The world believes that you have to take a higher risk to get a higher reward. Value investors chuckle at this model as they believe in low risk high reward model. After reading this book by Marks, I can’t help but chuckle at the value investors too. Value investors are looking at the ratio of risk to reward and comforting themselves, wherein all along they should only be looking at the probability of risk and nothing else. Think about this for a bit before reading further. The REWARD has nothing to do with the RISK probability, the only thing to consider is the PROBABILITY OF THE RISK. These probabilities should be evaluated separately.

Great quotations from the book

  • “Experience is what you get, when you don’t get what you wanted.”
  • Good times teach only bad lessons, that investing is easy and that you know its secrets, and that you needn’t worry about risk.

Second-Level Thinking


  • Everything should be made as simple as possible, but not simpler.
  • Investing is not supposed to be easy. Anyone who finds it easy is stupid.
  • Investing can’t be reduced to simple algorithm and fed into a computer. No rule can always work, as circumstances rarely repeat exactly.
  • Investing, like economics is more art than science, which means it can get pretty damn Investing – The last liberal Art
  • First level thinking is simplistic and superficial, whereas second level of thinking is borderline convoluted but definitely deep and Straight and Crooked Thinking
  • Think in terms of RANGES and not in terms of numbers.
  • Think in terms of PROBABILITIES along with every occurrence. Probability – A very short Introduction
  • There is massive difference in workload between first and second level thinking.
  • All investors cant beat the market, since collectively they are the market.
  • You cannot do the same things that others do and expect to outperform the market.
  • Great profits are generally not found in comfort.
  • Unconventionality should not be a goal in itself, but rather a way of thinking.

Market Efficiency

  • In theory there is no difference between theory and practice, but in practice there is.
  • To beat the market you should be able to hold an idiosyncratic or non consensus view.
  • If riskier investments could be counted on to produce higher investments, they wouldn’t be riskier.
  • In the great debate over efficiency versus inefficiency. I have concluded that no market is completely one or the other. It is just a matter of degree.


  • To be reliably successful, a range of accurate value is an indispensable starting point. Without it any hope for consistent success as an investor is just hope.
  • The oldest rule is also the simplest, “ BUY LOW, SELL HIGH”.
  • If something cannot go on forever, it most definitely will stop.
  • Being correct is not being correct right away.
  • Unless you buy at the exact bottom ( which is close to impossible ), you will be down at some point after you make your investment.
  • Many people tend to fall further in love with the thing that they’ve bought as the price rises.

Price VS Value

  • It has been demonstrated time and again that no asset is so good that it cant become a bad investment if bought at too high a price.
  • There is no such thing as a good or a bad idea, regardless of price.
  • Well bought is half sold.
  • There is nothing better than buying from someone who has to sell regardless of the price during the crash.
  • The most important discipline in investing is not accounting or economics, but psychology.
  • Nothing is perfect, however, and everything eventually turns out to have flaws. When you pay for perfection, you don’t get what you expected, and then the high price you pay exposes you to the risk of loss when reality comes to light. This is truly one of the riskiest things.
  • The greater fool theory only works till it does not.
  • The market can remain irrational longer than you can remain solvent.

Understanding risk

  • Risk means more things can happen than will happen.   CAN > WILL
  • Risk is inescapable.
  • When you consider investment results, the return means only so much. The risk taken has to be accessed as well.
  • Riskier investments are those for which the probability distribution of returns is wider.
  • Volatility is probably the least relevant of all the risks.
  • Loss of permanent capital is the ONLY risk to worry about.
  • Even fundamentally weak assets, can make for a great investment if bought at a low-enough price.
  • Most dangerous investments stem from psychology that is too positive.
  • Consider alternative histories that could have played out – Just because it did not happen does not mean that it could not happen.
  • Understand when you were merely a LUCKY IDIOT.
  • Many people have been right for the wrong reasons.
  • When a weatherman says there is 70% chance of rain and it doesn’t rain, is he wrong or right ?
  • There is a big difference between probability and outcome. Probable things fail to happen and improbable things happen all the time.
  • The best thing that we can do is fashion a probability distribution that summarises the possibilities and describes their relative likelihood. We must think about the full range and not just about the ones most likely to materialise.Some of the greatest losses arise when investors ignore the improbable possibilities
  • The correlation of different stocks in your portfolio can affect many of your stocks at the same time.
  • Absolute quantification often lends excessive authority to statements that should be taken with a grain of salt.
  • Don’t confuse Luck with Foresight and Prudence
  • Return alone – and especially return over short periods of time – says very little about the quality of investment decisions. Return has to be evaluated relative to the amount of risk taken to achieve it. And yet risk cannot be measured.

Recognising Risk

  • We are told that risk increases during recessions and falls during booms. In contrast, risk actually increases during upswings as financial imbalances build up.
  • Risk can be defined as the uncertainty about which outcomes will occur and about the possibility of loss when the unfavourable ones do.
  • Risk tolerance is antithetical to successful investment. When people aren’t afraid of risk, they’ll accept risk without being compensated for doing so…..and risk compensations will simply disappear.
  • When people swallow worry free beliefs, it is truly the riskiest thing.
  • Too much trust, too little worry – make you your own enemy.
  • Worry and its relatives, distrust, skepticism and risk aversion are essential ingredients in a safe financial system.
  • People vastly overestimate their ability to recognise risk and underestimate what it takes to avoid it; thus, they accept risk unknowingly and in doing so contribute to its creation.
  • The truth is that the herd is wrong about risk al least as often as it is about the return.
  • Investment risk resides most where it is least perceived and vice versa.
  • Broadly negative opinions can make a stock the least risky thing as all optimism has been driven out of its price.

Controlling Risk

  • Outstanding investors are distinguished at least as much for their ability to control risk as they are for generating return.
  • Careful risk controllers know that they don’t know the future.
  • You cant run a business on worse case assumptions. You won’t be able to do anything. At the same time, one must know about the worst case assumptions.
  • The math behind the compounding of negative returns – a 40% loss in one year requires a 67% return to fully recover.


  • Rule no 1 : There will be cycles.
  • Rule no 2 : Some of the greatest opportunities for gain and loss come when other people forget rule no 1.
  • The process of cycles
    • The economy moves into prosperity.
    • Lenders increase their capital base.
    • Risk is perceived to have reduced because of the scarcity in bad news.
    • Risk averseness disappears.
    • Financial institutions begin to provide more and more capital.
    • They compete for market share rather than profitability.
    • The worst loans are thus made at the best times.
  • When things are going well, extrapolation produces a great risk.

Pendulum Effect

  • When things are going well and prices are hight, investors rush to buy, forgetting all prudence. Then, when there’s chaos all around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will ever be so.
  • The market swings are like a pendulum, with one side being bearish and the other bullish. The mid-point though average, is almost inconsequential as the pendulum is almost always in a bullish or a bearish zone.
  • The pendulum continuously swings between
    • the risk of losing money &
    • the risk of losing opportunity.


  • To buy when others are selling and to sell when others are buying takes great courage, but provides opportunities for the greatest profits.
  • The less prudence with which other conduct their affairs, the greater prudence with which we must control our affairs.
  • Contrarianism itself has become too popular and can thus be mistaken for herd behaviour.
  • If the stock that you own declines everyday and makes you feel like a failure, remember that you own fractional interest in a business that you will be able to buy at a greater discount to underlying value.
  • A profitable investment which doesn’t begin with discomfort is an oxymoron.

Finding Bargains

  • Make room for bargains by selling lesser ones and staying clear of the worst.
  • Good Buys > Good Assets
  • Potential bargains generally display some objective defect, and are beaten down because of that.
  • A diamond with a flaw is better than a pebble without imperfections.
  • Look for stigmas or revulsion for best bargains.
  • Treasure route
    • Little known
    • Not fully understood
    • Controversial and borderline scary
    • Inappropriate for respectable portfolios
  • If everyone feels good about something and is glad to join you, it won’t be bargain priced.
  • People don’t do their own research and rely too much on ratings, which makes them buyer of conventional wisdom.
  • Investment bargains mostly don’t have much to do with high quality, in fact, things tend to be cheaper if their low quality has scared people away.

Patient Opportunism

  • The market is not an accommodating machine. It wont provide you high returns, just because you need them.
  • Remember, there aren’t always great things to do and sometimes we maximise our contribution by being discerning and relatively inactive – Waiting for bargains is often your best strategy.Just watch this !
  • You’ll do better if you wait for investments to come to you than you go chasing after them. Select from the list that sellers are motivated to sell.
  • One of the hardest things to master for professional investors is to – come in each day for work and do nothing.
  • It is what it is – MUJO.
  • Understand that you simply cannot create investment opportunities when they are not there.
  • High valuations can often go higher, for long periods of time, frustrating disciplined and patient value investors.
  • “Regardless of price” are the most beautiful words if you are on the other side of the transaction.

Knowing what you don’t know

  • There are two classes of forecasters, those who don’t know, and those who don’t know that they don’t know.
  • Try to know the knowable and control the unknowable.
  • You can’t prove a negative. 
  • Never underestimate the full range of possibilities.
  • If you know the future, it is silly to play defence.

Having a sense of where we stand

  • Cycles are inevitable. It would do you very well to always have a sense about which part of the cycle you currently are in. Every trend will stop sooner or later. Nothing will go on forever.
  • Those who cannot remember the past, are condemned to repeat it.
  • Look around and ask yourself, are investors optimistic or pessimistic.
  • You can easily tell when too much money is competing to be deployed.
  • In 2004 there was a silly notion that if you cut risk into small pieces and sell the pieces to investors, that are best suited to hold them, the risk disappears. Sounds like magic. 

Appreciating the role of luck

  • Every once in a while someone makes a risky bet on an improbable or uncertain income and ends up looking like a genius. But we should recognise that it happened due to luck and boldness and not skill.
  • Learn to identify which of your outcomes are due to luck.
  • Things that happened are only a small subset of things that could have happened. Thus, the fact that a stratagem or action worked – under the circumstances that unfolded – doesn’t necessarily prove the decision behind it was wise.
  • The quality of any decision should not be purely judged by its outcome. 
  • People are right for the wrong reason all the bloody time. Often good decisions fail to work and bad decisions succeed. Mujo.
  • Once you realise the vast extent to which randomness can affect investment outcomes, you look at things in a very different light.

Investing Defensively

  • In tennis, if you are an ordinary player you have a higher chance of extraordinary wins, by not playing in an extraordinary manner, but by simply not losing points. i.e in amateur tennis, points aren’t won, they are lost.
  • If you minimise the chance of loss in an investment, most of the alternatives are pretty good. 
  • Batting average > No of 4s and 6s
  • Rather than doing the right thing, a defensive investor tries not doing the wrong thing.
  • Worry about the possibility of loss. Worry that there’s something you don’t know. Worry the you can make high quality decisions but can still be hit by bad luck or surprise events. Investing scared will avoid hubris; will keep your guard up and your mental adrenaline flowing; will make you insist on adequate margin of safety; and will increase the chances that your portfolio is prepared for things going wrong. And if nothing goes wrong, surely the winners will take care of themselves. 

Avoiding Pitfalls

  • An investor needs to do very few things right as long as he avoids big mistakes.
  • Failure of imagination – the inability to understand in advance the full breadth of the range of outcomes.
  • Double sixes should come up once every 36 times in rolls of the dice. But they can come up five times in a row – and never again in the next 175 rolls – and in the long run have occurred as often as they’re supposed to. 
  • You must allow for Outliers
  • Stop focusing on a single most likely scenario.
  • Generally what might go wrong > what might work. Murphy’s Law
  • Always consider earnings yield, which is the inverse of PE, to compare to fixed income alternatives.  1/(P/E)  at 8% yield a Fixed deposit is 12.5 PE.  Interesting comparison here. If you find a company with very low risk trading at less than 12.5 PE it could make a compelling argument for investment.
  • Always understand how much pain you can take on the downside, before you being your investments.

“When there is nothing clever to do,

the potential pitfall lies in insisting on being clever.”


3 replies on “RISK and its many Avatars by Howard Marks

  1. When a weatherman says there is 70% chance of rain and it doesn’t rain, is he wrong or right ?
    He’s 70% wrong 😉

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