Charlie Munger (Trades, Portfolio) may keep a lower public profile than his famous business partner, Warren Buffett (Trades, Portfolio), but he is no less insightful when it comes to the study and practice of investing. Indeed, as a key architect of Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) vaunted investment strategy, he clearly knows what he is talking about.
While Munger has offered countless valuable lessons on a multitude of investment topics, he has been consistent regarding one point: Investors should only invest in companies they really understand.
Stick to what you know
Munger has argued many times that too much complexity can lead to confusion, which tends to result in losses for investors. Investors are better off sticking to what they know, what Munger and Buffett have dubbed a "circle of competence." By investing only within their circles of competence, individuals can leverage their superior understanding to seize opportunities, as Munger told Daily Journal Corp. (DJCO, Financial) shareholders in February 2019:
"The whole trick of the game is to have a few times when you know something is better than average, and invest only where you have that extra knowledge. If that gets you a few opportunities, that's enough."
This idea has been at the heart of Berkshire's strategy for decades. Munger even highlighted it at Berkshire's annual meeting way back in 1999:
"Our game is to find a few intelligent things to do. It's not to stay up on every damn thing that's going on in the whole world."
Investing in what you know can give you an edge, while drifting into unknown industries or sectors can be a recipe for trouble.
Beware temptation
Over the years, Munger has watched a host of industries emerge and grow while others have faded. He has witnessed booms and busts and everything in between. Rather than chasing fads or following momentum, investors are better off focusing on what they understand. Munger helped embed this philosophy into Berkshire's DNA:
"We have three baskets for investing: yes, no, and too tough to understand."
Munger has largely avoided stocks, and even whole industries, that he does not understand, as famously evidenced by Berkshire's historical avoidance of complicated tech stocks. According to Munger, such forbearance is essential to staying out of trouble:
"One of the greatest ways to avoid trouble is to keep it simple."
Discipline yields rich rewards
Berkshire Hathaway is perhaps the greatest living proof of the power of Munger's philosophy of disciplined value investing. The sprawling conglomerate is a true money-making machine. While Berkshire may have missed out on the fat gains that would have come from early investments in the likes of Apple Inc. (AAPL, Financial) or Microsoft Corp. (MSFT, Financial), it has consistently bought solid, profitable businesses. In the long run, that pays.
While it may be hard to avoid temptation, especially when markets are bubbly, yielding to it too often yields bitter fruit. As Munger opined during Berkshire's 2000 annual meeting, the wealth one can accumulate through dedicated application of his investment philosophy ought to be more than sufficient compensation for missing out on big moves in stocks one does not understand:
"Generally, I would say that if you have a lot of lovely wealth in a form that makes you comfortable, and somebody down the street has found a way to make money a lot faster, in a way you don't understand, you should not be made miserable by that process."
Munger's long track record of success is clear proof of the power of disciplined investing. Investors would be wise to heed his advice.
Disclosure: No positions.
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