"Damn Right" Book Review:
March 16, 2001
Charlie Munger: Berkshire's other half
Joe Dancy, Co-Editor of the Internet Financial Connection, provides the following book review. Below is the write-up.
Numerous books have been written on Warren Buffett and his investment philosophy, but until recently few journalists had focused on Buffett's lawyer and investment partner, Charlie Munger. Munger played a key role in building Berkshire Hathaway and provided a significant influence on Buffett's investment theory and strategy.
Volatility not a concern: ignoring beta
According to Janet Lowe, author of a new book on Munger's career entitled Damn Right!, volatility does not bother him. Lowe notes that Munger had no problem focusing on a few good investment ideas, concentrating his portfolio in these ideas and letting the long-term growth of these firms compound his returns.
Munger maintains that if you can't afford to have the value of your stock decline by 50 percent you probably shouldn't be in the market. Longer term, he claims investors should position themselves so that regardless of what happens to the market they can "stay in the game" by limiting downside losses.
Both Munger and Buffett ignore beta -- the measure professional investors use to gauge volatility and hence "risk" -- preferring to focus instead on the risk/reward relationship of the business over the longer term. "Volatility over time will take care of itself" according to Munger, provided favorable odds exist that the business will grow.
In addition to his law practice and the real estate activities that Munger was involved with early in his career, he also owned an investment partnership named Wheeler, Munger & Company. The company was set up as a classic hedge fund, similar to those that became popular in the 1990s, but the returns were very volatile.
For example, during the market decline in the early 1970s, an investment of $1,000 made in the partnership on January 1, 1973, would have been worth only $467 two years later. And although Munger was not concerned because he knew longer-term value would surface, reporting temporary losses to his investors was painful.
Munger's ten rules for investment success
Several themes appear in the book that help explain Munger's incredible success accumulating wealth as an investor:
1. Live below your means. Munger notes that it is very important to consistently underspend your income, especially when starting a career, investing the excess funds wisely. According to Munger, the most difficult part of building wealth is "accumulating the first $100,000 from a standing start, with no seed money." Making the first million is the next big hurdle.
2. Understand your risk tolerance. Every investor has to know the level of risk that they can comfortably assume. Since losses are inevitable -- and the book discusses numerous mistakes made by both Munger and Buffett -- each investor must adopt a strategy that fits his or her risk profile. Since recent behavioral finance studies indicate that losses are three times as painful as gains for most investors, many investors may want to adopt a relatively conservative strategy.
3. Research opportunities. Investors must be able to process a massive amount of information effectively, and must learn to evaluate the risks and rewards of potential investments. Business magazines are a great resource for evaluating trends, and Munger notes that "I don't think you can get to be a really good investor. . . without doing a massive amount of reading."
4. Invest for the long term. Volatility has not been a major concern of Munger, provided the long-term odds of success are in his favor. In fact, volatility can allow an investor to accumulate positions in a viable enterprise at prices below intrinsic value. A long-term focus is essential when ignoring the volatility of markets and individual stocks and can provide impressive gains that tend to compound over time.
5. Funds are no substitute. Americans are oversold on the benefit they receive from money managers, especially mutual fund managers, and that bothers Munger enormously. Transaction costs, taxes and fees can significantly reduce total returns. Munger advocates buying index funds, or alternatively buying high-quality stocks that are not overvalued and holding for the long term.
6. Patience, coupled with decisive action. Excellent investment opportunities are not common. Investors should continually search and evaluate opportunities. Utmost patience is required until one is found that has extremely favorable odds of success. "People underrate the importance of a few simple big ideas," says Munger. Extreme decisiveness, once the commitment is made, dramatically improves financial results over a lifetime.
7. Tax planning. Taxes and tax planning play a major role in wealth accumulation. As a lawyer drawing an income, Munger was subject to relatively high income tax rates, significantly above what he paid on capital gains, which reduces the ability to build wealth. The recognition of any capital gains on investments can often be delayed or offset by investment losses, thus allowing the investment to compound at an accelerated rate.
8. Love the process. Because investors must initially be willing to live below their means, have the skills to conduct a massive amount of due diligence, exhibit patience, read voraciously, manage risk effectively, and make decisive actions when the odds are in their favor, an investor must love the evaluation and investment process since it is not without a massive amount of work.
9. Pay a reasonable price. Although value is important, investors should buy good businesses that are in sectors that exhibit favorable business characteristics. Management can only do so much with a company in a declining industry. Good businesses will grow in value over time.
10. Choose good partners. Every investor relies on the advice of others in making investment decisions, whether those are investment advisors, brokers, newsletters or business partners. Munger was fortunate to have selected some of the best partners available to assist in evaluating investment issues. Successful investors will have top-quality investment partners.
Well worth reading
Damn Right! is well worth reading. It contains little advice or insight on stock selection techniques that is contained in some of the recent books on Warren Buffett. But the investment lessons documented by the author, as well as Munger's philosophy, strategy, failures, and evaluation process, can serve as a valuable tool for today's investor. |
