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Bulls, Bears, and Biases with Howard Marks

The latest episode of The Decision Education Podcast just dropped
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  • Annie Duke

Episode description

How does the stock market express uncertainty? In this insightful conversation, co-founder of Oaktree Capital, renowned investor, and Alliance Board member Howard Marks, who happens to be one of my favorite people on the planet, joins me to discuss the psychology behind market volatility and investor behavior. Howard explains how fluctuations in stock prices often reflect investor sentiment rather than changes in a company’s intrinsic value, and discusses the biases that arise in both stable and volatile markets. Howard also examines the pitfalls of striving for above-average returns without the requisite skills and knowledge, stressing realism and patience as vital components of successful investing.

Key takeaways include how optimism is inherent in investing, why investors mistake price changes for information, and the value of understanding base rates for making informed decisions.

Transcript

Producer’s Note: This transcript was created using AI. Please excuse any errors.

Annie: Welcome, Howard. We’re recording this in 2025 at a time when the markets have been kind of insane, right? I know that you think a lot about uncertainty in a variety of different ways. I wanted to start with kind of a basic question for you, which is how does the market express uncertainty? So when there’s uncertainty in the world, right? How does that get expressed in the market?

Howard: Well, I think that prices fluctuate radically reflecting volatile fluctuations in psychology or expectations. You know, the market was down 4% or 6% on last Thursday and Friday, and then it was up 12% yesterday or something like that, and it’s down 4% today. The fortunes of companies don’t fluctuate like that. The value of company XYZ 10 years from now doesn’t change much from day to day today. So clearly the volatility reflects psychology, and the fact that things go up and down and up and down is a reflection of uncertainty. I like it. I don’t like it. I hate it. It’s not that bad. You don’t like that. So, volatility.

And there is something called the VIX index. You can trade it or buy it, bet against it. That’s a way to bet on whether the world is going to be placid or fallow. So that’s a way to gauge it. And then of course the other thing is when people are more optimistic, it results in them putting a higher value on future possibilities. So insured prices go up. So if you have a company whose earnings grow at 10% a year, if the stock goes up much more than 10% in a year, you would have to say that people were warming toward the long-term prospects. So feeling more certain, you wouldn’t put a high price on future earnings if you weren’t pretty certain of them.

Annie: So I think it’s interesting because you mentioned how psychology plays into this. So I would love for you to talk about two different situations, right? When the market is relatively placid and not a whole lot is happening, what are the types of biases that can interfere with people being accurate in their decisions as far as investing is concerned, and how do you think about that?

And then in a market where there’s very high volatility, where the VIX is high, there seems to be a lot of uncertainty. Stocks are moving around day to day in these very big moves, particularly given what you’re saying, which is the actual underlying value of the company really isn’t changing that much day to day. But we’re seeing these big fluctuations in equities. How does psychology play into that, specifically as in regards to cognitive biases that are interfering with people’s ability to think objectively about those two situations? Because I would imagine that in both cases you have bias at play.

Howard: Well, the first thing I want to say is about human nature, not about a systematic bias, but I guess what I’m saying is there’s a bias toward overreaction. That’s not a directional bias, but it’s a bias. And so, you know, the way I put it is that in the real world, things fluctuate between pretty good and not so bad, but in investor minds, they go from flawless to hopeless. And so there’s an enormous tendency to overreaction if you think about it.

If you look up at the economy, some years it goes up 2%, some years 1%, some years 3%, some once in a while down 2%. The fluctuations are small. Company profits go up 10% or down 10%, or up 15 or up five. They’re larger because companies are levered. They have financial leverage and operating leverage. So the profits fluctuate more than the economy to which they’re sympathetic. But stock prices go up 30, 50, down 70, up 80, down 20. You know, crazy numbers. The difference is psychology and it’s this flightiness or tendency to exaggerate. So that’s number one.

Now, specifically, you asked about what contributes to biases on the upside when the market is placid or doing well. First of all, I think you have to accept that the normal state of nature is that investors are biased toward optimism. What I mean by that is what is investing? You take your money, you hand it over to somebody else in the hope you’ll get back more later.

Annie: Oh, that’s, that’s a very interesting point.

Howard: So if that’s true, which it sounds like you think it’s true, then don’t you have to be an optimist to do that?

Annie: Yeah.

Howard: So there you go. So in good times, that optimistic bias is exaggerated and when things are going well, the economy is performing and companies are doing well, and company earnings are increasing and security prices are increasing, people get excited and they become more enthusiastic, more optimistic. As I said before, they tend to put more credence in future expectations. They don’t demand what we call a risk premium, that is a discount for uncertainty or a discount because the thing is far off. And so prices rise, we would say, relative to intrinsic value. So that’s number two, rising optimism.

Number three, in general there is this pendulum, which I’ve written about for—my second memo was written in ‘91, and it talked about the pendulum. And the point is that investors fluctuate between optimistic and pessimistic, fear and greed, skepticism, incredulousness, risk aversion and risk tolerance. And so when things go well, they become more optimistic, more greedy, more credulous and more risk tolerant. And these things cause the good news to be overexaggerated in prices.

Another really important thing is envy or FOMO. I believe that envy, of all the forces in the world, is the strongest. And related to it is FOMO, or the fear of missing out. So when there’s an idea and it catches, and the thing starts to go up and people start making money and they appear on TV, and articles are written about how much money they made, people get crazy and they start thinking about—he made money, I didn’t make money. I’m going to castigate myself. I may jump off a building, et cetera. And this drives them. And maybe it’s Bitcoin or gold or NVIDIA, and you didn’t do it because you thought it was not substantial. The outlook wasn’t too good. Maybe you thought it wasn’t a real thing, and then it starts to perform.

And then it goes up 20%, and you say, well that’s, you know, I still don’t think it’s reasonable. It goes up another 20. You say, I’ve got to rethink. It goes up another 30%. Then you say, well, maybe it’s a real thing, and it goes up, doubles again. Then you say, I’ve got to buy, I can’t stand being on the sidelines and being on the outside looking in. I’ve got to get in there. So FOMO takes over. And the thing you wouldn’t buy at 20, you buy at a hundred.

Annie: Right.

Howard: And that’s why we get bubbles. Now if you take Econ 101 and you learn about supply and demand, you learn that the demand curve is downward sloping. As prices go up, demand goes down. But not in the securities market. And when prices go up, it makes people want to have more. And eventually even the diehard cynic or skeptic reaches a point of, they can’t take it. I capitulate, I throw in the towel. There’s a book, Manias, Panics, and Crashes by Kindleberger. And in a later edition, which he wrote with Bob Aliber, he said something to the effect, there is nothing so injurious to your mental well-being as to watch your friend get rich. And I think that’s a very accurate description of human nature. So that’s why bubbles are self-feeding and self-reinforcing.

This is all human nature stuff. It has nothing to do with what’s going on in the real world, and I think these are the greatest forces. The psychologists may be able to talk about some systematic biases that are missing, but these are the forces that I’ve encountered in my life.

Annie: So I’m thinking about a quote by Danny Kahneman. I’m going to get it mostly right, which is: nothing is as important as it feels when you’re thinking about it. And I feel like in what you were talking about, there’s so much of that quote in there, this idea that when you’re in the middle of hearing the news, it will feel much more important as it would if you looked back on it a year later, for example. Do you feel like part of, kind of what’s happening in the market when you’re talking about these overreactions is, you know, what we would call present bias? Just we’re sort of in the moment. It’s very hard for us in the middle of these kinds of fluctuations, in the middle of news, to be able to step back from that and say, let me sort of look at the longer view.

Howard: Right. So when something’s going up that you don’t own and somebody else has it and they’re getting rich, it’s the only thing you can think about. Now clearly it’s not the only thing in the world, but I think that we’re not computing machines, and we get excited about things or depressed about things, and they hog our focus and they preoccupy us.

Annie: So when you talk about this fluctuation between, you know, risk aversion and risk seeking, it sounds like it’s sort of the same mechanism that’s working. It’s that you’re looking at the situation and you’re like, oh, the market’s just sort of had an upward march and doesn’t feel like it’s ever gone down. And so you aren’t properly hedged against that situation because you’re underestimating the chances that a bad thing will happen in the future because nothing bad is happening now.

Howard: Well, I think that’s right. And you know, Nassim Nicholas Taleb used the example in Fooled by Randomness as he compared investing to Russian roulette in which there’s a gun. It has six chambers in the cylinder. One of them has a bullet. You spin this cylinder, you put it to your temple, and you pull the trigger and you hope it’s one of the five that doesn’t have a bullet. And he says that investing is more like a gun with a hundred chambers and there’s one bullet. And so you spin and you pull and you don’t get shot and pull again. You don’t get shot. You do it six or seven times and you start to think there’s no bullet. And I think that’s right.

I think there’s a huge tendency on people’s part to think that what they’ve gone through and especially what they’ve gone through recently is normal.

Annie: Right.

Howard: And when things are chaotic, they think it’ll never end. And when things are smooth, they think it’ll never end. And the truth is usually somewhere in between. And what’s really going to influence you is when it switches from what it has been to that other thing. And sometimes changes in prices overstate the truth, and sometimes smooth prices understate the truth.

In negative times, you take this person who’s a born optimist, which he by definition is because he’s an investor, and you shatter his dreams. I did this to get rich and I’m getting poor. What the hell’s going on here? Along with envy, I think disillusionment is a very strong factor. Not disappointment—but I had this belief and now I don’t have that belief. What the hell am I going to believe in if I can’t believe in that? So I think that it’s a very strong force, and of course people get excited, they feel rich, and then things start to get worse and they start feeling poorer. And there’s what we call the negative wealth effect. It’s another very strong force. If you think about it, since the intrinsic value of securities doesn’t change that much, most of the time when the price goes down a lot, it’s the equivalent of merchandise at the department store being put on sale.

Annie: Hmm.

Howard: And Buffet said, “I like hamburgers, and when hamburgers go on sale, I eat more hamburgers.” That’s what we all do. You know, I buy my underwear at Nordstrom’s, and during the annual sale I buy more. Except for in the securities markets. In the securities markets, when the price starts going down, people say, I don’t know. I better take a hard look at this. When it goes down a little, they say, now I’m getting worried. Maybe it’s not such a great idea. When it goes down a lot, they say, I’m afraid I’m going to lose the rest of my money. Get me out. So in other words, the lower the price goes, the less they want something. And the demand curve is downward sloping. Right? And you know, at lower prices, you want more, at higher prices, you want less. It doesn’t work that way in the securities market, which tells us that there must be something at work that produces this perverse result. And it’s human nature, psychology, bias, whatever you want to call it.

But you know, we started a business in 1988 called distressed debt, investing in the bonds, mostly, of companies that are bankrupt or destined to go bankrupt. Now, you would say, well, why would you want to invest in that? These companies obviously have a terrible outlook. But the answer is people get so scared off by the difficulties and the fact that the prices have collapsed, that they disgorge them, and maybe we can buy them cheap and the record over the last 37 years suggest that we were buying them cheaper than we should have because we made what a theoretician would call excess returns.

Annie: So it sounds like in some ways what you were really doing from the beginning was identifying particular ways in which people are biased and then trading those biases.

Howard: Well, I take a little exception because I don’t use the word trade. We’re not traders. A trader is somebody who plays on the short-term fluctuations of values, but we don’t do that. We hold for years. But we still want to buy more when people are disgorging and buy less, or maybe sell, when they’re avidly accumulating.

You know, I know and use a lot of adages and one of the greatest ones I was ever taught was in the mid-seventies, so let’s say 50 years ago, somebody said to me, “I’m going to tell you about the three stages of the bull market. The first stage, you’re on the heels of a meltdown or a crisis or something, the bubble just burst. And prices have collapsed and only a few exceptional people appreciate that things could get better. In the second stage, most people accept that things actually are getting better, and in the third stage everybody thinks things can only get better forever.”

And then, yeah, 20 years ago I reversed it, started talking about the three stages of a bear market. In the first stage, a few smart people think things may not stay this good forever. They could get worse. In the second stage, people realize that things actually are deteriorating, and in the third stage they think it’ll get worse forever. What matters in the short- or maybe even intermediate-term sense is which phase you buy in.

Annie: Right.

Howard: The person who buys in the first phase of the bull market makes a lot of money. The person who buys in the third stage is riding for a fall. So it’s not what you do, it’s what you pay. It’s when you do it. And in order to do it right, you have to be kind of a little, I always think of it as kind of judo. You don’t use your strength, but you use the extremeness of your opponent’s behavior against him in order to be able to outperform him. So I think that works pretty well.

Annie: Right, right, right. So when you talk about: this person made so much money and I missed out, right, like I didn’t get in NVIDIA, I didn’t get in Bitcoin, where you’re sort of comparing the alternative, the counterfactual of, I could have gotten into this and that person did really well. And then, you know, I also think about when someone’s in a bull market and you know, let’s imagine they have a 60/40 or 65/35 split or something like that, and they’re comparing their returns to, what if I weren’t holding those bonds or treasuries, right? I would’ve made so much more money. And then obviously on the flipside, when things are going so horribly, it’s if I didn’t have all these equities, I would be doing so much better.

And so I think about that as like two problems. One is just what are you comparing it to in terms of the reference point, right? Are you comparing it to expected value? Are you comparing it to the base rate? And the other is vantage point, right? When you’re thinking about the counterfactual and like what could have been and what that person did, it’s like you’re making two mistakes. It’s like from the wrong vantage point because like right now you’re not thinking about the long term. You’re not like putting yourself in the future and looking back. And then you’re also not understanding what the expected value of, like, your positions are.

So, you know, I would love to sort of hear your thoughts on that, about how are people getting these, kind of, reference points messed up? And obviously so much of this is coming from the fact that you are making decisions, whether they’re investment decisions or other types of decisions, under uncertainty. So these reference points are sort of hard to figure out what they are and you’re sort of looking at what you see and you don’t necessarily know for sure.

Howard: Let me just say first that everybody and his brother says, “I’m going to invest in the market.” I don’t think they ever sit down and say, “What is my goal?” They just say, “I want to make money.” But in what sense? How much money do you want? What would represent success? I think the proper goal for investing, since I’m not a trader and I don’t know that traders themselves make that much money either, but I’m an investor. So my goal is to get on board with companies that will grow over time and lend money to companies that will pay us back along with the promised interest. Those are the important things. I want to participate in this economic machine, and I’d like to become more aggressive when it’s more propitious and less aggressive or more defensive when it’s precarious.

Now what determines when it’s propitious or precarious, in my opinion, is primarily the relationship between the price of the asset and something called its intrinsic value. So the proper thing for an investor to do is to look at a company or other asset, figure out what it’s really worth, then look at the relationship between the price and the intrinsic value. And determine your behavior in that way. Now I think that sounds pretty reasonable. It has nothing to do with beating your neighbor.

Being a successful investor, for most people who can’t be, you know, some Wall Street genius has to do with buying good things, holding for the long term, and buying more of them when they’re cheap and holding less of them when they’re dear, to the extent that you want to manipulate in the short run. There are people like Buffett who buy good things, which have a good trajectory and they just hold them forever. When they’re priced above what they’re worth or whether they’re priced below what they’re worth, they just hold them and they participate in the underlying. The goal, in my opinion, is mostly to participate in the underlying. And things like thinking about day-to-day value fluctuations and what the other person is doing and that kind of thing—those are just distractions.

If you want to be a long-term investor, probably the best thing you can do is study a company, buy its securities. Never look at the price, just look at how the company’s doing, and as long as the company’s doing well, hold onto it. Now, somebody who’s a little more price conscious would say, well, if the price gets to much, much above what I think it’s worth, let it go. And, okay, I can accept that. Or much below what it’s worth, you should buy more. Okay. But daily ups and downs, you know, here’s a great one. You’re a behaviorist. Everybody looks at the prices of their stocks every night. Why? Why? They’re not going to buy more. If they go down, they’ll get depressed. They’re not going to buy more. If they go up, they’re getting excited, they’re not going to sell. Why look?

Annie: And actually if they’re down and they get depressed, they might sell them.

Howard: Well, that’s right.

Annie: Because they’re sad.

Howard: So wouldn’t you do better just to ignore it or, well, let’s say you look every six months, that would be reasonable. But it indicates, in my opinion, there’s something wrong if you look every day, but who doesn’t? So I think you have to have a proper goal. The proper goal is to participate in the underlying, in the U.S. economy and the performance of the company.

But, you know, you go to a football game, the real thing that matters is the thing that’s happening on the field, which team wins there? You want some excitement. In theory, you should be able to enjoy the game, but you might want some excitement, so you bet on one team or the other, that’s okay. You bet on which team’s going to win. But then you get bored. So then you start betting on whether the next play’s going to be a pass or a run, whether it’s total score’s going to be over 45 or under 45, and which of the running backs is going to have more yards. These are just side bets, which don’t have anything to do with the outcome of the game, and they’re just designed to pander to your desire for action. In my opinion, that’s what trading is. That’s what derivatives are when you bet on VIX, you’re not betting on whether a company will become more valuable or not. You’re betting on whether tomorrow’s market is going to be placid or unsettled. The two have no relationship to each other. And when you get away from trying to figure out what companies are going to be worth in the long run and owning them or not, and you go into those other things, I think it’s another human failing. It’s a need for action and a need to demonstrate that you’re smart.

Annie: Yeah. For people who aren’t experts.

Howard: Yeah. Right.

Annie: Yeah, I just want to make that clear because there are people who are absolutely experts in that area.

So you’re an average Joe, you’re not an expert, right? When you’re looking at the market every night, there’s some information, right? There’s some information that’s contained in those moves, but a lot of that information is noise. It’s being generated by overreactions or underreactions in some cases, or, you know, you get these moves in the stock that don’t really make sense in terms of the intrinsic price and things like that. And so if you’re looking at that, you think you’re looking at something that’s a reflection of actual information. But some of it is just a reflection of the way that people are actually reacting to the market. So now you’re, like, at the second derivative, right? It’s like what you’re sort of looking at, and then if you become a participant in that, you’re now part of the overreaction.

Now, that’s not to say that to your point, that there isn’t sometimes where there’s some news or something happens where it seems very clear that it’s going to have some effect, maybe even, you know, certainly on the intrinsic value of the company or the economy in general, that’s going to then have an effect on the intrinsic value of the company because it’s going to cause demand to go down for people’s products or something like that, where that might be foreseeable. But what you’re saying is those instances are rare and probably, as human beings, we think they’re much more frequent than they actually are.

Howard: So, you know, I write these memos to the clients and I’ve been doing this for 35 years. And in 2015 I wrote a memo called On the Couch and it, I think the market was going down because oil was going down. Is it good or bad that oil goes down? It’s bad for the oil companies, but it’s good for everybody else. So why should the market go down because oil prices go down? And it was going up because of this and down because of that. And I thought the market was exaggerating terribly. So I wrote this memo, On the Couch, about the market’s failings.

Then I went on some TV shows and people would say to me like, “Doesn’t it trouble you that the market’s collapsing? Doesn’t it tell you that there’s something wrong?” So then I, four or five days later, I put out another memo. The title was, What Does the Market Know? The market doesn’t know anything. In fact, the market doesn’t have some special intelligence.

You know, Ben Graham, Buffett’s teacher at Columbia, said that in the short run, the market is a voting machine. Every day, everybody casts their vote. General Motors is worth 52. Somebody else says 52 and a half. Somebody says 41 and a half. You know, everybody casts their vote, and the consensus of opinion is 52 and it trades at 52.

But the market is no smarter than the average of the members. It doesn’t have some special intelligence, and if they’re all subject to a bias, then they’re all wrong. But the idea that you should take instruction from the market is really flawed. If you think the market is smarter than you are, then you shouldn’t be in the market or you should just invest in it passively. But how can you expect to outsmart the market and do better than the market if you think the market knows something you don’t? It’s just oxymoronic.

Annie: So if you’re looking at the market, it’s just a reflection of the people who are trading, who are overreacting, right? Is kind of what you’re saying. And that’s where you see this kind of, like, crazy up and down, up and down, up and down, up and down.

Howard: Yeah. I think Buffet said, Annie, “Forecasts tell us more about the forecaster than they do about the future.” Stock price fluctuations tell us more about the investor than they do about the company.

Annie: Gotcha. I want to imagine like I’m an average Joe. I’m not an expert, you know, I’m not somebody who’s trading options and has an army of quants who can help me do that. And you know, I’m not a doctor and I have to figure out stuff about medical decisions or diet or things like that. Because those are investments also, obviously. And I want to invest in the market and I don’t have the time or the wherewithal, the understanding of economics, to be able to really study a company and to say, this is what I think the underlying is. This is what the intrinsic value of this company is.

Can you talk a little bit for the average person as you’re trying to get out of this kind of overreaction like optimism doom cycle and actually try to get to a place of a better understanding of how do I make decisions about my investing going forward, even if I’m just passively investing. Can you talk a little bit about what the importance of base rates are? What are they? Why should you care? How do they help to kind of ground somebody in a better reality?

Howard: Investing in the stock market represents buying interest in companies. So if you own all of every company, and if values appreciate alongside profits, which is a reasonable assumption, then you’ll make six or 8% a year. That’s what you call the base rate.

Annie: Right.

Howard: And so the question is, are you content with that? And if you’re not content with that, then that’s why some type people try to buy the sexier companies. They end up paying prices that are commensurate with sexiness or more. And so even though the earnings may grow faster, the price may grow slower because they come down from overvaluation to fair valuation.

But you know, the long-term expectation in investing in stock growing might reasonably be six to eight. And then you add in a few dividends and you get to 10. And by the way, the S&P has returned 10% a year for the last hundred years. Now, 10% a year for the last hundred years was sufficient to turn a dollar into $14,000 with reinvestment.

Is that enough or do you want to make more? And if you want to make more, and it’s easy to say no, no, I don’t want to be average, I want to be above average, how do you be above average? Well, to be above average, you have to be more skillful than average. So ask yourself if you are, if there’s reason to think so, other than the fact that you love yourself. And then you have to know something other people don’t know. Ask yourself if it’s reasonable to think that you can accomplish a knowledge advantage, knowing that a lot of knowledge advantages are illegal and it’s a crime to obtain corporate information or can be a crime to obtain corporate information that other people don’t have, and the SEC’s, one of the main goals is to make sure nobody does it so. If you want to be above average, what’s the root to being above average and what’s your reason for thinking you have the equipment to do it? If it takes bearing above average risk, maybe you don’t want to do it. Another way is to be what you call a trader. And rather than just hold these companies in the short run, you buy Ford instead of General Motors, then you switch from Ford to General Motors, and back. You get in the market today and out tomorrow and in the next day and out the day after that, what’s your reason for believing you can do that better than others?

Annie: So I think you’re getting at something really deep, right? This thing that you’re saying about, okay, you would’ve turned a dollar into $14,000, is that good enough? If it’s not good enough for you, you need to now do something. But if you’re going to do something, you better be better than average in some way, right?

So, you know, one of the things that I think about, and this is something that Kahneman talked about a lot, like so much of our decision-making is driven by wanting to have a positive self narrative, right? I want to go back and be able to look at the story of my life and for me to be able to tell a positive story about my life. And actually there’s something called the better-than-average effect, where we can see how this is part of it, right? Which is, I want to feel like I’m pretty smart. And I can beat other people at their game, and I’m pretty good at it. When in reality, of course, there’s a lot of very smart people, particularly if you’re doing active trading, right? There’s a lot of people that you’re trading against who have a lot of very sophisticated models and so on and so forth.

But what I try to think about is like if you have a deep understanding of the ways that you might be biased, the types of mistakes that you might make that would cost you in the long run, either it could—money if you’re investing, but you know, happiness, health, healthy relationships, fulfillment, those kinds of things, and you step back and say, I understand that thing better than other people do, so I’m not going to fall for this mistake. And so I certainly don’t feel bad about myself. I’m indexing the market because I understand something that the average Joe who’s trying to do active trading or trying to make decisions day to day about what positions they have on and things like that, just sort of reacting to what’s going in the market, I understand something they don’t, right? Which is, I probably think I’m better than I am. I’m probably going to overreact to what I’m seeing, and if I look at the base rates, that’s probably better information than whatever’s going on in my own head. And so I should kind of ignore myself. I think that it’s a way to kind of like have your cake and eat it too, meaning the cake being, having this positive sense of yourself where it’s not this first order, like I’m better than other people because I know how to pick companies, but it’s, I get something that other people don’t, so I’m actually willing to step away from things that I shouldn’t be actually making active decisions about.

Howard: Well, that’s great, and in fact, it should be possible to say, “I’m better than other people because I realize I’m not better than other people.”

Annie: Yeah, yeah.

Howard: That’s what you’re saying. You know?

Annie: Yeah.

Howard: Unlike everybody else who’s crowding the brokerage office and throwing money into the commission bowl, I understand that I don’t know enough to try the hard game. I’m going to play the easy game, which is I’m going to subscribe to the base rates and I know that I’ll be successful in the long run because economies and companies grow and it won’t cost me much to try, and I run a very slim chance of being below average.

You know how much I like to play tennis and I play all summer, but what would you say if I said, “So I’m going to devote the next 10 years to tennis and I’m going to go out and try to beat Nadal,” you would probably say that’s quixotic.

Annie: Please don’t do that.

Howard: So really what we’re talking about, Annie, is the juxtaposition between this desire to feel special, which many people feel, and realism. And if that is a conflict, as I believe we’re saying, and I think it’s accurate, then realism should win. Because if you ignore reality in pursuit of your quest, it may end badly.

Annie: Right. And I think if you get to the second order place where it’s the fact that you’re able to be realistic, that you’re getting the positive self narrative from, then you still get to have the positive self narrative. So when you realize, no, like I’m actually not smarter than the average person trading in the market. So like that’s cool with me because I recognize that when maybe other people wouldn’t.

Howard: And if you pursue the positive narrative about yourself through the mature acceptance of reality, you have a high probability of achieving your goal.

Annie: Right.

Howard: Whereas if you try to create the positive narrative about yourself by taking on some herculean task, like me winning the U.S. Open, you have a low probability of succeeding. Our bias should be to doing things where we have, not the most crazy dream we can think of, but things where we have a good probability of success.

Annie: Well, you know, I think that’s interesting because I think that brings us back to what we started the conversation around, which is this present bias, and how are we reacting to things in the present at the moment we’re thinking about them as opposed to having this kind of longer term view. Right? So what I hear you saying is that in the moment, if you’re like, no, I just want to feel good about myself because I’m better than other people. Actually that’s trading the wellbeing of your future self, right? It’s saying, I’m going to now hurt my future self in favor of, I’m going to make this trade in favor of me feeling good about myself in the present.

Whereas if in the present you say, you know what I’m, maybe I’m not so great, but that’s okay because I’m recognizing it, that you’re actually more likely to be taking good care of the future version of you. So I love that idea of like, we have to make these trade-offs all the time between what we want now and what we want in the future. And what I hear you saying is if you can get to a place of reality, it might hurt a little bit now, but that’s better because the future version of you is actually going to get the things that you want.

Howard: Well, I just turned away and made a note for a minute. What I wrote down was: long-term goals, patience, and delayed gratification.

Annie: Yeah.

Howard: And you can certainly become financially well off in the future if you get on the merry-go-round, don’t try any trick shots, and accept the base rate with certainty. But if you try to pander to your ego needs by showing how smart you are and getting in, getting out, and buying more of NVIDIA or this, and none of those boring, safe stocks, you may never get to your goal. And my approach to life is quite humble in terms of being an expert. By the way, all the hundred mutual funds that were studied at the University of Chicago were experts and none of them beat the market.

But I always say that if you stand at a bus stop long enough, you’ll probably get a bus. If you run from bus stop to bus stop, you may never get a bus and you’ve got to think about that. So you have to have patience. And you think in the long term you say, I’m going to wait at this bus stop. I’m sure I’ll get a bus. It’s not exciting. It’s not dull. Somebody who runs around from bus stop to bus stop may get there 10 minutes before you. But I think that our brains are wired to underestimate the merit of solutions that are highly likely to provide moderate success—maybe that’s my bottom line—and to overrate the allure of strategies that have a distant probability of making you rich as Croesus.

Annie: You know, I love that idea. I always think about this problem of, you know, if you’re in a market where the market goes up 7% that year, and someone comes to you and says, I made 19% last year. Now I have this mental model of being like, oh, you must have been running from bus stop to bus stop.

Howard: Yeah, yeah, yeah.

Annie: And there’s a lot of risk involved in that, right?

Howard: Right.

Annie: And I’m guessing next year you’re not going to catch a bus.

Howard: Right. I’ll just tell you one more story.

Annie: Okay.

Howard: Around 2006, I think it was, there was a hedge fund called Amaranth, and Amaranth melted down and people in Amaranth lost just about all their money, almost all their money. So I wrote about it. I wrote a memo. It was called Pigweed. Why? Because I looked it up, I didn’t know what Amaranth meant, so I looked it up in the dictionary, it says, synonym: pigweed. Oh, amaranth sounds much sexier than pigweed. Anyway, so I wrote in this memo, I think under the heading of what’s real maybe, but in the Talebian sense, when did Amaranth’s problems start? They didn’t start in 2006 when it was down 90 odd percent, they started in 2005 when it was up a hundred percent

Annie: Right.

Howard: The guy made a bet that there would be three hurricanes implicit in buying gas futures or something.

Annie: Yeah.

Howard: And there were three hurricanes and the guy made a ton of money and the fund doubled. Was that a prudent bet based on sober analysis that had a high probability of being right? Or was it a crazy hail Mary pass where the guy got lucky?

Annie: Right.

Howard: Okay. Now here’s the next series of questions. If you are in a fund, the goal of which is to make 15 or 20% a year, and you get a letter which says, we made a hundred percent, what should you do?

Annie: I’m selling.

Howard: You should say, “Just a minute.”

Annie: Well, I want to know what happened. Right.

Howard: Yes, you should say, what did the guy do?

Annie: Right. What happened?

Howard: How did he make that money? What risks did he expose me to? And you should be biased toward getting out.

Annie: Yeah. What I would say is, all else being equal, I’m getting out. In other words, if there wasn’t some crazy something that explains it.

Howard: What do most people do?

Annie: They invest because they’re like, oh my gosh, I don’t want to miss out.

Howard: They send in more money, they said, this is great. Here’s another hundred grand. So that’s an example of a victory of greed over prudence.

Annie: Right, right, right, right.

Howard: And I would urge all of your listeners to restrain their greed and be prudent.

Annie: Is it okay if I ask you two just lightning questions?

Howard: Yes. Yes.

Annie: Okay. The first question is what decision-making tool or idea or strategy, you know, I mean, obviously you’re thinking so much about how to make great decisions under these circumstances, human biases, so on and so forth. What decision-making tool, idea, or strategy would you want to pass down to the next generation of decision makers?

Howard: I would say try to base your decisions on knowledge and try to assess whether you really know the things you think you know. And if you think you have a hunch, but there’s no real good support for it, then don’t bet on it. And it’s really being realistic like that.

If you want to play cards, you have to know when you have the cards and when you don’t. As Mark Twain said, “It’s not what you don’t know that gets you in trouble. It’s what you know for certain that isn’t true.” You’ve got to be painfully honest with yourself about what you know and what you don’t know. And if you’re making a decision in an area where you really don’t have knowledge, either because you’re not educated or because it’s an area where knowledge cannot be achieved, you have to say, “I don’t know.”

Annie: Right.

Howard: And those are the greatest three words in the world. But then if there are other areas where it’s possible to have knowledge, and you’re reasonably sure that you have it, then you might make an affirmative decision and do something great. But you have to be realistic about the difference.

You use the expression decision-making under uncertainty. We make our decisions under uncertainty. There’s a great quote from a guy named Wilson who I believe ran General Electric, and he said, “There is no getting around the fact that all of your knowledge is with regard to the past and all of your decisions are with regard to the future.” And predictions are hard, especially with regard to the future, but it’s really important to be realistic about the thing you’re trying to accomplish.

Annie: Right. Skepticism. Be skeptical. Know that you’re going to be biased toward thinking you know more than you do. And then obviously people can buy Mastering the Market Cycle, which is a wonderful book. I highly recommend it. If listeners want to go online and just learn more about you and your work, where would you suggest that they start?

Howard: Well, what I would recommend is that I’ve been writing these memos for 35 years. There are close to 200 of them. And they tell you, not only would I say I thought at the time, but what I really thought at the time. So you can kind of watch it in real time. So you can go to oaktreecapital.com, click on Insights, and click on Memos from Howard Marks. There are the memos on paper. There’s podcasts. There’s new podcasts about why certain memos were written, called The Rewind. And the only thing I guarantee the listeners is that the price is right because they’re free.

Annie: Well, I can guarantee the listeners a lot more than that because your memos are so incredibly insightful, and a lot of people would think, well, if I’m interested in investing, I should go read Howard Marks’s memos. But what I would say is that, oh, well beyond that, if you’re interested in decision-making, if you’re interested in really understanding human psychology, if you’re interested in becoming a better decision maker in any aspect of your life, that is a place that you should go and read, because your insights are just so fabulous and can be generalized, not just specific to someone who’s interested in what Oaktree Capital is up to.

Howard: Well, thank you, Annie. From you, that’s high praise. And it means a lot to me.

Annie: Well, it’s not high praise. It’s realistic praise. Well, I really appreciate this, for listeners, anything that we’ve talked about in the podcast will be linked in the show notes.

Howard: I love it.

Annie: But this has been absolutely fabulously fun for me, super educational as always. I always totally love talking to you, and thank you so much for giving us so much of your time.

Howard: Well, me too, Annie. Let’s do it again.

Annie: Absolutely.

Guest bio

Since the formation of Oaktree in 1995, Howard Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction. From 1985 until 1995, Mr. Marks led the groups at The TCW Group, Inc. that were responsible for investments in distressed debt, high-yield bonds, and convertible securities. Previously, Mr. Marks was with Citicorp Investment Management for 16 years, where from 1978 to 1985 he was vice president and senior portfolio manager in charge of convertible and high-yield securities. Between 1969 and 1978, he was an equity research analyst and, subsequently, Citicorp’s Director of Research.

Mr. Marks holds a B.S.Ec. degree cum laude from the Wharton School of the University of Pennsylvania, with a major in finance and an M.B.A. in accounting and marketing from the Booth School of Business of the University of Chicago. He is a CFA® charterholder.

Mr. Marks is a trustee and advisory member of the Investment Committee at the Metropolitan Museum of Art. He is a member of the Investment Committee of the Royal Drawing School in London. He also serves on the Shanghai International Financial Advisory Council and the Advisory Board of Duke Kunshan University and is an emeritus trustee of the University of Pennsylvania, where from 2000 to 2010 he chaired the Investment Board.

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