How the rich think: Lessons from an expert
The architect of investment giant Berkshire Hathaway thinks too much diversification is nuts. Say what? That’s actually what I said to myself after first reading that Charlie Munger, Warren Buffett’s longtime business partner and the vice chairman of Berkshire, isn’t a fan of spreading out your portfolio.
Experts have long told us it’s important to diversify so you can mitigate risk during market swings. If one stock or class of investments is down, it’s likely that another is thriving.
Yet Munger believes that if you have a portfolio of 50 or more stocks, the losers will cancel out the winners. “This worshiping at the altar of diversification, I think that is really crazy,” he says in a book about his philosophy on investing and life.
If you’re not a seasoned investor, you probably haven’t heard of Munger. Yet the better-known Buffett says his part-
ner has been instrumental in their company’s success.
So let’s learn from Munger. This month’s Color of Money Book Club selection is “The Tao of Charlie Munger: A Compilation of Quotes from Berkshire Hathaway’s Vice Chairman on Life, Business and the Pursuit of Wealth” ($24, Scribner).
Munger’s quotations are accompanied by commentary from David Clark, who has written several best-selling books breaking down Buffett’s investing shrewdness.
And after Clark explains Munger’s perspective on diversifying, it makes more sense. Munger isn’t anti-diversification per se. He just warns against thinking that it alone will protect you from losses.
Clark gathered the book’s quotes from a number of sources, including interviews and shareholder meetings. I appreciate the context on the thoughts of the 93-year-old Munger, who’s worth billions but has lived a frugal life. The latter is an important point because I’m more inclined to heed the advice of people who live well but don’t need to show their excess.
This is a flip-through kind of book. You can start from the beginning or just skip around for inspiration. It’s divided into four parts, with the first three focusing on investing, banking and business. The final section is Munger’s advice on everything from marriage, success, education and truth to the pursuit of happiness.
Following are five of my favorite quotes from the book.
“Knowing what you don’t know is more useful than being brilliant.”
Clark writes: “What Charlie is saying is that we should become conscious of what we don’t know and use that knowledge to stay away from investing in businesses we don’t understand.”
Munger didn’t invest in Internet companies in the 1990s because he didn’t get it. He was later vindicated for sitting out the mad rush to those types of stocks.
“Mimicking the herd invites regression to the mean.”
This quote definitely needs some explaining. Munger isn’t a fan of index funds. In his mind, investing in them gives you only average returns. “An average can also mean losing,” Clark says. “If we buy into an index fund at the height of a bull market and the market tanks, it is possible we might lose money for a number of years. In Charlie’s world, one buys as others are selling, which is hard to do if one is running with the herd.”
I should note that Buffett’s hot investing tip is just the opposite of what Munger advocates here. He says the average investor is better off buying low-cost index funds. In his recent letter to shareholders in Berkshire’s annual report, Buffett says: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsize profits, not the clients. Both large and small investors should stick with low-cost index funds.”
“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.”
Clark writes: “Charlie and Warren have never worried about anyone mimicking their investment style — because no other institution or individual has the discipline or patience to wait as long as they can.”
“Banks will not rein themselves in voluntarily. They need adult supervision.”
No interpretation needed here.
“One of the great defenses — if
I appreciate the thoughts of the 93-year-old Charlie Munger, who’s worth billions but has lived a frugal life. The latter is an important point because I’m more inclined to heed the advice of people who live well but don’t need to show their excess.
you’re worried about inflation — is not to have a lot of silly needs in your life, if you don’t need a lot of material goods.” Enough said! You want to be prosperous? Read how the rich think.
I’ll be hosting an online discussion about “The Tao of Charlie Munger” on March 30 at washingtonpost.com/ discussions. Clark will be joining me to take your questions about one of the richest men in America.
Write Singletary at The Washington Post, 1301 K St. NW, Washington, D.C. 20071 or firstname.lastname@example.org. To read more, go to wapo.st/michellesingletary.
Michelle Singletary THE COLOR OF MONEY