Learn from Charlie Munger, but take his advice with pinch of salt
Berkshire Hathaway vice-chair is a genius so we should sometimes look the other way
It shows how hard it is to be rational on something very simple, said Charlie Munger at 2019’s Daily Journal annual meeting. “How many kinds of crazy ideas people have that don’t work, and you don’t even know why they don’t work even though it’s perfectly obvious if you’ve been properly educated.
“And, by the way, my definition of being properly educated is being right when the professor is wrong. Anybody can spit back what the professor tells you. The trick is to know when he’s right and when he’s wrong. That’s the properly educated person.”
But while there are not too many people in this world, now or in the past, who have had more investing success than Munger, as with the professors it’s important to know when he is wrong. There are a number of occasions when Munger’s ideas should be rejected, such as when it comes to:
Munger famously savaged diversification as the refuge of the “know-nothings”, saying: . “What’s wrong with owning a few securities? Warren [Buffett] always says that if you lived in a growing town and you owned stock in three of the best enterprises in the town, isn’t that diversified enough? The answer is of course it is. It’s perfectly possible to buy only one thing because the opportunity is so great and it’s such a cinch. So the whole idea of diversification when you’re looking for excellence is totally ridiculous.”
Thing is, while Munger and Buffett may be able to determine “the three best enterprises in town”, most of us cannot. So while it’s true that if you could pick just one stock you can be absolutely sure about and watch it take off and hold on to it as it keeps going up in price you’re bound to do pretty well, the question is how many stocks you can be absolutely sure about. Unfortunately, for most of us the only right answer is none. Not one. Should you dare to think otherwise it could cost you everything; to justify putting the bulk of your wealth into a single investment would require a level of confidence that only drunks messing with firearms tend to have. The outcome would be about as dangerous, at least in financial terms.
“In my 45-year career as an investment counsellor,” said John Templeton, “humility did show me the need for diversification to reduce risk.” Better to assume that you’re a “know nothing”, as Munger puts it, and take the refuge diversification offers. If only to ensure one result: that being wrong about too few stocks doesn’t prove fatal to your financial future.
Peter Lynch provided better advice for most of us in
when he suggested not relying on any fixed number of stocks, but rather investigating how good they are case by case. “It’s best to own as many stocks as there are situations in which (a) you’ve got an edge and (b) you’ve uncovered an exciting prospect that passes all the tests of research,” says Lynch
David Abraham echoed this when he said: “We believe in diversification for risk reducing, but we don’t want to diversify ourselves into ignorance.”
Munger said: “We have a history when things are really horrible of wading in when noone else will.” But again, this says more about the special edge Berkshire has when it comes to investing than acting as good advice for the rest of us. Don’t catch a falling knife is a well-known maxim in the stock market. It’s good advice too. Many an investor who has rushed in when things have gone wrong has regretted the decision. The general rule of thumb is not to go against the market unless you know something it doesn’t. And you probably don’t know anything the market hasn’t priced in.
“Everybody engaged in complex work needs colleagues,” says Munger. But that’s not necessarily true. Buffet, John Templeton, George Soros and other great investors have argued in favour of going it alone. Buffet says if you don’t know enough about a situation to make your own decisions, you should get out of decisionmaking. “Make your decision and leave it at that, without feeling the need to consult other people: no committees.”
Templeton’s initial success resulted from an extreme strategy hitting points of maximum pessimism with borrowed money he would never have got past an investment committee. That also applies to Soros’s decision to take on the Bank of England.
Then there are the stories of otherwise successful individuals who suffered when they broke their isolation: Jesse Livermore’s escapades with “Cotton King” Percy Thomas; Nicolas Darvas’s losses after he moved into his brokers’ offices in New York. Steuart Walton worked in solitude, with not even a secretary to help him manage his fund. “I found that having another opinion in the office was very destabilising,” he said “If I have someone working for me every day they may as well be running the money because I’m no longer making my own decisions. And while not everything always has to make perfect sense, it’s important that you make your own decisions.”
All intelligent investing is value investing. As Jack Schwager concludes from his many interviews for his Wizards books, “there are a million ways to make money in the markets, it’s really a matter of finding a method that is right for you. There are people like Jim Rogers who have complete disdain for technical analysis. He’d say the only people he’s met that make money in technical analysis are those who sell their technical analysis services. On the other hand, you’ve got people like Martin Schwartz who spent a decade as a fundamental analyst, but I got rich as a technician. I’ve come to believe that the idea that either one is right or wrong is wrong, and each approach works for different individuals.”
“It’s not just fundamental vs technical,” says Schwager. “Nor is it short term vs long term. Do you want to trade stocks? Do you want to trade futures? Do you want to trade currencies? The variations go on and on. Nobody else can tell you.”
As a closing comment, though, it may be worth keeping in mind that if we do go against some of Munger’s advice, it will also mean having to go against his assertion that “I’m right, and you’re smart, and sooner or later you’ll see I’m right”.
NOT EVERYTHING HAS TO MAKE PERFECT SENSE ... IT’S IMPORTANT TO MAKE YOUR OWN DECISIONS