When it comes to investment theory, no one knows the subject better than Charlie Munger (Trades, Portfolio), the vice chairman of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and Warren Buffett (Trades, Portfolio)'s right-hand man.
Over the years, Munger has issued pages of advice on how investors can improve their investing experience by bettering themselves. He has also talked on many occasions about the process of finding high-quality businesses as well as effectively managing portfolios.
Avoid forecasters
Advice on how to avoid making mistakes both in investing and in life is another area of expertise for Munger. He is particularly wary of investment forecasts and believes it is nonsensical to place too much emphasis on forecasts because, more often than not, they are wrong.
Investors should try and avoid forecasters as taking their advice may only lead to trouble. As Munger once said:
"People have always had this craving to have someone tell them the future. Long ago, kings would hire people to read sheep guts. There’s always been a market for people who pretend to know the future. Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts."
To put it another way, someone will always be willing to tell you what you want to hear, for a price.
Crowd folly
Munger is also highly aware that in many situations, humans tend to seek comfort in large numbers. This "crowd folly," as Munger labeled it, can push usually sensible investors to make foolish decisions just because they want to be part of the crowd.
It is essential to try and remove this bias from your thinking -- after all, how do you expect to outperform if you are doing the same thing as everyone else:
"'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."
Naturally optimistic
Another human bias that can cause investors to make stupid decisions is an excess of optimism. Most people are too optimistic and fail to consider worst-case scenarios before investing, which can lead to disaster if you have not considered both the bull and bear arguments for a particular investment.
"The Greek orator was clearly right about an excess of optimism being the normal human condition, even when pain or the threat of pain is absent. Witness happy people buying lottery tickets or believing that credit-furnishing, delivery-making grocery stores were going to displace a great many superefficient cash-and-carry supermarkets."
Business is not a science
Munger also believes business is not a science, it is an art form. He does not believe in scientific formulas such as beta and modern portfolio theory. Instead, he is quite happy to place his trust in high-quality businesses with sustainable competitive advantages, acquired at a low price. Indeed, he once said:
"Beta and modern portfolio theory and the like— none of it makes any sense to me. We’re trying to buy businesses with sustainable competitive advantages at a low, or even a fair, price. How can professors spread this [nonsense that a stock’s volatility is a measure of risk]?"
Don't believe the synergy
Munger has also warned investors not to take managers' promises of synergies to be achieved from deals too seriously. Both Buffett and Munger believe most business deals end up wasting shareholders' capital, and only benefit investment bankers, who are able to pocket fat fees.
Don't believe the hype, he warned investors. Managers, just like everyday investors, are generally overly optimistic when it comes to discussing potential deals. More often than not, these promised synergies fail to materialize:
"The reason we avoid the word 'synergy' is because people generally claim more synergistic benefits than will come. Yes, it exists, but there are so many false promises. Berkshire is full of synergies— we don’t avoid synergies, just claims of synergies."
Disclosure: The author owns shares of Berkshire Hathaway.
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