Chapter 60 - Charlie Munger: The Complete Investor
Today’s Chapter is based on the book “Charlie Munger: The Complete Investor” by Tren Griffin.
Here’s what I have learned about:
Learn from Others
“If I have seen further, it is by standing on the shoulders of giants.”
— Isaac Newton
As we have learned previously from other great people, the fastest way to earn wisdom is to learn from the success and failure of others. As a matter of fact, life is way too short to learn everything on your own, and that’s without saying how much pain we can avoid by learning from mistakes of others instead of committing them ourselves.
As Charlie Munger once said, “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.”
In the case of Charlie Munger, he loved to read biographies as it is a great way to learn from the masters of each disciplines. Here’s how he explains it:
“I am a biography nut myself. And I think when you’re trying to teach the great concepts that work, it helps to tie them into the lives and personalities of the people who developed them. I think you learn economics better if you make Adam Smith your friend. That sounds funny, making friends among the “eminent dead,” but if you go through life making friends with the eminent dead who had the right ideas, I think it will work better for you in life and work better in education. It’s way better than just giving the basic concepts.”
— Charlie Munger
Charlie Munger, who was Warren Buffett’s partner at Berkshire Hathaway, is considered one of the greatest investor of all-time. Buffett and Munger’s track record at Berkshire is exceptional, returning over 19.8% compounded annual gain from 1965 to 2022 compared to only 9.9% for the S&P 500 Index. What’s the secret to their success? Well, I believe that part of the reason is because both Munger and Buffett are compounding learning machine. As a matter of fact, Munger mentions that he doesn’t know any single successful investor who do not read voraciously.
In fact, even Munger and Buffett became successful investors by learning from others. As we have seen previously, Buffett’s investing strategy was inspired by Benjamin Graham’s value investing. According to Buffett, he took three main principles from Benjamin Graham’s investment philosophy:
A stock is the right to own a little piece of a business. A stock is worth a certain fraction of what you would be willing to pay for the whole business.
Use a margin of safety . Investing is built on estimates and uncertainty. A wide margin of safety ensures that the effects of good decisions are not wiped out by errors. The way to advance, above all, is by not retreating.
Mr. Market is your servant, not your master . Graham postulated a moody character called Mr. Market, who offers to buy and sell stocks every day, often at prices that don’t make sense. Mr. Market’s moods should not influence your view of price. However, from time to time he does offer the chance to buy low and sell high.
Furthermore, Munger clarifies that an important part of learning is the concept of unlearning and to change one’s mind. In fact, he once said that “Any year that passes in which you don't destroy one of your best-loved ideas is a wasted year.”
As such, in Munger and Buffett’s case, while they first started as value investors similar to Benjamin Graham, they quickly realised that it was a lot better to buy wonderful companies than to purchase companies trading below net asset value. As Buffett once said, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” It is well-known that Munger was the one that convinced Buffett to focus on buying wonderful companies instead of cigar butts. This method allowed Munger and Buffett to “sit back and collect money” from cash generating businesses rather than to be always on the lookout for cheap companies which takes more effort and requires one to make more decisions. This is what Munger calls the “Sit on Your Ass” investing approach.
This concept of changing one’s mind reminds me of what we have learned from Lee Kuan Yew, the founding father of modern Singapore. For Lee, governing was all about finding a solution that worked no matter where it came from. It is by being an “utilitarian” that he was able to transform Singapore from a small and impoverish British colony into a prosperous, modern city-state with a strong economy, efficient government and high standard of living.
Rather than trying to be right, he was trying to find the truth. As a matter of fact, Lee Kuan Yew’s guiding principle is to review all solutions and to choose the solution with the highest probability of success. If his proposed solution fails, then he will go over the alternatives solutions and find another way. By not being guided by a philosophy or a theory, Lee Kuan Yew didn’t need to force himself into chasing ideas when they didn’t work.
“I chase ideas provided they work. When they don't work, I say, look, this idea maybe sounds bright, but let's try something that works. So we try something that works, let's get it going.”
— Lee Kuan Yew
Invert, Always Invert
“Invert, always invert.”
— Carl Gustav Jacob Jacobi
Charlie Munger is well-known for promoting the concept of keeping things simple. Munger once said that “If something is too hard, we move on to something else. What could be simpler than that?” In fact, when it comes to investing, Munger explains that at Berkshire Hathaway, they have three baskets(in, out and too tough) in which they classify new investment ideas. And most often then not, ideas tend to go into the too tough pile. As Buffett once said, “I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”
As a matter of fact, I believe that this concept of Munger of keeping things simple comes from the power of inversion that was inspired by the famous mathematician Jacobi, who often solved complex issues by inverting the problem. Similarly, Munger came up with the concept that one can succeed in life by avoiding stupidity by using the power of inversion. Munger gives the example of a professional tightrope walker for 20 years. He is successful in his art because he knows what he cannot do, because he knows that if he gets it wrong, he won’t survive.
Similarly, Munger understands that to succeed in life, one must avoid taking stupid paths. For one, Charlie Munger mentions that “three things ruin people: drugs, liquor and leverage.”
“We all know talented people who have ruined their lives abusing either alcohol or drugs—and often both.”
— Charlie Munger
Secondly, Munger explains that envy and jealousy are extremely dangerous as nothing good will come out from enjoy or jealously. As Buffett once said, “it’s not greed that drives the world, but envy.” If one is interested in learning “how to guarantee a life of misery”, I recommend listening to Charlie Munger’s speech in 1986 at Harvard, where he advices students on a few prescriptions on how to lead a successful life.
This concept of avoiding stupidity reminds me of what we have learned from Jeff Bezos. He started Amazon with the idea of making it Earth’s most customer-centric company in the world. This concept came to him through the model of inversion. While he realized it was too difficult to predict changes in the future, he figured it was a lot easier to find out what would not change.
As a matter of fact, he realised that: “under all kinds of regulatory frameworks that I can imagine, customers are still going to want low prices. They’re still going to want fast delivery. They’re still going to want big selection. These are so fundamental and what we do.” As such, by working backward, he always required Amazon to acquire new competencies to fulfil these never-changing customers' needs:
“In our retail business, we have strong conviction that customers value low prices, vast selection, and fast, convenient delivery and that these needs will remain stable over time. It is difficult for us to imagine that ten years from now, customers will want higher prices, less selection, or slower delivery. Our belief in the durability of these pillars is what gives us the confidence required to invest in strengthening them. We know that the energy we put in now will continue to pay dividends well into the future.”
— Jeff Bezos
Similarly, Munger’s investment philosophy also follows the idea of focusing on what will never change, such as:
Investing with a margin of safety
Investing in companies with sustainable competitive advantages
First, as mentioned previously, Benjamin Graham came up with the concept of investing with a margin of safety, a precept that will never be obsolete according to Munger. In fact, the best way to be successful in investing is to avoid fatal capital loss. The concept of margin of safety is similar to the process that exists in engineering. As Buffett once explained, “When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it. And the same idea works in investing.”
“The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule. And that's all the rules there are.”
— Warren Buffett
Secondly, Munger mentions that it is very difficult for a company’s stock price to defer from the business fundamentals during a long period of time. As he once explained, “I think it’s roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don’t think it’s totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. “
As such, it is important to invest in companies with great business fundamentals, meaning businesses that have a significant track record of generating high, sustained, and consistent financial returns, in order to have great investing records. And as we have seen previously from Warren Buffett, only companies with sustainable competitive advantages can maintain these type of numbers. By consequence, Munger explains that the investment game is to “ buy businesses with sustainable competitive advantages at a low—or even a fair price.” That’s the simplest way to find success in investing during a long period of time.
Patience
“The big money is not made in the buying or in the selling, but in the waiting.”
— Charlie Munger
Charlie Munger is well known for his patient approach in investing. As a matter of fact, Munger is a believer that success comes to those who are very patient, yet aggressive when it is the time. He once said that, “Patience combined with opportunity is a great thing to have. My grandfather taught me that opportunity is infrequent and one has to be ready when it strikes. That’s what Berkshire is.”
Both Charlie Munger and Warren Buffett often compare investing to baseball. In baseball, the best batters always wait for the right pitch before swinging for the fences. Similarly, a great investors should remain patient until a great opportunity comes to him. However, unlike baseball, investing allows you an infinite amount of strikes. Furthermore, the great news is that in investing, you don’t need that many great investment ideas to become successful.
“The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.”
— Charlie Munger
However, patience doesn’t stop there. Once you’ve purchased stocks of a company, you also need to have the temperance and the patience to hold onto the company. As a matter of fact, it is quite often for stocks to go through long period of drawdowns. In the case of Berkshire Hathaway, the stock was cut in half four times!
As Charlie Munger once said, “If you’re not willing to react with equanimity to a market price decline of 50 percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
“The stock market is a device for transferring money from the impatient to the patient.”
— Warren Buffett
While this seems easy in theory, it is a lot harder in practice due to human irrationality. While in the long term, the power of compounding is more evident, in the short term, understanding the power of compounding is not a natural state for the normal human being. Hence, this is the reason why Charlie Munger and Warren Buffett believe that temperance and not IQ is the most important quality to become a great investor.
As Charlie Munger once said, “Having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control.”
As we have learned previously from Benjamin Franklin, temperance is considered one of the most important virtue and that is especially true in investing. In fact, investors need to avoid making decisions under their internal cognitive biases and external factors such as irrational movement from the stock market and irrelevant news. To do so, we must be able to face the challenge of inactivity. As Blaise Pascal once said “All human unhappiness comes from not being able to sit quietly in a room alone.”
This is especially true in the current environment we live in with social media and information being as accessible as it has ever been. In fact, America's past-time has been slowly changing from baseball to more fast-paced game like basketball and football. I believe that a part of the reason is because baseball requires more knowledge and patience and yet, lack actions compared the two other sports.
As such, it is crucial to arrange rules and an environment to avoid making big decision under irrational emotions. For example, investors can apply this by setting rules such as only putting trade orders when the market is closed and only following stock prices once per month, etc.
Another example is the idea of waiting a certain time before responding an unhappy email when you know you are currently in an irrational state:
“Another one, for example, that I think a lot of smart people say is, “If you're angry about something, or if you get an unhappy email and you want to respond, don't respond for 24 hours.” What does that do? You calm down. The emotions subside, the hormones go down, and you're in a better mental state 24 hours later.”
— Naval Ravikant
Do not fear inactivity, as it does bring huge benefits to those that are able to master their emotions and their urge of action. As a matter of fact, this intelligent behaviour has allowed great investors such as Nick Sleep and Warren Buffet more time to read and think. It is no wonder that this super ability has allowed Buffett to find time to learn and improve even at his age.
Mental Models
“You’ve got to have models in your head. And you’ve got to array your experience—both vicarious and direct—on this latticework of models.”
— Charlie Munger
Charlie Munger is considered one of the greatest thinker of his time. As a matter of fact, Buffett once added that 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.”
The reason why he’s such a great thinker is due to the fact that he possesses a range of different mental models from many disciplines, such as psychology, history, mathematics, physics, philosophy, and biology. Munger is a believer of having a multidisciplinary approach as he mentions that one do not want to fall into the “Man with a hammer” syndrome. He once said, “To the man with only a hammer, every problem looks. “To the man with only a hammer, every problem looks like a nail.”
In terms of investing, Munger mentions that people who think broadly and possess various mental models from different disciplines make better decisions and are therefore better investors. He reiterates that understanding disciplines such as biology, psychology, chemistry, physics, history, philosophy, or engineering will make you a better investor.
For example, we have seen how value investors like Warren Buffett and Charlie Munger use the concept of margin of safety from engineering, in order to limit their risk of capital loss.
“In engineering, people have a big margin of safety. But in the financial world, people don’t give a damn about safety. They let it balloon and balloon and balloon. It’s aided by false accounting.”
— Charlie Munger
Similarly, we have also learned from Edward Thorp about the importance of compounding in investing, a principle shared from mathematics. According to Warren Buffett, the understanding of compounding interest is the first and most important mathematical concept to learn. Not only is it important in investing, but it is also useful in terms of seeking wisdom and obtaining good habits.
As a matter of fact, a one percent improvement every day leads to 37x improvement in a year. Similarly, it is very possible to become wealthy even if our investments grow at a small rate as long as it happens on a long period of time. Edward Thorp once said that “Over a sufficiently long time, compound growth at a small rate will vastly exceed any rate of arithmetic growth, no matter how large!”
The rules of compounding are very simple once you get the concept: start early and do not ever interrupt it. As Charlie Munger famously said, “The first rule of compounding: Never interrupt it unnecessarily.” Thorp understood the importance of compounding beyond the stock market. As a matter of fact, it is this principle that encouraged him to lead a healthier lifestyle. For every hour he spent on fitness was one less day he would spend in a hospital.
“Americans supposedly spend an average of forty or more hours a week watching television. Those who do have plenty of “junk time,” which they can use instead for an exercise or fitness program. Five hours a week for this can add five years of healthy life.”
— Edward Thorp
Previously, we also learned from Wayne Huizenga how one can become a great entrepreneur and investors through recognizing patterns due to the power of convergence from biology. Charles Darwin was one of the first to recognise the power of convergence when he said, “Animals, belonging to two most distinct lines of descent, may readily become adapted to similar conditions, and thus assume a close external resemblance.” Similarly, in terms of business, while two businesses may not be in the same industry, the same business model may be used in order to succeed. This is what happened with Huizenga with Waste Management Inc. and Blockbuster.
In his book “What I Have Learned About Investing From Darwin” by Pulak Prasad, he explains that rather than to invest in individual businesses, he prefers to invest in convergent patterns based on the power of convergence in evolutionary biology. As Prasad explains, “As we saw, “replaying the tape of life” often yields the same result. We operate on the principle that the business world is no different.” And I believe Huizenga’s story is a perfect example of this.
“There is a big difference between asserting “I love this business” and “I love this business construct.” We are fans of the latter, not the former. We don’t care about a business; we are deeply attached to a business template.”
— Pulak Prasad
Finally, Munger often mentions how the most important mental model to understand comes from psychology: the power of incentives. As he once said, “Show me the incentive and I will show you the outcome.” And yet, he believes that not many people understand how powerful incentives are.
“For instance, I think I’ve been in the top 5 percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I’ve always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.”
— Charlie Munger
As investors, it is often advised to invest in companies where management have skin in the game. In fact, as shareholders, it is important to invest your money with management teams that also have most of their assets invested in the company, as you can be sure that their interests are aligned with you.
Similarly, Munger explains how important incentives are in running a business. My favourite example on the power of incentives from Munger come from Federal Express:
“The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast. And Federal Express had one hell of a time getting the thing to work.
And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.”
— Charlie Munger
Charlie Munger also provided an interesting case study on how Les Schwab tire store was able to come out ahead despite competing with the bigger tire companies such as Goodyears and later on, with huge price discounters like Costco and Sam’s Club. How did he do so? Munger believes that a big part of this is due to the fact that he “must have a very clever incentive structure driving his people. And a clever personnel selection system, etc.”
Similarly, we have also learned from Paul Orfalea, the founder of Kinko’s how a great incentive structure led this company to success. In fact, Orfalea realized that the workers behind the counter at Kinko’s were the true heroes of the company.
As a matter of fact, being in the retail copy centers business, Orfalea had plenty of competitors considering it is an industry with no barriers to entry. As such, if he wanted to beat his competitors, he would have to make Kinko’s a great place to work; he would have to create an incredible corporate culture and make it a competitive advantage. This starts by setting the right incentives in place. In fact, Orfalea mentions that it is a lot easier to manage the work environment than the people in a store. He once said that “when people are properly motivated, they will essentially manage themselves.”
Beyond the Book
Read "Standing on the Shoulders of Giants" by Farnam Street
Read "The Buffett Formula: Going to Bed Smarter Than When You Woke Up" by Farnam Street
Read "Inversion and The Power of Avoiding Stupidity" by Farnam Street
Read "How to Guarantee a Life of Misery” by Charlie Munger
Read "The Power of Incentives: The Hidden Forces That Shape Behavior" by Farnam Street