Darren Sits Down with Charlie Munger

Charlie Munger’s partner in running Berkshire Hathaway for the past five decades, Warren Buffett, compares Munger to Benjamin Franklin and says he has the quickest and sharpest mind of anyone he knows. Bill Gates, a Berkshire Hathaway board member and longtime friend of Buffett and Munger, says Charlie is “truly the broadest thinker I have ever encountered.”

It should be no surprise that Munger is a learning machine, “a book with two legs sticking out,” as his children and grandchildren see him. “I met the towering intellectuals in books,” he says, and he did so at an early age. “I can’t remember when I first read Ben Franklin. I had Thomas Jefferson over my bed at seven or eight. My family was into all that stuff, getting ahead through discipline, knowledge, and self-control.”

Given Charlie’s own towering intellect (and experience, among other things, as a master investor, philosopher, and philanthropist) we were excited when our Darren Pollock had the good fortune to spend an evening with him last quarter. Charlie was at his best – generous with his knowledge and quick with his wit. What follows is a selection of topics they discussed, with quotes from the evening (as best they were remembered), interwoven with more of our favorite Munger wisdom that he has offered over the years. Consider it an incomplete tribute to an intellectual hero of ours as he turns 93 years young.

On Holding Cash

Darren and Charlie talked immediately about portfolio management and Darren expressed Cheviot’s desire to hold a considerable amount of money market funds for our clients given the historically elevated levels of not just the prices for stocks but also bonds and real estate. Charlie’s eyes seemed to twinkle:

“That’s right, you should hold a lot of cash! People don’t understand the wisdom of that let alone the value of it. Does anyone complain about that? Actually, I know they must. I hope you tell them to find something else to worry about!” And he laughed. It reminded us of when he previously said, “There are worse situations than drowning in cash and sitting, sitting, sitting… It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”

“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene [at birth], you’ve got to work very hard to overcome that.” It takes considerable time and much study to determine which companies to buy. And successful investing requires discipline to wait for those companies to be priced right for purchase. To Munger, the investor needs “this crazy combination of gumption and patience, and then being ready to pounce when the opportunity presents itself, because in this world opportunities just don’t last very long.”

On Portfolio Diversification

Early in the conversation, Charlie wanted to know how many different stocks we own for our clients. The answer must have proven sufficiently low as Munger referred to it as “very sensible” and then spent a few moments dismantling the idea that diversification is appropriate. From a prior speech, Charlie said, “The idea of excessive diversification is madness… a person with almost all wealth invested long-term in just three fine domestic corporations is securely rich. And why should such an owner care if at any time most other investors are faring somewhat better or worse?”

“I think it can be a rational choice, in some situations, for a family or a foundation to remain 90% concentrated in one equity. Indeed, I hope the Mungers follow roughly this course… Ben Franklin required just such an investment practice for the charitable endowment created by his will. Why not thus imitate Ben Franklin? After all, old Ben was very effective in doing public good. And he was a pretty good investor, too.”

“Our culture is very old-fashioned, like Ben Franklin’s or Andrew Carnegie’s… A lot of the businesses we buy are kind of cranky and old-fashioned like us… Berkshire is full of people who have a peculiar passion for their own business. I would argue passion is more important than brain power. [That’s easy for someone with Charlie’s brain power to say!]… We are more disaster-resistant than most other places.”

“For many of our shareholders, our stock is all they own, and we’re acutely aware of that. Our culture of conservatism runs pretty deep… I’m happy having 99% of my net worth in Berkshire stock. We’re going to try to compound it at a reasonable rate without taking unreasonable risk or using leverage.”

On Berkshire Hathaway

As Charlie told Darren:

“Berkshire is vastly underappreciated for how great it is. Are the companies owned by Berkshire better, the same, or worse than the average publicly traded company? I can answer that: they are of far better quality. Can they grow faster and earn higher returns on capital than other companies the same size? Absolutely they can. So you have this business [Berkshire] of much better businesses that can grow for a long time. And I would argue that even the larger businesses can grow faster than many other large businesses that Berkshire does not own. Berkshire’s utility business is protected and has so many opportunities for future investment. That’s something that will grow for a very long time. Then think about Burlington Northern. There’s really no risk to the railroads. They may have an off year, but there’s no risk of failure. Berkshire is simply loaded with businesses where there is little risk because they are such better businesses.”

Warren and Charlie grew Berkshire at an astonishingly brisk pace in the 1970s, 80s and 90s. Today’s Berkshire, due to its larger size, cannot grow as rapidly as it did in prior decades. “That [rate of growth] will never happen again,” Charlie said. “So some people know this and will sell their Berkshire shares. They don’t know what they’re doing! Berkshire will still grow for a very long time because it is a collection of better businesses than you can buy elsewhere.”

Charlie reiterated several times that “the culture at Berkshire is not going to change.” As he has said elsewhere, “Berkshire is drowning in money. We have great businesses pounding out money. If the stock went down, Berkshire could buy it back. There’s no reason to think it will go to hell in a bucket, and I think there’s reason to believe it could go quite well. I’d be horrified it isn’t bigger and better over time, even after Warren dies.”

“If anyone would have a reason to worry, it would be me [by virtue of his and his family’s large and concentrated stake in Berkshire shares]. But having known the Buffett family for decades, I say to you, ‘Don’t worry about it.’”

On the Financial Disservice Industry

Munger disdains Wall Street’s orthodoxy not just as it pertains to diversification but to several other concepts that strike him as ludicrous. The Efficient Market Hypothesis and Modern Portfolio Theory[i] are two ideas that are easy for investment advisors to sell to individuals.

“I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, ‘My god, they’re purple and green. Do fish really take these lures?’ And he said, ‘Mister, I don’t sell to fish.’”

As for sales practices, Darren and Charlie discussed the Wells Fargo scandal. Munger has said before, “Show me the incentive and I will show you the outcome.” This can be applied to the improper practices at Wells Fargo. Charlie referred to the behavior of the Wells Fargo employees several times as “stupid” and he appeared somewhat dismayed.[ii]

Darren asked if Warren was disappointed, if not angry, about the fiasco. Charlie swatted away the notion: “Warren does not get angry. He just doesn’t. It’s not that he isn’t capable of it, it’s that he’s seen everything so many times before that he isn’t surprised by anything. His expectations are appropriately set so when someone does what someone will inevitably do, then he has no reason to be surprised.”

Last quarter, Buffett stated, “The former [Wells Fargo] CEO created an incentive system with perverse consequences. [Once the bad behavior began,] He should have acted quickly [to stop it] but he did not.”

Know the Boundary of Your Knowledge

Both Buffett and Munger speak frequently about the advantage of knowing one’s limitations. “If you have competence, know the edge. It wouldn’t be a competency if you didn’t know where the boundaries lie… There are a lot of things we pass on. We have three baskets [on our desks]: in, out, and too tough…We have to have a special insight, or we’ll put it in the ‘too tough’ basket.”

“Confucius said that real knowledge is knowing the extent of one’s ignorance. Aristotle and Socrates said the same thing. Is it a skill that can be taught or learned? It probably can, if you have enough of a stake riding on the outcome… Knowing what you don’t know is more useful than being brilliant.”

And one should not try to fake their way through this. Though there is this enjoyable story told by Charlie:

“There’s a famous story about [the physicist] Max Planck which is apocryphal: After he won his [Nobel] prize, he was invited to lecture everywhere, and he had this chauffeur that drove him around to give public lectures all through Germany. And the chauffeur memorized the lecture, and so one day he said, ‘Gee Professor Planck, why don’t you let me try it as we switch places?’ And so he got up and gave the lecture. At the end of it some physicist stood up and posed a question of extreme difficulty. But the chauffeur was up to it. ‘Well,’ he said, ‘I’m surprised that a citizen of an advanced city like Munich is asking so elementary a question, so I’m going to ask my chauffeur to respond.’”

“In this world,” concludes Munger, “we have two kinds of knowledge. One is Planck knowledge, the people who really know. They’ve paid the dues, they have the aptitude. And then we’ve got chauffeur knowledge. They have learned the talk. They may have a big head of hair, they may have fine temper in the voice, they’ll make a hell of an impression. But in the end, all they have is chauffeur knowledge. I think I’ve just described practically every politician in the United States.” And, we believe, countless professionals in the financial services industry.

On Lifelong Learning

Munger’s successful formula since childhood has been simple: to learn as much as possible. “I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.”

To be a successful investor, vast knowledge and awareness of its boundaries must be paired with the proper mindset. “You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy.” Munger pulls no punches: “If you stay rational yourself, the stupidity of the world helps you.” Charlie admits that finance is “a hard subject to be rational about.” But, “there is nothing wrong with keeping your head when all about you are losing theirs – Kipling was right.”

As he told Darren about Warren: “Remember, he’s lived a very successful life as a result of the stupidity of others.”

On the Future Economic Environment

Though opportunities to capitalize on misbehavior in markets will continue to exist over time, Munger is less sanguine on the future prospects for the U.S. economy. In this way, he differs from his partner, Buffett. He told Darren:

“In time, life will get tougher in the U.S. Future generations will probably have a more difficult time than we’ve seen in the past. Our economic future will be much more difficult. It will be harder to make money.” Charlie’s solution? “You would be very smart not to acquire large spending habits. Other people, too!”

As he has previously said, “One of the great defenses if you’re worried about inflation is not to have a lot of silly needs in your life. You don’t need a lot of material goods.”

“There once was a man who became the most famous composer in the world but was utterly miserable most of the time, and one of the reasons was because he always overspent his income. That was Mozart. If Mozart can’t get by with this kind of asinine conduct, I don’t think you should try.”

Live a Good Life: Be Good to Others

A young shareholder at Berkshire’s annual meeting once asked him how they could follow in his footsteps, with an emphasis on generating the wealth that Charlie has earned during his lifetime. Munger said the following:

“We get these questions a lot from the enterprising young. It’s a very intelligent question: You look at some old guy who’s rich and you ask, ‘How can I become like you, except faster?’ Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts… Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve.”

Charlie may even believe that our capitalist system has provided him with more than he deserves. “To the extent that all I’ve done is pick stocks that have gone up and sat on my [behind] as my family got richer, I haven’t left much contribution to society. I guess it’s a lot like Wall Street. The difference is, I feel ashamed of it. I try to make up for it with philanthropy.”

Munger’s philanthropic efforts have and will continue to be immense. Among a variety of others, he is known to support hospitals, women’s rights, and educational institutions.

“You don’t want to be like the motion picture executive who had many people at his funeral, but they were there just to make sure he was dead. Or how about the guy who, at his funeral, the priest said, ‘Won’t anyone stand up and say anything nice about the deceased?’ and finally someone said, ‘Well, his brother was worse.’”

So how does Charlie want to be remembered?

“I like to ask Warren what he wants to be remembered as, and he says a teacher. Who else in America who is a CEO says he wants to be remembered as a teacher? I like it.”

“I wouldn’t mind being remembered as a teacher, but I won’t be. I may be remembered as a wise ass!”

 

DISCLAIMER: The above article is not a recommendation to purchase or to hold an investment in any securities of Berkshire Hathaway. It should not be assumed that any investment in Berkshire Hathaway will prove profitable. Charles Munger is the long-time Vice Chairman of Berkshire Hathaway. His comments may include forward-looking statements and his statements are not guarantees of future performance. Mr. Munger’s comments represent his own opinion and are for informational and educational purposes only.

 

[i] “EMH” states that market prices accurately reflect underlying value, therefore there is no advantage that can be gained through the value investing approach; “MPT” is another hypothesis proposing that portfolio returns can be optimized according to the correlation among assets within the portfolio.

[ii] Berkshire Hathaway is the larger shareholder of Wells Fargo. Employees were paid commissions to open new accounts – and had no authorization to open more than two million of them. Wells Fargo will pay a fine of $185 million and incur “tens of millions” of dollars’ worth of costs to improve the company’s procedures and try to restore its reputation.


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