Charlie Munger: How to Keep a Cool Head in Bubbling Markets

Some thoughts from Munger on how to remain calm

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Jan 21, 2020
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The past decade has seen one of the longest and strongest bull markets in history.
In this environment, it is very easy for us investors to get caught up in the moment and overlook critical details. It is easy to make sloppy mistakes, as even bad companies can be profitable in a bull market.

Just because you are earning money does not necessarily mean that you are using the right strategy in a market where are even unprofitable companies that are eating up shareholder capital attract sector-leading valuations.

Keeping a cool head in these markets is vital for long-term investing success. Making a mistake now could cost you dearly when the decline eventually comes. However, adopting a defensive posture in a bull market comes with a big disadvantage; underperformance.

Investment experience

Two investors who have more experience than almost anyone else on this subject are

Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio).

These two billionaires have been investing in the stock market for around seven decades. Over this time, they've seen numerous bull markets and bear markets, and their investment strategies have remained relatively constant.

Munger, in particular, has become an authority on patient investing. He has often spoken about how important it is to stick to your strategy and not be sidetracked by other investors who appear to be making buckets of money using simple strategies.

Poor Charlie's Almanack

"Poor Charlie's Almanack" contains plenty of advice on this topic. Munger has been particularly vocal about the impact of irrational human behavior on stock prices:

"My foregoing acceptance of the possibility that stock value in aggregate can become irrationally high is contrary to the hard-form "efficient market" theory that many of you once learned as gospel from your mistaken professors of yore. Your mistaken professors were too much influenced by "rational man" models of human behavior from economics and too little by "foolish man" models from psychology and real-world experience. "Crowd folly," the tendency of humans, under some circumstances, to resemble lemmings, explains much foolish thinking of brilliant men and much foolish behavior - like investment management practices of many foundations represented here today. It is sad that today each institutional investor apparently fears most of all that its investment practices will be different from practices of the rest of the crowd."

He has also warned investors to remain alert to "febezzlers," which are, simply put, investment managers who received a higher income in bull markets for doing little extra work.

The investor is happy to pay the additional cost because rising stock prices camouflage the charges:

"You people, I think, have created a lot of "febezzle" through your foolish investment management practices in dealing with your large holdings of common stock.

If a foundation, or other investor, wastes three percent of assets per year in unnecessary, nonproductive investment costs in managing a strongly rising stock portfolio, it still feels richer, despite the waste, while the people getting the wasted three percent, "febezzlers" though they are, think they are virtuously earning income."

There are two primary lessons we can take away from these statements. For a start, it is always sensible to remember that stock prices are driven by human emotion more than rational pricing behavior — i.e. careful calculation of intrinsic value and buying at a discount.

Secondly, no matter how much money you are making in your investment portfolio, it is always sensible to keep an eye on the little things, such as investment costs and investment management fees. This applies to all sections of life as well as portfolio management. Keeping an eye on costs and not paying more for a good or service that you might be able to get cheaper elsewhere is a critical part of wealth creation.

Disclosure: The author owns no share mentioned.

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