Big Mistakes: Charlie Munger

'If you seek big returns, whether they're compressed into a few years or over our investing lifetime, big losses are just part of the deal'

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Jul 01, 2019
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Often overshadowed by his partner, friend and collaborator Warren Buffett (TradesPortfolio), Charlie Munger (Trades, Portfolio) is considered an investing genius in his own right. But he was also an investor who made mistakes during his investing journey.

He is profiled in “Big Mistakes: The Best Investors and Their Worst Investments” because he too went through periods when he performed poorly. In this book by Michael Batnick, the goal was to help individual investors cope with their losses and to understand that losing is an inherent part of investing.

To emphasize that point, he led off the chapter with one of Munger’s pieces of advice: “You need patience, discipline, and an ability to take losses without going crazy.”

The author followed up with brief histories of the three most successful companies in the past two decades: Amazon (AMZN, Financial), Netflix (NFLX, Financial) and Alphabet (GOOG, Financial)(GOOGL, Financial). Almost all of us look at them and wistfully wish we had bought them when they were young and relatively inexpensive. Yet, each of them had severe pullbacks or drawdowns that scared away many investors who did buy at the right times.

For example, Amazon has averaged an annual compounding rate of 35.5% since its initial public offering in 1997 and altogether is up 38,600%. However, that broad perspective hides the ups and downs of its stock price. On three separate occasions, its share price was cut in half. After the dot-com bust in 2000, it plummeted 95%; if you had invested $1,000 in 1997, your investment would have risen to a high of $54,433 and then collapsed to $3,045. Who wouldn’t be tempted to sell out in disgust?

Munger was never tempted by Amazon, but he was a man of extraordinary discipline. Looking back, he graduated from Harvard Law School in 1948 and followed his father into a law career. Part of his practice involved real estate development projects, which Batnick reported brought in his first million dollars. That triggered an interest and passion for investing.

In 1959, he was introduced to Buffett by a mutual friend. That friend, Ed Davis, an investor in Buffett’s first fund, said he found the pair exceptionally alike. Munger and Buffett took to each other immediately and became close friends. So it was no surprise when Munger set up his own hedge fund, Wheeler, Munger & Co., in 1962. Three years later, Munger gave up his law practice to become a full-time investor.

He was an immediate success. Wheeler, Munger & Co. generated an average annual return of 37.1% (before fees) from 1962 to 1969. Underlining that success was the difficulty of investing during those eight years; the S&P 500 gained only 6.6% in the same period. His fund was in operation for 14 years and his returns averaged 24%, while the S&P averaged 6.6%.

All very good, but did investors stick with Munger as they did or not stick with Amazon? It would have been difficult to hold for the long term with him. Buffett said of his friend, “He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with results shown.”

Concentrate he did. At one point, near the end of 1974, Blue Chip Stamps made up 61% of the fund’s portfolio. When the worst bear market since 1929 hit, the company was crushed. Munger wrote, “As for the original business of Blue Chip Stamps: ‘I presided over a reduction in trading stamp sales from over $120 million down to less than $100,000. So I presided over a failure of 99.99 percent.’”

Blue Chip Stamps would recover and go on to purchase See’s Candies, the Buffalo Evening News and Wesco Financial. And, after two years with losses of more than 30%, the fund recovered and returned 73.2% in 1975 (later, it was merged in Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)).

Munger also lost an important investor in his hedge fund and, according to Batnick, the whole episode left him feeling mentally and emotionally depleted. He subsequently liquidated the partnership. Later, he would go on to more investment glories with other vehicles, including Wesco and Berkshire.

Batnick observed, “The takeaway for mere mortals like you and me is that if you seek big returns, whether they're compressed into a few years or over our investing lifetime, big losses are just part of the deal.”

He added that there are two types of losses. First, absolute losses show how an investment worked out on its own. In Munger’s case, there was the Blue Chip loss while managing his own hedge fund. Later, as a co-manager of Berkshire, he would experience six separate drawdowns of at least 20%. In other words, the stock made six separate all-time highs, only to see them subsequently fall 20% or more.

Relative losses refer to what you might have earned had you invested in another asset. For example, Buffett and Munger did not buy into the dot-com boom and their results suffered for a couple of years. Berkshire shares gave up 49% of their value, while the Nasdaq 100 gained 270%.

That situation later reversed itself and showed that Berkshire was better run than most investment management firms. However, Buffett was concerned, “Relative results are what concern us: Over time, bad relative numbers will produce unsatisfactory absolute results.”

Munger wrote, “Warren and I aren't prodigies. We can't play chess blindfolded or be concert pianists. But the results are prodigious, because we have a temperamental advantage that more than compensates for a lack of IQ points.”

And Batnick touched on temperament as he concluded the chapter:

“You must react to losses with equanimity. The time to sell an investment is not after it has declined in price. If this how you invest, you're destined for a long life of disappointing returns. Learn from one of the best whoever did it, and do not attempt to avoid losses. It cannot be done. Instead, focus on making sure that you're not putting yourself in a position of being a forced seller. If you know that stocks have gotten cut in half before, and undoubtedly will again in the future, make sure you don't own more than you're comfortable with.”

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

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