Charlie Munger: Trying to Be a Better Investor by Not Being Stupid

Is there anyone among the investing gurus who is as enigmatic as Charlie Munger (Trades, Portfolio)? Although best known as the sidekick of Warren Buffett (Trades, Portfolio), he is an outstanding investor in his own right and a complex intellectual.

Tren Griffin set out to create what he calls a “unified theory” of Munger’s thought in his book, “Charlie Munger: The Complete Investor”:

BTK.A 30-Year Financial Data “While Munger has delivered The intrinsic value of BTK.A numerous speeches, written Peter Lynch Chart of BTK.A essays, and entertained legions of shareholders at Wesco Financial and Berkshire Hathaway annual meetings, his ideas have not yet been presented in a form that might be called a unified theory. This is probably because Munger’s mind is capable of feats that are too hard for people of more conventional intelligence. For ordinary people, simultaneously juggling what he calls “multiple models” in their head is not an easy task without an understandable framework for the ideas. The intent of this book is to teach you how to think more like Charlie Munger.”

Griffin’s book was published by Columbia Business School Publishing in 2015. He is an executive at Microsoft (MSFT); previously, he had been a partner at the private equity firm Eagle River, which makes investments in telecommunications firms and startups.

He reported that Munger, like Buffett, grew up in Omaha, Nebraska. Munger interrupted his study of mathematics at the University of Michigan to enlist for service in World War II. During the war, he served as a meteorologist after being trained at the California Institute of Technology. Munger studied at Harvard Law School once the war was over and, after graduation, he and a few partners started what would become a prestigious law firm.

Munger, however, made only a brief stop in the legal profession. Between 1962 and 1975, he ran an investing partnership which produced average annual returns of 20%, much more than average 5% returns in the Dow Jones Industrial Average.

In 1984, he became CEO and Chairman of Wesco Financial, a company partially in the stable of Berkshire Hathaway (BRK.A)(NYSE:BRK.B). He remained in that position until 2011, when Berkshire acquired 100% of Wesco’s shares. He is currently vice-chairman of Berkshire and continues to work closely with Buffett, as he did while at the helm of Wesco.

In the book, Griffin focused on Munger’s close connection with value investing pioneer Benjamin Graham, an attachment Munger shares with Buffett. Graham’s four core principles of value investing were:

1. Think of investing as owning a proportional piece of a business. 2. Only buy at a “significant” discount to intrinsic value, thus creating a margin of safety. 3. Make Mr. Market your servant rather than your master. 4. Always be rational, objective and dispassionate.

In addition to following these principles, Munger believes investors must have the right personal attributes, so they can avoid common psychological and emotional mistakes. He also believes investors must become “learning machines,” reading and thinking constantly (Munger's own children call him a “book with legs sticking out”).

In chapter one, Griffin emphasized Munger’s strong connection with what he calls The Graham Value Investing System. The most important characteristic of that system, according to the author, is that it is simple, and one that Munger said anyone could use. Buffett added a caveat to this idea by saying investing is simple, but not easy.

Munger went on to argue it is important to follow a fundamentally sound process, even though that process may sometimes produce bad results. In the long run, it is best to focus on following the right process.

From there Griffin argued that an investment process should be simple and should avoid complexity. Munger and Buffett wrote, “Simplicity has a way of improving performance through enabling us to better understand what we are doing.” Griffin added:

“By focusing on finding decisions and bets that are easy, avoiding what is hard, and stripping away anything that is extraneous, Munger believes that an investor can make better decisions. By “tuning out folly” and swatting away unimportant things “so your mind isn’t cluttered with them … you’re better able to pick up a few sensible things to do,” said Munger. Focus enables both simplicity and clarity of thought, which in Munger’s view leads to a more positive investing result.”

Part of the appeal of Graham’s investing system is how it strips from the process many decisions that might lead an investor to make mistakes.

In addition, successful Graham investors also work hard to minimize the downside risk of an investment; buying at a discount to intrinsic value. Author Griffin noted that the Graham system works best during flat or falling stock markets when discounts are most common; it is also designed to underperform an index during bull markets. Think of this as a trade-off in which a Graham investor gives up some of the upside in a bull market in exchange for outperformance in bear or bearish markets.

A corollary of this is that investors who cannot accept underperformance in the short term, for long-term overperformance, should not be using the Graham system.

Munger wrote in Wesco’s Annual Report for 1989, “It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folks saying, 'It’s the strong swimmers who drown.'”

Much has been written about Munger’s belief in “inverting” problems, to find a solution. This is an example, where he is saying you need not be brilliant to be a successful investor —just be less stupid than other investors.

In the context of investments, Munger looks for those in which a solidly positive outcome is obvious. Unfortunately, such investments are rare and so investors must be very patient, and then be very aggressive when the time is right.

He shares with John Bogle, the father of low-cost index investing, a strong belief in keeping costs down. As Griffin wrote, it is irrefutable that investing is a less-than-zero sum game after fees and expenses are considered.

Munger also pointed out that for a security to be mispriced, some other investor must be a “damn fool.” What is difficult, and impossible for some investors, is having the patience to wait for a damn fool to create mispriced assets. Griffin wrote, “Successfully learning and especially implementing the Graham value investing system is what Munger has called 'a trained response.' You must learn to overcome certain behavior that drives poor decisions.”

The difficulty most investors face in understanding and implementing the Graham system led Munger to offer this solution: “Our standard prescription for the know-nothing investor with a long-term time horizon is a no-load index fund.” Griffin defines a know-nothing investor as someone who does not understand the fundamentals of investing.

Buffett agreed with Munger, “By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”

(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.