Charlie Munger is the less visible but equally important half of the Berkshire Hathaway investing brain trust. Recently, the highly-respected investment blog Farnam Street uncovered an old shareholder letter from Berkshire's vice chairman that contains what could be the single most important lesson for non-professional investors.
Mr. Munger writes, "[We] continue to try more to profit from always remembering the obvious than from grasping the esoteric. … 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."
This "Not-Stupid" investment strategy, combined with iron-willed patience and discipline, has been the backbone of the Warren Buffett/Berkshire Hathaway success story.
The Psy-Fi blog, an essential information source on behavioural economics and the ways in which human psychology is terribly ill-suited to investing, developed a Munger-inspired Not-Stupid plan consisting of five investor commandments:
- Firstly, thou shalt use simple decision rules in a complex environment.
- Secondly, thou shalt recognize that ignorance is bliss.
- Thirdly, thou shalt understand that past results are a fragile guide to the future.
- Fourthly, thou shalt appreciate that complex models need huge data sets.
- Fifthly, thou shalt avoid complex rules for they shall cause you to act like a mindless box-ticker.
Berkshire Hathaway follows the first three rules religiously. The company's stock selection method is incredibly simple – buying companies with the most stable long term cash flow growth (not the highest) at times when they trade at a 30 per cent valuation discount to their historical average.
Berkshire Hathaway also avoids making any investing decision based on forecasts of future results. This is an admission of ignorance, an understanding that the future is so unpredictable that it's not worth even trying. The defensive "prepare for anything" aspects of the Berkshire investment strategy – buying only companies with steep valuation discounts and strong competitive advantages – also imply their outlook on the unknowable nature of markets.
The latter two rules are warnings that Warren Buffett and Mr. Munger have heeded, namely about what not to do.
For most investors, the key lesson of Not-Stupid investing is to build a portfolio that will perform reasonably well in any potential future economic or business environment. Admittedly, accepting that picking winners is more a matter of luck than skill over the long term takes a lot of the fun and excitement out of investing.
But although the boring nature of Mr. Buffett and Mr. Munger's management strategy is one of the main reasons why investors find it psychologically difficult to follow, despite its simplicity and obvious success, it's also why most investors underperform.