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Charlie Munger’s 10 Rules for Investment Success

Charlie Munger's 10 Rules for Investment Success When Charlie Munger talks, people listen— particularly if they want to know how to invest their money.

Munger, who is the vice-chairman of Berkshire Hathaway, has delivered instrumental guidance to Berkshire’s renowned founder, Warren Buffett, and many others. By means of what Munger identifies as “elementary world wisdom,” Munger’s technique weighs risk and reward, make the most of fact-based data and abating emotion.

Keeping it simple, Munger declares, “I observe what works and what doesn’t and why.” Like Buffett, Munger pulls much of his motivation from post-Great Depression era investor Benjamin Graham, a “value investor.” Graham sought “mispriced assets” with values greater than people think.

Charlie Munger has some advice for investors.

  1. Measure risk: All investment evaluations should begin by measuring risk, especially reputational.
  2. Be independent: Only in fairy tales are emperors told they’re naked.
  3. Prepare ahead: The only way to win is to work, work, work, and hope to have a few insights.
  4. Have intellectual humility: Acknowledging what you don’t know is the dawning of wisdom.
  5. Analyze rigorously: Use effective checklists to minimize errors and omissions.
  6. Allocate assets wisely: Proper allocation of capital is an investor’s No. 1 job.
  7. Have patience: Resist the natural human bias to act.
  8. Be decisive: When proper circumstances present themselves, act with decisiveness and conviction.
  9. Be ready for change: Accept unremovable complexity.
  10. Stay focused: Keep it simple and remember what you set out to do.

Munger has argued that if “you’re investing for 40 years in some pension fund, what difference does it make if the path from start to finish is a little more bumpy or a little different than everybody else’s so long as it’s all going to work out well in the end? So what if there’s a little extra volatility.”

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Warren Buffett’s Tips for Long-Term Investing

Warren Buffett's Tips for Long-Term Investing WSJ extracts four tips for long-term investing from Warren Buffett’s 2014 annual letter to Berkshire Hathaway’s shareholders. Here are excerpts.

  1. Own low-cost S&P 500 index funds: “Don’t try to pick winning stocks. Instead “own a cross section of businesses that in aggregate are bound to do well.” A low-cost S&P 500 index fund helps any investor do this well.”
  2. Ignore your or anyone else’s predictions about long or short-term price changes. “Focus instead on productivity of assets.”
  3. Ignore the macro environment and political environment: “Buffett notes that when he and his partner Charlie Munger buy stocks, they think of them as “small portion of businesses” and try to see the earnings power of these businesses over the next five years or more. “In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment.””
  4. Make as few investments as possible: “Investors these days are pushed to be active and to buy low, sell high. Frequent buying and selling only cuts into long-term returns. Mr. Buffett continues: “Ignore the chatter, keep your costs minimal, and invest in stocks as you would a farm.””
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Ben Graham and Warren Buffett on Temperament in Investing

  • “We have seen much more money made and kept by “ordinary people” who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had an extensive knowledge of finance, accounting, and stock-market lore.”
    Ben Graham, Father of Value Investing and mentor of Warren Buffett
  • “Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
    Warren Buffett
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To Allocate Capital, You Need a Good Search Strategy

'Keeping America Great' at Columbia with Warren Buffett and Bill Gates

At the 2009 CNBC Town Hall Event called “Keeping America Great” at Columbia University with Warren Buffett and Bill Gates (video here), Buffett said that to allocate capital, you need a good search strategy. Developing this strategy requires a lot of hard work, “turning pages” as Buffett calls it:

If you are going to spend a lot of time on investment, you know I just advise looking at as many things as possible and you will find some bargains. And when you find them, you have to act. … And you have to find them yourself. The world isn’t going to tell you about great deals. You have to find them yourself. And that takes a fair amount of time. So if you are not going to do that, if you are just going to be a passive investor, then I just advise an index fund more consistently over a long period of time. … Good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it.

It is not possible to pick the bottom. Learn how to value companies, practice until you get good, and buy when you find a good business that you understand, with good management, available at an attractive price.

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Charlie Munger’s Sit-on-Your-Ass Investing Concept

Charlie Munger presented the model of “Sit on your ass investing” at the 2000 Berkshire Hathaway Annual meeting. Description courtesy of Losch Management Company, an Orlando, Florida-based investment advisor.

'Charlie Munger: The Complete Investor' by Tren Griffin (ISBN 023117098X) You have value investing, and growth investing, but now we also have “sit on your ass investing”, which is better.

The problem with value investing is it requires too much work.

First you have to find an undervalued stock and buy it cheap. Then you have to sell it when it the price reaches or exceeds your calculated figure for its intrinsic value.

Because this requires many decisions over a long period of time, Charlie Munger prefers his own method in which all you have to do is pick a really great company when it is attractively priced, and then just sit on your ass. The great advantage being that it only requires one decision.

Charlie said: “If you buy a business just because it’s undervalued then you have to worry about selling it when it reaches its intrinsic value. That’s hard. But if you can buy a few great companies then you can sit on your ass … that’s a good thing.”

The whole idea of not having to do something extraordinary is one all investors should heed, yet it is easy to forget, particularly in stressful situations.

Recommended Reading: ‘Charlie Munger: The Complete Investor’ by Tren Griffin

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Mungerisms: Amusing Quotes from Charlie Munger from the Berkshire Hathaway 2014 Annual Meeting

Amusing Quotes from Charlie Munger from the Berkshire Hathaway 2014 Annual Meeting

Charlie Munger is not always politically correct, always offers a wealth of information, and hilarious now and then. At the 2014 annual meeting of Berkshire Hathaway, here are some of his best zingers:

  • On the interplay between CEOs and corporate directors regarding compensation: “You start paying directors of corporations two or three hundred thousand dollars a year, it creates a daisy chain of reciprocity where they keep raising the CEO and he keeps recommending more pay for the directors.”
  • On CEO pay and work habits: “Does the Supreme Court work less hard because they don’t get paid like corporate executives? We have some corporate directors who draw more pay than members of the Supreme Court. That’s crazy,”
  • 'Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger' by Peter D. Kaufman and Ed Wexler (ISBN 1578645018) On taxing the 1%: “The taxes on wealth were much higher when I was much younger. So for somebody of my age, I don’t think they’re ruining the world because I’ve lived through way more punitive taxes on the rich than we have now … I don’t think everybody who’s been especially favored should take the last dollar that he or she should get. I think we all have an obligation to dampen these fires of envy.”
  • On Facebook, Twitter, and the appeal of social media: “It just doesn’t interest me at all to gab all the time on the Internet with people and I certainly hate the idea of young people putting in permanent form the dumbest thoughts and the dumbest reports of action that you can ever imagine.”
  • On his favorite advance in technology: “I’m in love with the Xerox machine.”
  • On Donald Sterling, the then-owner of NBA Clippers, who then faced racial remarks and lifetime ban:”He’s a peculiar man. He’s past 80. His girlfriend has had so many facelifts she practically can’t smile. This is not the noblest ideal of what the American businessman should be.”

Insightful books about Charlie Munger

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Prem Watsa’s Recommended Books for 2015

Prem Watsa of Fairfax Financial Holdings (Canada)

Legendary investor and philanthropist John Templeton was Prem Watsa’s mentor and was deeply interested in spiritual growth. In the past, Watsa has recurrently recommended Templeton’s “Riches for the Mind and Spirit”, “The Templeton Plan”, and “Discovering Laws of Life”.

Legendary investor and philanthropist John Templeton In the Fairfax Financial Holdings’ annual meetings in previous years, Watsa has also highlighted an inspirational movie called “The Little Red Wagon” that the Templeton Foundation supported. In an interview with online investment community Gurufocus, Watsa previously said,

But I try to be neutral, sometimes more short than long, but that’s John Templeton. So John, one of the key lessons he taught me was to be flexible. His investment philosophy was always value oriented, long term, buy at the point of maximum pessimism, but be flexible in your thinking, and that’s what we try to apply.

Books Recommended by Prem Watsa at Fairfax’s Annual Meeting on 16-Apr-2015

At the annual meeting of shareholders of Fairfax Financial Holdings Limited on 16-Apr-2015 at the Roy Thomson Hall in Toronto, Prem Watsa recommended the following books:

  1. John Templeton’s “Riches for the Mind and Spirit”. Watsa mentioned a quote about giving that he said Fairfax feels very strongly about: “Self-improvement comes mainly from trying to help others.” In speaking of Fairfax’s philanthropic efforts, Watsa also said it’s better to help the receivers grow.
  2. Stephen G. Post’s “Is Ultimate Reality Unlimited Love?” For fifteen years, Post held discussions with John Templeton on the topic of pure unlimited love. The book covers how John Templeton arrived at his philosophy as a youth growing up in Tennessee. This book draws from previously unpublished letters and interviews with physicists, theologians, and other close associates and family of John Templeton.
  3. 'Investing the Templeton Way' by Lauren Templeton, Scott Phillips (ISBN 0071545638) Lauren Templeton and Scott Phillips’s “Investing the Templeton Way”. Lauren Templeton is the grand-niece of John Templeton and Scott Phillips is her husband. Together, they run Chattanooga, Tennessee-based Templeton & Phillips Capital Management. Investing the Templeton Way focuses on the critical role of temperament, and how mastering this element to investing equips the investor to succeed across the span of time and varying market circumstances.
  4. Louis V. Gerstner, Jr.’s “Who Says Elephants Can’t Dance?” This book is an account of IBM’s historic turnaround led by Gerstner during his tenure as chairman and CEO of IBM from April 1993 until March 2002. Gerstner led IBM from the brink of bankruptcy and mainframe obscurity back into the forefront of the technology business.
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Few Professional Investors, Hedge Funds, and Mutual Funds Routinely Beat the Market

Wall Street, New York

Vanguard founder John Bogle, Warren Buffett, Charlie Munger, and many wise people have, with plenty of persuasive evidence, adviced that most people shouldn’t even try to beat the market or attempt to manage their investments actively. Instead, they should just pick low-cost index funds and assemble a balanced and portfolio based on their specific risk profiles and financial goals.

Few professional investors have actually managed to outperform the rising market consistently over those years. A study quoted in the New York Times indicates that perhaps only two mutual fund managers have beat the broad stock market indices: the Hodges Small Cap Fund and the AMG SouthernSun Small Cap Fund.

In other words, if all of the managers of the 2,862 funds hadn’t bothered to try to pick stocks at all—if they had merely flipped coins—they would, as a group, probably have produced better numbers. Instead of two funds at the end of five years, basic probability theory tells us there should have been three. (If you’re curious, I explained how the math works in a subsequent column, “Heads or Tails? Either Way, You Might Beat a Stock Picker.”

Warren Buffet’s The Million-Dollar Bet

In 2008, Warren Buffett bet that over a 10-year period the S&P 500 would outperform a sampling of hedge funds. Buffett’s The Million-Dollar Bet with was New York money manager Protege Partners pits the S&P 500, as represented by the Vanguard 500 Index Fund Admiral Shares, against five funds of hedge funds chosen by Protege Partners, the names of which have never been disclosed. A charity of the winner’s choice will receive $1 million or more at the end of the wager.

Fortune’s Carol Loomis mentions that, during the seven years through the end of 2014, the Vanguard 500 Fund is up 63.5% compared 19.6% for the Protege hedge funds of funds. Not all of the five funds had their final figures for 2014, when the Fortune article was published.

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Warren Buffet’s Big Gig: Capital Allocation

Warren Buffett's Recommended Books on Investing

Most of us know Warren Buffet as perhaps the greatest investor who has ever lived. Thinking about how to invest. But, behind the scenes, he also runs Berkshire Hathaway.

Warren Buffet is the CEO there at Berkshire Hathaway. No doubt, Berkshire owns stocks which Buffett himself purchased. But Berkshire also owns 100% of franchises whole bunch of other businesses. Including household names Diary Queen, Fruit of the Loom, Geico, Netjets, etc.

Warren Buffett started to make his living from investing on the stockmarket in 1951, and was deeply influenced by Ben Graham, who wrote a classic book on investment, “Security Analysis” (1934), and had been his tutor at Columbia University.

Berkshire Hathaway, for much of its long history, was only in the textile business. Using its very modest excess cash flow, Berkshire Hathaway in its present form was created. The morph of Berkshire Hathaway from a sleepy New England company producing men’s suit liners to the present day conglomerate generating more than $100 million of cash a week is one of the best business lessons of our age.

Bill Gates should take a close look at Warren Buffett’s business model at Berkshire Hathaway. Managers at the various Berkshire companies use whatever portion of the cash flow they generate to grow their respective businesses and send the rest to Omaha for Buffett to allocate as he sees fit. Net users of cash (like Executive Jet) get whatever cash they need from Omaha to continue growing their business.

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What is a Circle of Competence?

Twelve Steps to Get Things Done

“The fool doth think he is wise, but the wise man knows himself to be a fool,” said William Shakespeare in “As You Like It.”

Warren Buffett defined the concept of “circle of competence” in his 1996 letter to Berkshire Hathaway shareholders:

“What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”

Socrates Socrates said, “The only true wisdom is to know that you know nothing.” I is easy for people to get tricked into thinking that they know something when they really don’t.

Morgan Housel, a blogger on The Motley Fool said, “Realizing the limits of your intelligence one of the most important skills in finance.” The circle of competence is simply the premise that investors should choose a few well-identified areas in which to focus their investment research efforts. Preferably, such areas of competence should be market segments, industries and businesses that the investors’ skills and experiences are those of the average investor. Successful investors need not have a large circle of competence; they know reasonably well when they are operating outside their areas of unique expertises.

Cornell University psychology professors Dr. David Dunning and Dr. Justin Kruger studied a phenomenon in psychology that has come to be known as the “Dunning-Kruger Effect“: the widespread propensity of poor performers to overestimate their abilities compared with others—and, to a lesser extent, the tendency of high performers to underestimate their abilities.

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