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 Howard Marks, co-founder of Oaktree Capital Management.
Photo credit: Shira Yudkoff/Wharton Magazine.Remember your goal in investing isn’t to earn average returns; you want to do better than average.
Thus your thinking has to be better than that of others – both more powerful and at a higher level. Since others may be smart, well-informed and highly computerized, you must find an edge they don’t have.
You must think of something they haven’t thought of, see things they miss, or bring insight they don’t possess. You have to react differently and behave differently.
In short, being right may be a necessary condition for investment success, but it won’t be sufficient. You must be more right than others . . . which by definition means your thinking has to be different. . . .
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“For your performance to diverge from the norm, your expectations – and thus your portfolio – have to diverge from the norm, and you have to be more right than the consensus.
Different and better: that’s a pretty good description of second-level thinking.”
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Second-level thinking is what immediately pops into my mind when I think about Charlie’s (Munger) observation.
And it’s a good general heading under which to discuss the great many things that make superior investing a challenge. In short, to borrow from Charlie, anyone who thinks it’s easy must be a first-level thinker.
Let me use some simple examples from the book to illustrate the difference.
* First-level thinking says, “It’s a good company; let’s buy the stock.” Second-level thinking says, “It’s a good company, but everyone thinks it’s a great company, and it’s not. So the stock’s overrated and overpriced; let’s sell.”
* First-level thinking says, “The outlook calls for low growth and rising inflation. Let’s dump our stocks.” Second-level thinking says, “The outlook stinks, but everyone else is selling in panic. Buy!”
* First-level thinking says, “I think the company’s earnings will fall; sell.” Second-level thinking says, “I think the company’s earnings will fall far less than people expect, and the pleasant surprise will lift the stock; buy.”
First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first-level thinker needs is an opinion about the future, as in, “The outlook for the company is favorable, meaning the stock will go up.”
Second-level thinking is deep, complex and convoluted. The second-level thinker takes many things into account:
* What is the range of likely future outcomes?
* Which outcome do I think will occur?
* What’s the probability I’m right?
* What does the consensus think?
* How does my expectation differ from the consensus? |
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