they're going to have a lot more money and they're going to be really happy. What about a year from now? And not everybody is financially able to live through a decline and emotionally able. And so, as I said, the first purpose of investing, especially for people who have more money than they need to eat, should be to make you comfortable. When I started at the bank, Citibank, 50 years ago, they had a cartoon on the wall. It said, scared money never wins.

Starting point is 01:21:10 And it's true. And so everybody should invest only up to their comfort level. And so I think I would, I certainly agree with Warren that for most people, they can improve on an index fund. But that's, and I'm not saying that Warren says that everybody should put 100 percent of their net worth in the index fund, but clearly they shouldn't.

Starting point is 01:21:32 And I was once at a talk and I was preceded by a college professor. I won't identify him. Warren always says praise by name, criticize by category. So I'll only say, so I'll say I was preceded by a college professor and here's what he said. And this guy is known for pro-stocks attitudes. And he said, if you are of average risk tolerance, you should have 85% of your money in the stock. No, if you're below average risk tolerance, 85. Average risk tolerance, 105. If you're aggressive, 125% of your net worth should be in the stock market. And I just think that most people can't live in the long run, in the short run, with the consequences of being that much invested.

Starting point is 01:22:32 And being human, we are our own worst enemy. Everything that goes on in the world and the market conspires to make people buy when things are going well and prices are high and sell when things are going badly and prices are low. And fighting that is the number one theme of the book. And it's the number one theme of success. Just from personal experience, and I mentioned this earlier, but looking at my response in, say, 2008, I'd bought a house in 2007 with some very unfortunate mortgage terms and made some very bad decisions also with money that I had in the stock market at that time. And I think in part, it was because I couldn't have known how I would respond

Starting point is 01:23:19 under those circumstances. And when I filled out this very templated form, of course, for whoever it was at the time, I won't mention anyone by name, but it was, to what extent would you be comfortable with a drop in your portfolio over one quarter or one year, whatever the form of the question was, and it had 10%, 20%, 30%. And I thought, well, 30%, maybe. I mean, pulling an answer out of thin air. I had to answer it to get through the online form. But I'd never experienced anything similar to that. And this just came to mind because I'm looking at a book on your shelf, bringing down the house about games. We were talking about games earlier.

Starting point is 01:23:59 As I understand it, Bill Gates, I think also Buffett, played a fair amount of bridge. Certainly many people in the investing world, including some people who are really, really, really fantastic, some of the those games help someone to assess their risk tolerance for larger types of investing? Or are there other ways to in any way accurately determine that? I think accurately determine, yes, quantify, no. But I think that we can get a handle on our degree of risk tolerance, risk aversion, and we should. And, you know, I was with my son and one of his friends this week, and his friend is a great chess player. The interesting thing about people who play chess is that in chess there's no randomness.

Starting point is 01:25:11 You know, there's no dice to roll there's no wind to blow uh no card to pick from the deck and and every all the information is on the board and everybody has all the information so it tells you something about an intellectual process um and you know all the way out to craps, where everything's in play all the time based on randomness. So maybe which game we like tells us something about ourselves, but how we play also tells us about ourselves. Backgammon, which is one of my main games, which is highly probability intensive because it's all the dice. It's the dice and the skill, but the dice mean a lot. You know, in any situation with any

Starting point is 01:25:55 throw of the dice, there are aggressive and defensive ways to play. So, you know, probably the interesting thing was that if you played and I watched you for a couple hours, I would know if you're aggressive or defensive or risk-averse or risk-tolerant. And you should be able to do the same for yourself. As I said before, one of the great things is to understand ourselves. And without that, we're really in trouble. What are some of the things that otherwise smart people miss about cycles or misconceptions that they believe to be true, like you said with Mark Twain, that just ain't so? I think the, well, the biggest mistake you can make is ignore the repetitive nature of the cyclical pattern. Ray Dalio, in his book Principles, talks about how much analysis he and his partners did, the conclusion of which is the ability to

Starting point is 01:26:56 look at what's going on in the world or in the market and say, oh, that's another one of those. Life becomes very easy when you have studied the past to the extent that you've seen the recurring patterns and you can recognize them when they come up again. So, so, uh, I think that's, I think that's extremely important. Um, but the other thing is, and I think the guiding quote of the book is, uh, is another one from Mark Twain. History does not repeat, but it does rhyme. History does not repeat. The cycles are never the same in terms of amplitude, speed, duration, cause, or ramifications. But there are themes that repeat that can help us to identify and properly respond to cyclical occurrences. So I say in the book that I've been in the high

Starting point is 01:27:59 yield bond business now for 40 years. And there was a time when there arose a body of thought that most defaults occur on bonds second anniversary since issuance. And I don't think there was anything magical about the second anniversary. And if people believed that, then they would sell all the bonds they had that were 23 months old and buy them back when they were 25 months old if they had survived. But I don't think they would accomplish anything by that because I think they were assigning an import to a number that was not valid. So I think it's really important to recognize cycles and understand them. I think it's unimportant to assign importance to these numbers or rules, but it's very important to understand what's going on around us. And when the recovery is old, the bull market is old, the psychology is elevated,

Starting point is 01:29:08 the valuations are high, then you should know that the odds are not on your side, and you should take some money off the table and behave in a more cautious way and vice versa. Which I suppose also, on some level, necessitates cultivating a fair degree of patience. I mean, it would seem to me. Patience is essential. There was an investment sage named Peter Bernstein. And he said the market is not an accommodating machine. He will not give you high returns because you need or want them.

Starting point is 01:29:40 And, you know, I believe that right now we're living in a low return world. And if you say, Howard, I need high returns in a low return world. The only way to try to get them is by taking a lot of risk. And by definition, taking a lot of risk is not sure to work and could have negative consequences. So I believe that when you're in a low return world, you have to accept it and deal accordingly. Now, this comes from Mujo, which we started the interview with. I talked about Mujo in a memo about 20 years ago entitled, It Is What It Is. I think one of the most important things that we can do as adults, be it in the investment world or the real world,

Starting point is 01:30:27 is to say it is what it is. In other words, accept things for what they are, deal with them as they are, don't spend a lot of time wishing they were different, certainly don't act as if they were different. We have to accept the realities. Not that in my little tiny corner of investing, which is not quite scripture, but Buddhist thinking related to concepts like Muzo and Stoic philosophy, Epictetus and so on, how helpful that has been to tempering emotional reactivity. You mentioned someone I want to come back to for a second. Peter, is it Bernstein or

Starting point is 01:31:27 Stein? Bernstein. Bernstein. Financial historian, sadly passed away, I think it was in 2009. I've read that you consider him one of the smartest people you've ever met. Why is that? Are there any other things that you learned from him? 48 years ago, when I was a junior analyst following Xerox for Citibank, and I would give the portfolio managers at the bank my opinions, there any other things that you learned from him? 48 years ago when I was a junior analyst following Xerox for Citibank and I would give the portfolio managers at the bank my opinions, one of them came up to me and said, who is the best analyst on Wall Street on Xerox? And I said, well, the one who agrees with me the most is so-and-so. We always think that the people who agree with us are really smart. And Peter saw the world the way I did, but in many cases put it into words better

Starting point is 01:32:07 and I wrote a memo called Risk in 06, Risk Revisited in 14 and then bizarrely, one day I found a memo from him. You mentioned he passed away in 09. In 16, I found a memo from him on my desk. My desk is a little messy and there's a lot of stuff floating around. And it was a great memo entitled, Can Risk Be Reduced to a Number?

Starting point is 01:32:37 And I took a bunch of stuff from that in a redo of my memo entitled Risk Revisited Again. But I just think that Bernstein is great. And on the subject of risk, he said, every day we walk into the unknown. And as I said, the future is a distribution of possibilities, and some days we don't even know what the possibilities are. And I conclude, if I can borrow your copy of the book, I conclude with a quote from him because I think it's so good. And if I can find it quickly, he said, the future is not ours to know, but it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances. Being wrong comes with the franchise of an activity whose outcome depends on an unknown future.

Starting point is 01:33:49 And I think that that's a, and randomness of the world, I think you're likely to do a lot better in it. Now, that doesn't mean you can't invest. You can't invest even boldly. What it means is you have to assume that things are not going to always work out right away. Well, of course, they're not always going to work out, but they're certainly not always going to work out right away, which means what? You have to have patience. You have to have staying power.

Starting point is 01:34:33 You have to have fortitude. You have to not invest so much that if it goes against you, you're going to panic and get out. Preparing for an unknown world, unpredictable, maybe even hostile world in the short run is probably a lot smarter than assuming everything's going to go right and it's going to go the way you expected and it's going to go that way right away and you're not going to be tested. And so I think that this is the kind of thinking that, you know, when I read Bernstein or some of the other people I've mentioned, I just go, oh yeah, right, sure. That gets it for me, and that, and I'm paraphrasing here, but if he sees it in his inbox, or he sees one of your letters, it's one of the first things, or the first thing that he'll pick up to read. I'd love to ask you about your reading. Are there any, say, three to five specific newsletters, or columnists, or economists, or writers who

Starting point is 01:35:42 you find yourself excited to read these days? Anyone who comes to mind? I think the best, you know, I work mainly in the credit area, not the stock market. So, you know, most people invest mainly in the stock market. And we've talked a lot about the stock market. But that's not what I do professionally. And our Oaktree's investing is largely in something called credit, which means fixed income securities, bonds and notes and loans not issued newsletter called Grant's Interest Rate Observer. It's a little ironic because it, Grant's has nothing to do with interest rates or almost nothing, but it's about credit. And in particular, it exposes stupidity and it exposes companies companies which seem to be where people are not bringing enough skepticism and deals that seem

Starting point is 01:36:50 unwise and that kind of thing. And I think they do a great job. Now, I think it's fair to say that it has a negative cast. In other words, they're mainly talking about things which are rated higher than they should be, which you should avoid or bet against. I don't think they as often talk about the things that are rated lower than they should be and present profit opportunities. But for credit guys like us, avoiding the losers is extremely important. And I think that's a great newsletter, not only for the content, but for the attitude and the importance of identifying misperceptions. Misperception is the key

Starting point is 01:37:34 to operating in the markets. And variant perception, you understand things differently from the way everybody else understands them, is the key to success, assuming you're right. If you understand everything just the way everybody else does, clearly you can't outperform. That's the death knell for a would-be professional investor. So you have to see things different from others. That's a necessary condition for outperformance, but you also have to see it better than others. That's necessary too. The combination of those two is what I call second level thinking, which I mentioned a couple of times. You also mentioned how widely read Charlie Munger is. And certainly in Poor Charlie's Almanac, for instance, he talks quite a bit about, if I'm not misremembering, evolutionary biology and really is Lessons of History by Will and Ariel Durant, which I found really fascinating.

Starting point is 01:38:55 Also, I mean, talks about cycles in a way. Uh, are there any books that you found recommending a lot or that you've enjoyed in the last few years that are not specific to investing? Not specific, yes. My reading is usually closer in than Charlie's. So an example is the book I'm working on now, which is called Factfulness. And basically, it unmasks a lot of misperceptions that people have about the state of the world. And they hold these perceptions generally qualitatively, not based on data. And the author tries to substitute facts for these perceptions. He starts with a list of 13 questions describing the state of the world and fascinatingly, I guess he gives you the answer to one and you have to think about the answer to the other 12. The average score on the 12 is 2.

Starting point is 01:40:06 And he points out that if you flip the coin, you'd get 6 right. So the average American gets 2 of the 12 questions right. And so not only are they systematically wrong, but they're wrong in the same direction, which is they always pick the more pessimistic answer when the more optimistic one is true. And so he responds to our bias, and he tries to overcome the ignorance and the bias by using facts and some great, very communicative graphics. So I would recommend Factfulness, and I love the idea of unmasking biases. You mentioned that, and if I get this wrong as I'm restating, please correct me, but that in a low-yield environment to get high yield entails increased risk. I know you've written a little bit about cryptocurrency before.

Starting point is 01:41:04 The last I saw was I, from about a year ago. What is your current view or thoughts on cryptocurrency, if any? That's one place that people are going, often with no understanding of the technology or anything else. I mean, it scares me enough, although, anyway, I won't get into my view on that stuff. But people who are well outside of tech, well outside of all of that,

Starting point is 01:41:30 getting very, very bullish as it relates to cryptocurrency. But what are your thoughts? I am what is called a value investor. And that means you look at the situation, you don't look at the atmospherics, you don't look at the aesthetics. You look at the valueospherics. You don't look at the aesthetics. You look at the value, hard value, the company's assets and the cash flow that its business produces. And you value those things.

Starting point is 01:41:55 And you come to something called the intrinsic value. And then you see if you can buy it for less. If you pay full intrinsic value, you'll probably get a fair return. If you pay more, you'll probably have an unsuccessful experience. But if you can buy it for less. If you pay full intrinsic value, you'll probably get a fair return. If you pay more, you'll probably have an unsuccessful experience. But if you can buy it for less than the intrinsic value, you should have an above average return. That's value investing. And I think it is the intellectually soundest form of investing. And nobody has been able to tell me the intrinsic value of a Bitcoin. I believe there are assets in this world where you can come up to intrinsic value, and they are the ones that produce cash flow. Companies, stocks, bonds, buildings,

Starting point is 01:42:40 that kind of thing. There are a lot of assets in this world that do not produce cash flow. You cannot put an intrinsic value on oil, gold, diamonds, paintings, Bitcoin. Does it apply to all currencies? Yes, it does. Yes, it does. we cannot say how many pounds a dollar is worth. People look at them in terms of what's called purchasing power parity, but it doesn't really work very well. And the truth of the matter is that these macro considerations, the directions of economies and markets and currencies and commodity prices, I mean, what's the intrinsic value of an

Starting point is 01:43:34 orange? These things, I think, can't be predicted reliably. And in fact, the so-called macro funds have been doing quite poorly for years. So there are some things that can be valued and some things that can't. And I believe that Bitcoin is one of the ones that can't be valued. And everybody says to me, but you don't understand. And I wrote about this in my July 17 memo and returned to it in September. I learned something between July and September. That's why I put it in the next memo too. People said, you just don't understand. People are going to want a currency that the government can't deflate and that can't be counterfeited and can't be stolen and all these things. And so that's why I returned to it. But I still don't understand how it can be valued.

Starting point is 01:44:32 I don't, and today Bitcoin is $6,500 here on August the 10th and I don't see how you can say it's worth $7,500 or $5,500 or anything like that. You can say it's going to be useful in the future. You can say people want a currency, a non-governmental currency, but I don't see how you can put a value on it. And with all of its attractions, to the extent that people find attractions in it, last year it went from 1,000 to 19,000. Now, I could be wrong, but that tells me it's speculative buying. And by the way, the people who, remember what I said about people who have opinions, believe in their right.

Starting point is 01:45:15 Obviously, the people who, it traded at 19,000. Somebody thought it was a good buy at 19,000 because it was going higher. And today, it's a third of that so for the most part reasonably valued value investments do not go up 19 times in a year and then down by two-thirds are there any understanding that you are a value investor uh you mentioned a few other names in the in the introduction of your book joel greenblatt uh who I'm also a fan of. Are there any growth investors, venture investors who are certainly approaching things differently, but are there any particular growth or venture investors or people who are playing a slightly different approach

Starting point is 01:46:00 who you have a lot of respect for or admire for particular reasons? Sure. Let me say there are many ways to invest. There are many people who engage in activities that I think can't be done. And there are many people in each one who do very well. So, you know, I don't say mine is the only way. Venture is an example. And I'm not a futurist. I'm not a dreamer. I'm not highly risk tolerant. I'm not biased to risk taking.

Starting point is 01:46:33 And if 40 years ago when Citibank said to me they wanted me to start a high yield bond portfolio, if instead they would have said I want you to start a venture capital fund, I probably would have been a disaster. But in the venture field, you know, the firms that success seems to be recurring, not random, you know, if let's say 20%, 10% of venture capital funds are successful, you would think that any given firm, 20% of their funds would be

Starting point is 01:47:09 successful. But there are firms which are repeatedly successful. You know, I was lucky in the last year to get to meet Bill Gurley of Benchmark, and Bill was nice enough to give me a blurb for the jacket in my book. And I was very impressed by our conversation and by Benchmark's record of achievement. And Sequoia has a great record. And, you know, Kleiner Perkins, et cetera. So you can do it. But it wouldn't be right for me.

Starting point is 01:47:45 That doesn't mean it's not right for them. Macro, there are, you know, I said 15 minutes ago that macro funds have had a pretty bad record. Some of the greatest investors in history have been macro investors. George Soros and Stan Druckenmiller, for example, have been fabulous. They probably have the highest returns of everybody. And quantitative investing, Renaissance, and so forth. So, again, it would be a terrible form of hubris to say my way is the only way. My way is the way that works for me.

Starting point is 01:48:20 And, by the way, if you look at the others, the success ratio is not terribly high. But certainly there are people who've done it great. Yeah, there's a very high concentration of success in a handful, at least within venture. Yeah, Bill's a very smart guy. All the firms you mentioned have done really, really well. I've heard said, this is not from you in these words, really well. Uh, so I I've heard said, uh, this is not, not from, not from you in these words, I don't think, but that, you know, the right decision at the wrong time is the wrong decision. And, uh, I'm, I'm very excited about the new book and the literacy of

Starting point is 01:49:02 cycles that you are helping people to develop with this. And we're going to wrap up in just a few questions. Are there any particular mental models or heuristics that are in this book or that you've used in your investing life that you think are particularly valuable kind of across the board in life? I know that's a big question and you probably have quite a few different directions you could go with that, but just in terms of becoming a clearer thinker, a better operating human being, does anything come to mind that we haven't discussed so far as it relates to any type of mental model that would be worth mentioning before we wrap up? Well, you know, Tim, when I finished writing the book

Starting point is 01:49:51 and I was thinking about cycles, I said to myself, so, for example, the economy grows about 2%, 2.5% a year on average. Why doesn't it just grow 2.5 percent every year? Why is it sometimes four and sometimes one and sometimes five and sometimes negative? And the answer is excesses and their correction. And people get too excited and they overexpand their businesses or they invest too much or they invest too much using debt and then something goes wrong and their excesses produce booms and then something goes wrong and those excessive

Starting point is 01:50:34 activities turn out to be unsustainable and they are then corrected by selling off inventory, closing plants or liquidating a leveraged portfolio, and those produce busts. So excesses and their correction. And I think the best thing that people can do is be on the lookout for those things. And when other people are engaging in excesses to the upside, we should turn cautious. And when other people are overcorrecting to the downside, we should turn aggressive. And I think it's been a big part of what Bruce and I have accomplished for the Oak Tree investors and my other partners and colleagues too. And it's something that everybody can do if they turn their mind to it.

Starting point is 01:51:29 Well, Howard, I really appreciate the time today. Good, me too. This is very fun for me, and hopefully, and I believe, will be valuable for people listening. Just to mention a few things, of course, people can find Mastering the Market Cycle, subtitled Getting the Odds on Your Side,

Starting point is 01:51:44 everywhere books are sold. You can also learn more at masteringthemarketcycle.com. People can learn more about Oaktree at oaktreecapital.com. And on social media, you have Twitter, Facebook, and LinkedIn, all the same, Howard Marks Book. Is there anything else that you would like to say to the people listening? Any recommendation, question they should ponder, action you might ask them to take, anything at all besides the book itself, which I encourage people to check out? Well, first of all, we've made repeated reference to my memos. They're all available online at oaktreecapital.com under the heading of Insights, Chairman's Memos. You can get the last 29 years' worth.

Starting point is 01:52:31 You can also sign up for a service that will notify you when one is published. The price is right because they're free. And I hope people will read them. And I just want to say that I like to hear from people. So I don't always have time to answer everybody, but my writing of the memos and the books has been enormously rewarding because I get lovely memos from people which say that I made complex things seem clear. That's the one that gets me going the most. So if people want to comment or if they want to take issue or ask a question, I'll try to get back to them. And is the best way to reach out to send you a note on social media?

Starting point is 01:53:11 Or I would advise against giving out any type of email address that will get deluged. Or maybe the answer is they should figure it out. Well, we're on social media. Okay. And we'd be glad to hear from them there. Perfect. Well, Howard, thank you again so much for the time. And for everybody listening, links to everything we discussed will be in the show notes, as usual, at tim.blog forward slash podcast.

Starting point is 01:53:38 And until next time, thank you for listening. Hey, guys, this is Tim again. Just a few more things before you take off. Number one, this is Five Bullet Friday. Do you want to get a short email from me? Would you enjoy getting a short email from me every Friday that provides a little morsel of fun for the weekend? And Five Bullet Friday is a very short email where I share the coolest things I've found or that I've been pondering over the week.

Starting point is 01:54:02 That could include favorite new albums that I've found or that I've been pondering over the week. That could include favorite new albums that I've discovered. It could include gizmos and gadgets and all sorts of weird shit that I've somehow dug up in the world of the esoteric as I do. It could include favorite articles that I've read and that I've shared with my close friends, for instance. And it's very short. It's just a little tiny bite of goodness before you head off for the weekend. So if you want to receive that, check it out. Just go to 4hourworkweek.com. That's 4hourworkweek.com all spelled out and just drop in your email and you will get the very next one. And if you sign up, I hope you enjoy it. This episode is brought to you by Helix Sleep. Last year, I focused on dramatically improving a few things. Surprise, surprise. Most notably, the quality of my sleep, which seems to affect just about everything. This led me to revisit, you name it, my daily routine, morning routine, exercise, diet, including mattresses from Helix Sleep. Helix has built a

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Starting point is 01:56:23 actually two questions. Number one, how can I invest money to improve my quality of life? I use that in investing as well. The second, how can I spend a little money or moderate money to save significant time? Inktel is one of those investments. They're a turnkey solution for all of your imaginable customer care needs. I used Inktel during the launch of the 4-Hour Body, which was very, very involved. And they provided 24-7 customer service for my land rush campaign because it was critical for me to take care of every person who purchased my books and participated. This allowed me to focus on the things that I am better at, my strengths, like the marketing plan that we'd worked on for six months, implementing that.

Starting point is 01:57:05 Intel trains their experienced customer service reps to know your business and your products inside and out and make your customers raving fans. They answer more than a million customer service requests every year, and they can do so across all platforms, including email, phone, social media, text, even chat. Leaving your customers with poor service or just mediocre service, which, by the way, in a competitive pool is a huge liability, long wait times or unanswered messages, carries a massive cost and risk to your business. Intel removes the logistics and headaches of this type of communication,

Starting point is 01:57:41 allowing you to focus on your strengths and grow your business. It can be a real competitive advantage. And I see many, many e-commerce companies and tech companies thinking of customer service as a good enough checkbox or an afterthought. And just like Airbnb, you design in innovative ways to be a competitor and to win, you can do the same thing with customer service. So as a listener of this podcast, you can get up to $10,000 off. It's a big discount. $10,000 off your startup fees and costs by visiting Inktel.com forward slash Tim. So check it out. For more info, go to Inktel.com. I-N-K-T-E E L.com forward slash Tim.

The Tim Ferriss Show - #338: Howard Marks — How to Invest with Clear Thinking

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