Tao of Charlie Munger: A Compilation of Quotes from Berkshire Hathaway's Vice Chairman on Life, Business, and the Pursuit of Wealth With Commentary by David Clark

by David Clark

“The desire to get rich fast is pretty dangerous.” – Trying to get rich fast is dangerous because we have to gamble on the short-term price direction of some stock or other asset. There are a huge number of people trying to do the same thing, many of whom are much better informed than we are. The short-term price direction of any security or derivative contract is subject to all kinds of wild price swings due to events that have nothing to do with the actual long-term value of the underlying business or asset. Last but not least, there is the problem of leverage: to get rich quickly, one often has to use leverage/debt to amplify small price swings into really huge gains. If things go against us, they can also turn into really large losses.

“The desire to get rich fast is pretty dangerous.” – Trying to get rich fast is dangerous because we have to gamble on the short-term price direction of some stock or other asset. There are a huge number of people trying to do the same thing, many of whom are much better informed than we are. The short-term price direction of any security or derivative contract is subject to all kinds of wild price swings due to events that have nothing to do with the actual long-term value of the underlying business or asset. Last but not least, there is the problem of leverage: to get rich quickly, one often has to use leverage/debt to amplify small price swings into really huge gains. If things go against us, they can also turn into really large losses.

“Knowing what you don’t know is more useful than being brilliant.” – What Charlie is saying here is that we should become conscious of what we don’t know and use that knowledge to stay away from investing in businesses we don’t understand.

“Knowing what you don’t know is more useful than being brilliant.” – What Charlie is saying here is that we should become conscious of what we don’t know and use that knowledge to stay away from investing in businesses we don’t understand.

“People are trying to be smart—all I am trying to do is not to be idiotic, but it’s harder than most people think.”

“People are trying to be smart—all I am trying to do is not to be idiotic, but it’s harder than most people think.”

“Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand—you must learn to handle mistakes and new facts that change the odds.”

“Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand—you must learn to handle mistakes and new facts that change the odds.”

“My idea of shooting a fish in a barrel is draining the barrel first.”

“My idea of shooting a fish in a barrel is draining the barrel first.”

“Ben Graham had a lot to learn as an investor. His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him. . . . It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.”

“Ben Graham had a lot to learn as an investor. His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him. . . . It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.”

His investment philosophy was designed to make him money and to protect him from losses, but it also stopped him from ever benefiting from the compounding effect that a great business can generate over a period of ten, twenty, or more years.

His investment philosophy was designed to make him money and to protect him from losses, but it also stopped him from ever benefiting from the compounding effect that a great business can generate over a period of ten, twenty, or more years.

“Sit on your ass investing. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.” – This important investment philosophy assumes that one is better off buying a business with exceptional business economics working in its favor and holding it for many years than engaging in a lot of buying and selling, trying to anticipate market trends.

Charlie knows that time is a good friend to a business that has exceptional economics working in its favor, but for a mediocre business time can be a curse.

“Acknowledging what you don’t know is the dawning of wisdom.” – The smarter we get, the more we realize how little we actually do know. By acknowledging what we don’t know, we are putting ourselves into a position to learn more; thus, the dawning of wisdom.

Charlie’s road to all this wisdom began by acknowledging what he didn’t know and then doing something about it.

“In the corporate world, if you have analysts, due diligence, and no horse sense, you’ve just described hell.” – I think what Charlie is saying is that when analysts from a ratings company such as Moody’s Corporation issue a new rating on a bond, while being paid millions by the Wall Street investment bank that requested the rating, we should probably be a little suspicious.

“You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”

Charlie discovered that if we invest in companies that have great economics working in their favor, at a reasonable price, we can bring the number of companies we own down to ten or fewer and still be protected against an unexpected business failure, and have good growth of our portfolio over a ten- to twenty-year period. As the saying goes, too much diversification, and we end up with a zoo. It’s much easier to keep a sharp eye on our basket if there are only ten eggs in it.

“You should remember that good ideas are rare—when the odds are greatly in your favor, bet heavily.”

When are the odds in our favor? When some macroeconomic event causes stock prices to collapse, Charlie buys as much as possible. Remember, in Charlie’s world, as stock prices fall, the odds become more in our favor, provided we invest in companies with good long-term economics working in their favor. When that happens, Charlie recommends that we bet big!

“Mimicking the herd invites regression to the mean.”

“I’ve never been able to predict accurately. I don’t make money predicting accurately. We just tend to get into good businesses and stay there.”

He’s just a man looking for a good business he can buy at a fair price. However, the one thing he can predict is that the stock market will have moments of wild exuberance and high stock prices, usually followed by bouts of severe depression and much lower stock prices. Can he predict with accuracy when these events will happen? No. But he does know they will happen—he just has to have the patience to let them happen.

I would be amiss if I didn’t point out that random recessions/crashes are programed into Charlie’s buying strategy. Both Charlie and Warren let cash pile up, waiting for a recession/crash, even if it means getting low rates of return on their cash holdings as they wait for the inevitable. When the crash hits, they make their purchases.

As Charlie has said many times, it wasn’t brains that made him so rich, it was temperament.

“The way to get rich is to keep $10 million in your checking account in case a good deal comes along.” – Charlie advocates keeping $10 million in cash, and Berkshire keeps $72 billion sitting around in cash, waiting for the right deal to show up. The lousy return their cash balances are getting is a trade-off—poor initial rate of return in exchange for years of high returns from finding excellent businesses selling at a fair price.

This is also something most people get wrong about leverage and having excess cash. They’d rather put all their cash all the time in an asset that will grow a little rather than keep some cash available as margin for (1) mitigating downside or (2) investing heavily when a great opportunity comes your way. Charlie can do this because he has learned to recognize high asymmetric upside in his investments. For most, a margin of safety for downside and an index portfolio that you add to annually is best. It’s another barbell strategy. Don’t spend on most things and keep a cash reserve or bet heavily on the right opportunities— the ones with huge obvious asymmetric upside and a large margin of safety. Nothing in between.

“I succeeded because I have a long attention span.” – Patience is a virtue, and it is also an asset in the investment game. Most people think that means patiently sitting on some investment forever, waiting for its value to go up. In Charlie’s world it also means sitting patiently on a pile of cash waiting for some great business’s stock price to get beaten down. And it means having the patience to stay focused on looking for a great company selling at a fair price.

For Charlie and Warren, the time to buy the “equity bonds” of a wonderful company is when everyone else is trying to sell their Rembrandts.

Value common stocks like bonds, and let everyone else chase demand and selling. Find good businesses and buy them when everyone else is selling—in a buyer’s market.

“I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit earnings.’ ” – EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” Charlie considers interest, depreciation, and taxes to be very real expenses that have to be paid.

“Where you have complexity, by nature you can have fraud and mistakes. . . . This will always be true of financial companies, including ones run by governments. If you want accurate numbers from financial companies, you’re in the wrong world.”

Charlie’s lesson here is that a combination of supersmart people and large amounts of leverage often ends in disaster. I might add that the combination of really dumb people and large amounts of leverage usually ends in disaster as well.

Smart or dumb, avoid or minimize leverage. When used, short term and paid back quickly. Long term leverage is crippling. Overconfidence leads (smart) people to think they can beat the odds and make a big bet doing so for big upside. Maybe that’s true, but the downsides can be terminal.

“I know one guy, he’s extremely smart and a very capable investor. I asked him, ‘What returns do you tell your institutional clients you will earn for them?’ He said, ‘20%.’ I couldn’t believe it, because he knows that’s impossible. But he said, ‘Charlie, if I gave them a lower number, they wouldn’t give me any money to invest!’ ”

If you’ve thought this, ask, “would you want to be the other guy—the investor or the funding agency expecting something and never getting it?” Bad behavior. Unreliable.

“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait.” – Blaise Pascal, the seventeenth-century French mathematician, said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” Charlie agrees. You have to wait for the right company—one with a durable competitive advantage—that is selling at the right price. And when Charlie says wait, he means wait as long as it takes, which can mean years.

“In terms of business mistakes that I’ve seen over a long lifetime, I would say that trying to minimize taxes too much is one of the great standard causes of really dumb mistakes. . . . Anytime somebody offers you a tax shelter from here on in life, my advice would be don’t buy it.”

Hacks don’t work in the long term. Avoid hacks.

“An isolated example that’s very rare is much easier to endure than a perfect sea of misery that never ceases.” – Charlie is talking about the difference between an excellent company, which might confront a major problem a few times in a span of twenty years, compared with a mediocre company, which might go from problem to problem, year after year.

This bit of wisdom is also applicable to our personal lives; it is far easier to endure a brief moment of intense pain than it is to suffer a misery that drags on year after year.

“Favorable surprises are easy to handle. It’s the unfavorable surprises that cause the trouble.” – Prepare for the worst, and hope for the best. It is always wise to be prepared for the worst.

“Move only when you have the advantage—you have to understand the odds and have the discipline to bet only when the odds are in your favor.”

In the late 1960s both Charlie and Warren had their own hedge fund. As the bull market of the late ’60s raged on, everything became overpriced, and Warren, who was still following a Graham approach of buying bargains, could no longer find anything cheap to buy. So rather than alter his investment strategy, Warren shut down his hedge fund and returned the money to his partners, putting the vast majority of his own money into cash equivalents such as US treasuries. Charlie kept on investing, and enjoyed great returns until the stock market crash of 1973–74, when he lost nearly half of his partners’ money. He called it the worst time in his life. Warren, who was sitting on a huge amount of cash because everything running up to the crash had been overpriced, suddenly found himself surrounded by dozens of wonderful companies selling at bargain prices. Because Warren was awash in cash, he could buy them. Because Charlie didn’t have any cash, he couldn’t buy them. When the stock market recovered, Charlie’s investments recovered and he regained his partners’ losses. But the experience so shattered him that he shut down his fund. What did Charlie learn from all that? He learned that as stock prices rise, the odds start going against investors. And when prices fall, the odds start turning in investors’ favor. He also learned that if he stays fully invested in the market as it rises, he won’t have any cash to invest with when the market crashes. It doesn’t matter how good the odds ar...

“If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation of 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.”

Is the idea built to flip—short term value only if acted on soon and before conditions change—or, is it built to last—upside with an enduring moat that can continue to be improved over time?

The old Benjamin Graham method of buying undervalued stocks required an investor to set a valuation on a company and then, when the company reaches that valuation, sell it. This approach fails because it requires us to sell not only mediocre companies as they approach their valuation but also great businesses that have a durable competitive advantage, thus killing all opportunity to profit from the expansion of the underlying value of a business that occurs over time. Charlie and Warren’s theory is that a company with a durable competitive advantage has business economics that will expand the underlying value of the business over time, and the more time passes, the more the company’s value will expand. Thus, once the purchase is made, it is wisest to sit on the investment as long as possible, because the longer we own the company, the more it grows in value, and the more it grows in value, the richer we become.

“View a stock as an ownership of the business and judge the staying quality of the business in terms of its competitive advantage.”

Finding a business with a durable competitive advantage means determining whether it has staying power. If we are going to buy and hold a company for twenty years, we don’t want the product it is selling to become obsolete in year five.

When it comes to the truly great businesses, time is almost always on the investor’s side.

“I think that one should recognize reality even when one doesn’t like it; indeed, especially when one doesn’t like it.” – The reality that Charlie is talking about here is when a much-loved investment enters a new realm of economic reality—which means that over time the underlying economics of the company have changed so much that the once great business is no longer such a wonderful enterprise.

Most reinsurance companies don’t accept this reality and just keep selling reinsurance policies—even when it means they will make very little money off them. Berkshire, on the other hand, just flat out stops selling reinsurance, and will wait till prices rise again before getting back into the game. As a result Berkshire has become one of the largest and most profitable reinsurance operations in the world today.

“It is 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 folk saying: ‘It’s the strong swimmers who drown.’ ” – Strong swimmers are the ones who swim way out and potentially get themselves in trouble. Weaker swimmers stay close to shore, where it is safe.