Howard Marks, Oaktree Capital — 2022-01-13
-
Japanese
-
Korean
-
Simplified Chinese
-
Traditional Chinese
Memos from Howard Marks 2022-01-13T08:00:00.0000000Z" pubdate title="Time posted: >1/13/2022 8:00:00 AM (UTC)">Jan 13, 2022
- PDF (English)
- PDF (Translations)
- Listen to Memo
- Archived Memos
Subscribe
As I'm now in my fourth decade of memo writing, I'm sometimes tempted to conclude I should quit, because I've covered all the relevant topics. Then a new idea for a memo pops up, delivering a pleasant surprise. My January 2021 memo Something of Value , which chronicled the time I spent in 2020 living and discussing investing with my son Andrew, recounted a semi-real conversation in which we briefly discussed whether and when to sell appreciated assets. It occurred to me that even though selling is an inescapable part of the investment process, I've never devoted an entire memo to it.
The Basic Idea
Everyone is familiar with the old saw that's supposed to capture investing's basic proposition: "buy low, sell high." It's a hackneyed caricature of the way most people view investing. But few things that are important can be distilled into just four words; thus, "buy low, sell high" is nothing but a starting point for discussion of a very complex process.
Will Rogers, an American film star and humorist of the 1920s and '30s, provided what he may have thought was a more comprehensive roadmap for success in the pursuit of wealth:
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.
The illogicality of his advice makes clear how simplistic this adage – like many others – really is. However, regardless of the details, people may unquestioningly accept that they should sell appreciated investments. But how helpful is that basic concept?
Origins
Much of what I'll write here got its start in a 2015 memo called Liquidity . The hot topic in the investment world at that moment was the concern about a perceived decline in the liquidity provided by the market (when I say "the market," I'm talking specifically about the U.S. stock market, but the statement has broad applicability). This was commonly attributed to a combination of (a) the licking investment banks had taken in the Global Financial Crisis of 2008-09 and (b) the Volcker Rule, which prohibited risky activities such as proprietary trading on the part of systemically important financial institutions. The latter constrained banks' ability to "position" securities, or buy them, when clients wanted to sell.
Maybe liquidity in 2015 was less than it had previously been, and maybe it wasn't. However, looking beyond the events of the day, I closed that memo by stating my conviction that (a) most investors trade too much, to their own detriment, and (b) the best solution for illiquidity is to build portfolios for the long term that don't rely on liquidity for success. Long-term investors have an advantage over those with short timeframes (and I think the latter describes the majority of market participants these days). Patient investors are able to ignore short-term performance, hold for the long run, and avoid excessive trading costs, while everyone else worries about what's going to happen in the next month or quarter and therefore trades excessively. In addition, long-term investors can take advantage if illiquid assets become available for purchase at bargain prices.
Like so many things in investing, however, just holding is easier said than done. Too many people equate activity with adding value. Here's how I summed up this idea in Liquidity , inspired by something Andrew had said:
When you find an investment with the potential to compound over a long period, one of the hardest things is to be patient and maintain your position as long as doing so is warranted based on the prospective return and risk. Investors can easily be moved to sell by news, emotion, the fact that they've made a lot of money to date, or the excitement of a new, seemingly more promising idea. When you look at the chart for something that's gone up and to the right for 20 years, think about all the times a holder would have had to convince himself not to sell.
Everyone wishes they'd bought Amazon at $5 on the first day of 1998, since it's now up 660x at $3,304.
But who would have continued to hold when the stock hit $85 in 1999 – up 17x in less than two years?
Who among those who held on would have been able to avoid panicking in 2001, as the price fell 93%, to $6?
And who wouldn't have sold by late 2015 when it hit $600 – up 100x from the 2001 low? Yet anyone who sold at $600 captured only the first 18% of the overall rise from that low.
This reminds me of the time I once visited Malibu with a friend and mentioned that the Rindge family is said to have bought the entire area – all 13,330 acres – in 1892 for $300,000, or $22.50 per acre. (It's clearly worth many billions today.) My friend said, "I'd like to have bought all of Malibu for $300,000." My response was simple: "you would have sold it when it got to $600,000."
The more I've thought about it since writing Liquidity , the more convinced I've become that there are two main reasons why people sell investments: because they're up and because they're down. You may say that sounds nutty, but what's really nutty is many investors' behavior.
Selling Because It's Up
"Profit-taking" is the intelligent-sounding term in our business for selling things that have appreciated. To understand why people engage in it, you need insight into human behavior, because a lot of investors' selling is motivated by psychology.
In short, a good deal of selling takes place because people like the fact that their assets show gains, and they're afraid the profits will go away. Most people invest a lot of time and effort trying to avoid unpleasant feelings like regret and embarrassment. What could cause an investor more self-recrimination than watching a big gain evaporate? And what about the professional investor who reports a big winner to clients one quarter and then has to explain why the holding is at or below cost the next? It's only human to want to realize profits to avoid these outcomes.
If you sell an appreciated asset, that puts the gain "in the books," and it can never be reversed. Thus, some people consider selling winners extremely desirable – they love realized gains. In fact, at a meeting of a non-profit's investment committee, a member suggested that they should be leery of increasing endowment spending in response to gains because those gains were unrealized. I was quick to point out that it's usually a mistake to view realized gains as less transient than unrealized ones (assuming there's no reason to doubt the veracity of the unrealized carrying values). Yes, the former have been made concrete. However, sales proceeds are generally reinvested, meaning the profits – and the principal – are put back at risk. One might argue that appreciated securities are more vulnerable to declines than new investments in assets currently deemed to be attractively priced, but that's far from a certainty.
I'm not saying investors shouldn't sell appreciated assets and realize profits. But it certainly doesn't make sense to sell things just because they're up.
Selling Because It's Down
As wrong as it is to sell appreciated assets solely to crystalize gains, it's even worse to sell them just because they're down. Nevertheless, I'm sure many people do it.
While the rule is "buy low, sell high," clearly many people become more motivated to sell assets the more