Charlie Munger: The Pragmatic Investor Who Knows How to Create Wealth

Last Updated June 26th 2019
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Trading Education is sharing with you the inspiring story of billionaire investor Charlie Munger and the lessons you can learn from his investing principles and mental models.

Although Warren Buffett is the man usually in the spotlight when it comes to the investment success of Berkshire Hathaway, much of the success should be attributed to his colleague Charlie Munger, the vice chairman of the firm.

Who is Charlie Munger?

Charlie Munger

Image: www.valueresearchonline.com

Charlie Munger is Warren Buffett's right-hand man. Alongside his commitments to Berkshire Hathaway, he is the chairman of the Daily Journal Corporation in Los Angeles and director of the Costco Wholesale Corporation. In February 2018, Forbes estimated Munger's net worth to be roughly $1.74 billion.

The early life of Charlie Munger

Both Buffett and Munger are from Nebraska, where Charlie was born in Omaha in 1924. Munger worked at a local food shop as a teenager, which was owned by Warren Buffett's grandfather.

Munger then began his higher education at the University of Michigan, where he was studying for a degree in mathematics. But, just after his 19th birthday Munger left university to serve in the U.S. Army Air Corps. Munger was one of only a few soldiers to be commissioned as an officer without holding a degree.

Following his service, Munger completed several advanced courses through a variety of universities, even entering Harvard Law School without an undergraduate degree where he graduated magna cum laude in 1948.

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The early career of Charlie Munger

In 1962, Munger founded the real estate law firm Munger, Tolles & Olson, which is still a renowned practice today. Although, investing was never far from his mind, as between 1962 and 1975 he ran his own investment partnership, which generated compound annual returns of 19.8 per cent over this period. Munger and Buffett met at an early stage within their investment careers in 1959, with the friendship gradually developing into an investment relationship.

The relationship between Charlie Munger and Warren Buffett

Charlie Munger and Warren Buffett Image: www.cnbc.com

The budding friendship between the pair led to Munger leaving a successful career in law, to join forces with Buffett to run Berkshire Hathaway BRK.B.

The pair have been working together for a number of years and have established a great rapport, between both themselves and the shareholders. Buffett is known for his useful insight, while Munger uses his quick wit to bring a touch of humour to the annual meetings. A brilliant example from 2005 is shared by Morningstar, when the pair were discussing the compensation of a variety of board directors.

Buffett was describing how after being a part of 19 boards he has never seen fees as an issue concerning a CEO's compensation, with compensation committees acting like Chihuahuas, rather than Great Danes or Dobermans. Buffett then showed a little concern by explaining that he was worried about insulting any friends who may be present on a compensation committee, to which Munger replied with the witty comment "You're insulting the dogs".

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Munger's investment philosophy

Munger is known for being an investor of strong businesses with a variety of competitive advantages. In his multiple speeches, Munger introduced the concept of elementary, worldly wisdom and its relationship to business and finance.

Munger believes that any business which relies on trickery is destined for failure, a good business should be an ethical business. Munger uses great levels of knowledge and business ethics within his investing principles, where he purchases undervalued stocks based on their business quality, rather than just focusing on how cheap they are.

Lessons we can learn from Munger

How budding investors should gain worldly wisdom to achieve success when it comes to picking stocks? Munger believes the key lies in understanding a variety of subjects, rather than limiting investments to a few narrow topics. By improving levels of knowledge, investors begin to understand the economics of multiple industries and stay focused on long-term success, where others fail due to short-sightedness.

Constant Renewal describes Munger's approach to investment as rather unique when compared to most top executives. Although he holds a similar educational background, he doesn't share any radical new philosophies or promises to change the world. Instead, he maintains a low profile and adheres to a simple philosophy, to avoid stupidity rather than trying to be very intelligent.

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Understanding your competencies

Munger doesn't encourage others to seek out brilliance, instead, he believes we should avoid making mistakes. Both Munger and Buffett follow the same rule, which they call the 'circle of competence', which describes how each person should stick to their area of knowledge. For example, neither Munger or Buffett invested in Google or Amazon, as technology is out of their circle of competence.

According to this theory, we are all amateurs once we step outside our circle of confidence, but many of us do not have the humility to admit it. Munger believes that to stay ahead, investments should be made conservatively to outlast the competition. Expectation management is also an integral part of any investment.

The power of mental models

Charlie Munger investing principles

Despite never taking a course in anything relating to investment, Munger has still thrived in his career. Munger has used his levels of knowledge to build a latticework of powerful mental models. The complexity of the world around us can be difficult to understand with its thousands of variables, making every investment situation impossible to predict. By continually striving to improve our knowledge and challenging ideas, it is possible to build new mental models, which we can rely upon to provide a framework to approach a problem with both caution and insight.

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Sources:

[1] https://www.investopedia.com/terms/c/charlie-munger.asp

[2] https://constantrenewal.com/avoiding-stupidity/

[3] http://news.morningstar.com/classroom2/course.asp?docId=145665&page=2

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