by Ben Carlson, A Wealth of Common Sense
āIf you donāt have superior insight, how can something be to your advantage?ā ā Howard Marks
Last week I had the chance to speakĀ to a group of finance students at Drexel University about my experiences in the investment industry. I tried to share with these students some of the things I wish I had been taught when I was in school.
One of the subjects I touched on was second level thinking. This is an important concept onĀ market expectations developed by Oaktreeās Howard Marks. Marks explained this theory in detail in his book,Ā The Most Important Thing. Hereās one of his examples:
First level thinking says, āItās a good company; letās buy the stock.ā
Second level thinking says, āItās a good company, but everyone thinks itās a great company, and itās not. So the stockās overrated and overpriced; letās sell.ā
Following the talk, one of the students asked how to develop a second level thought process. I thought this was a great question, because a simple example doesnāt always tell the whole story.Ā This isnāt just something you can pick up from a book and master right away, if ever. Having a deep understanding of what is likely priced in and consistently making smart decisions based on that analysis is what puts Marks in the top 1% of investors. Itās not easy.
But even if youāre unable to develop the same kind of second level mind that Marks has crafted over the years, you can still use this thought process to make yourself a better investor. Here are a few things I shared with this student on how to generally utilize second level thinking:
- Always be willing to see both sides of every argument or investment stance you take. You have to be willing to actively seek out opinions that are different than your own. No one isĀ right all the time and thinking about where you could be wrong shows intellectually honesty and the self-awareness to know youāre not infallible.
- Think in terms of probabilities, never certainties.
- Donāt judge your decisions based on the outcomes; judge them by the process you took to make them.
- Remember to think in terms of relatives, not absolutes.Ā Markets are all about expectations, especially over the short to intermediate term. Itās not always about things getting better or worse, but less good or less bad. A misunderstanding of this concept has cost plenty of investors a lot of money over the past 5 or 6 years.
- Be humble or the market will do it for you.
- Always consider the difference between price and value. Any security or asset class can make for a good investment at one price and a poor one at another.
- Never become too confident in your own abilities.
Very few investors are able to do what Howard Marks does. Everyone has to be willing to ask themselves:
- Do I have insight into this investment that someone else doesnāt?
- What is myĀ edge here?
- What do IĀ know that the market doesnāt?
I concluded my talk with this student by telling her that you donāt have to have an opinion on everything thatās going on in the markets, nor do you need to act on every impulse you get from the marketās movements or your own research. I told her that I always start with the assumption that less is more. No one has all the answers and youāll never be able to outsmart the markets at all times.
Source:
The Most Important Thing
Further Reading:
One of the Worst Arguments in Finance
A Lesson in Market Crashes
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