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Rupert Hargreaves
Rupert Hargreaves
Articles (742)  | Author's Website |

Charlie Munger and the Need to Invert

Investing lessons from Buffett's right-hand man

March 08, 2018 | About:

One of the mistakes I think most investors make is trying to look for answers. Not answers about how to invest, but answers as to which stocks are the best to buy.

Rather than doing the hard work themselves, a considerable percentage of investors just copy the positions held by others or find the first recommendation they can in a magazine or online, not bothering to do any research themselves.

I have written plenty of times before about the importance of rigorous due diligence and its process in reducing risk, so this piece is not going to be on that topic. Instead, I want to look at the thought process of one of the world's greatest thinkers and investors, Charlie Munger (Trades, Portfolio).

Munger, the right-hand man of Warren Buffett (Trades, Portfolio), is not known for his investment prowess, so I am willing to bet many people do not consider him an investor at all. (Munger started out running his own investment partnership just like Buffett and also manages the portfolio of the Daily Journal Corp. (NASDAQ:DJCO), so you cannot say he knows nothing about investing).

It is Munger's way of thinking that stands out. He has had a tremendous impact on Buffett's mind and the development of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) over the years, so I believe that listening to his insights is a better guide for investing-- that's adaptable to every investment environment -- than just following the investment advice of Buffett or any other guru.

Buffett has commented on Munger's influence in the past:

"Benjamin Graham taught me to only buy statistically cheap stocks, and Charlie allowed me to change my thinking. That's the real impact Charlie had on me. I needed a powerful force to break the well-entrenched limitations imposed by Graham's theories. Charlie's mindset was that source of power. He expanded my horizons."

One of the most important lessons I believe investors can learn from Munger is the process of inverting. Munger has adopted an approach to solving problems by looking at the problem from the opposite direction. Value investor Li Lu wrote about Munger's unique approach in the foreword to the Chinese version of Munger's memoir, "Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger":

"When Charlie thinks, he always starts by inverting. To understand how to be happy in life, Charlie will study how to make life miserable. To examine how businesses become big, strong and successful, Charlie first studies how businesses decline and fall. When most people care only about how to succeed in the stock market, Charlie is most concerned about why most fail in the stock market. His way of thinking comes from the saying in the Farmer's philosophy: 'All I want to know is where I'm going to die, so I never go there.'"

"Throughout his life, Charlie has been constantly collecting and researching the notable failures in each and every type of person, business, government and academic research. He then arranges the cause of failures into a checklist for making the right decisions. Because of this, he has avoided major mistakes in his decision-making over his life and career. The importance of this on the performance of Buffett and Berkshire Hathaway over the past 50 years cannot be emphasized enough."

When you invest, ultimately, there's very little you can control apart from cost and the price you pay. Often, if something goes wrong, the ordinary shareholders are the last to hear about it. This is where inverting helps. Over the years, thousands of companies have gone out of business for different reasons. Only by considering these reasons and understanding what went wrong can you avoid investing in an industry that may repeat the same mistakes in the future. It is a small lesson to learn to build a process that could potentially save you from making significant mistakes.

Disclosure: The author owns no stocks mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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