Published June 12th, 2015
Charllie Munger is Warren Buffett’s business partner and vice-chairman of Berkshire Hathaway.
Before Munger partnered with Buffett, he managed his own investment partnership. Munger’s partnership averaged returns of 19.8% a year from 1962 to 1975 versus just 5% a year for the DOW over the same time period.
Munger, Buffett, & Investing
Charlie Munger heavily influenced Warren Buffett’s investment style. Munger believes in holding a hyper concentrated portfolio of extremely high quality businesses. Munger eschews diversification – he is comfortable holding as few as 3 securities at a time.
Munger’s philosophy of buying and holding high quality businesses for the long-run clearly rubbed off on Buffett. Before Munger, Buffett was much more of a traditional value investor. After Munger, Buffett focused on high quality businesses trading at fair or better prices. You can see Warren Buffett’s top 20 stocks here.
Charlie Munger’s interests go far beyond investing. He is a generalist with broad knowledge across multiple fields. Munger is perhaps best known for his ‘mental models’ approach to solving problems.
Warren Buffett says Munger has “the best 30 second mind in the world. He goes from A to Z in one move. He sees the essence of everything before you even finish the sentence”.
Munger advises you understand the ‘big ideas’ from a wide range of subjects – from philosophy, science, physics, investing, and so on. This ‘latticework’ of mental models will help you come to correct conclusions by viewing the problem from multiple vantage points.
Charlie Munger’s mental models approach to life gives him a unique perspective. If there is anyone who offers better investment quotes than Warren Buffett, it is Charlie Munger. Several of Munger’s best quotes are analyzed below.
“Opportunity cost is a huge filter in life. If you’ve got two suitors who are really eager to have you and one is way the hell better than the other, you do not have to spend much time with the other. And that’s the way we filter out buying opportunities.”
Munger’s concentrated approach to investing flows from the idea of using your capital on your best ideas. The cost of diversifying is forgoing putting more capital to work in your best idea. Viewed in this manner, a concentrated portfolio is logical – if you have a high conviction your forecasts are accurate.
”When any guy offers you a chance to earn lots of money without risk, don’t listen to the rest of his sentence. Follow this, and you’ll save yourself a lot of misery.”
There are far too many people looking to take advantage of less informed investors. There are also many people who mean well but don’t understand the risk they are taking. If something is too good to be true, it probably is.
“Everywhere there is a large commission, there is a high probability of a rip-off.”
Outperforming the market is very difficult. When investors pay large fees, it becomes virtually impossible. The lower your investing costs, the more money you can put to work in the stock market for yourself. ‘Just’ 1% or 2% a year adds up to a tremendous amount of lost money over the course of an investing lifetime.
“Someone will always be getting richer faster than you. This is not a tragedy.”
There will always be a subsector of the economy that is ‘on fire’. The investors who happen to be in this subsector (recently it has been biotech stocks) will show phenomenal results – for a time.
Keeping a cool head and investing in high quality businesses with long histories of rewarding shareholders may not be as exciting, but it will generate solid returns over time with less risk than investing in ‘the next big thing’. When the crowd moves on, large losses often follow large gains.
“You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”
Buying businesses below their fair value requires you have an idea of what fair value is. When the crowd becomes overly pessimistic they focus on negative possibilities and discount positive possibilities. Having a better estimate of the real probabilities gives an investor a sizeable edge that can be exploited.
“A great business at a fair price is superior to a fair business at a great price.”
A great business at a fair price compounds investor wealth year after year. A fair business at a great price only offers the potential to compound investor returns when it reaches fair value – then it must be sold. A great business potentially never needs to be sold.
“I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart…”
Reading and understanding the great ideas in philosophy, economics, science, and other disciplines slowly opens your mind to different possibilities in a way that staying in one narrow field alone will never be able to accomplish.
“Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat.”
In the short-run people and businesses can get richer faster by being dishonest. In the long run, honesty and integrity build a reputation that is worth more than the quick gains that come from trickery. Being honest and acting with integrity makes it easy to sleep at night.
“Our ideas are so simple that people keep asking us for mysteries when all we have are the most elementary ideas.”
Like other great investors, Charlie Munger advocates simplicity. Keeping things simple greatly reduces errors. The more complicated an idea or investment thesis, the more likely it is to be wrong. This is because there are simply too many moving parts and too many estimates that are all prone to error.
“Today, it seems to be regarded as the duty of CEOs to make the stock go up. This leads to all sorts of foolish behavior. We want to tell it like it is.”
The job of a CEO is to maximize long-term value for shareholders. Often, long-term value maximization comes at the expense of short-term profits.
CEOs who seek to boost the stock price at all costs will repurchase shares at the worst possible times and pursue short-term profits above all else, destroying shareholder value in the process.
“Understanding how to be a good investor makes you a better business manager and vice versa.”
Investors should not think of stocks as electronic lottery tickets. Stocks are fractional ownership claims to real businesses. Thinking in terms a business manager would helps avoid speculative stocks. Conversely, thinking like a good investor helps business managers avoid paying absurd valuation multiples for investments.
Charlie Munger’s mental models approach to investing has produced phenomenal success for Munger himself and for Berkshire Hathaway. Hisunique perspective is a combination of the wisdom of several fields. At its core, Charlie Munger’s approach is similar to Warren Buffett’s – invest in high quality businesses that generate above average returns.
Businesses that generate above average returns must have a competitive advantage that prohibits competitors from undercutting the company. Patents, strong brand names, and economies of scale can all result in above average returns.
The Dividend Aristocrats Index is an excellent place to look for high quality businesses. To become a Dividend Aristocrat, a business must pay increasing dividends for 25 or more consecutive years in a row. Not surprisingly, the Dividend Aristocrats Index has outperformed the S&P 500 by an average of over 2 percentage points a year over the last decade.