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Financial Literacy

Charlie Munger’s Checklist for Investing

  • Even though he plays “second fiddle” to Warren Buffett, billionaire Charlie Munger is a compelling character with a lot to teach investors.
  • Today, Nicholas Vardy shares some of Munger’s wisdom on how to grow your wealth.

I recently revisited one of my favorite figures in the world of investing: Charlie Munger.

Munger may be the vice chairman of Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B), but he does not have the high profile of his lifelong investment partner.

Still, even Buffett is quick to admit that Munger is the far more compelling character. And once you read what Munger has to say, it’s hard to disagree with Buffett’s self-deprecating assessment.

Like Buffett, Munger has never penned a book. Instead, he has poured his wisdom into various speeches over the decades.

Luckily, die-hard Munger fans compiled his scattered works in one of the most remarkable investment books out there: Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger.

The Remarkable Mind of Munger

Buffett has called Munger “the best 30-second mind in the world,” stating, “He goes from A to Z in one move. He sees the essence of everything before you even finish the sentence.”

What’s Munger’s secret?

He has spent his life studying the best ideas across a wide range of disciplines.

This deliberate practice helped Munger identify a set of “mental models.” Munger reckons that if you understand about 80 or 90 of these models, you’ll know enough to have the world figured out.

Munger’s advice is to be a “learning machine.” All investors need to learn and relearn basic principles. And that means they must read and think constantly.

Munger believes the “psychology of human misjudgment” is by far the most critical area in mental models.

Ironically, Munger disdains most of academic psychology. That’s because academics teach and research the wrong things.

We all recognize universal emotions, like fear and greed. The same is true for, say, envy.

But good luck finding an academic treatise on any of these topics. Munger says he has never even seen the word envy in the index of an introductory psychology textbook.

Munger’s Investment Checklist

I suspect the 95-year-old Munger would like the world to remember him more as a thinker than as an investor.

Still, most of us are more curious about the investment philosophy that turned him into a billionaire.

Munger is a big fan of using checklists in decision making.

Pilots use checklists to improve their performance. Surgeon Atul Gawande wrote a book on the importance of lists in the operating room. Munger believes that all investors should use checklists too.

Like his mental models, Munger’s investing checklist is not original. Instead, he derives it from investment pioneer Benjamin Graham’s principles of value investing.

No. 1: Treat a share of stock as a proportional ownership of the business.

If you cannot understand the business of a company, you cannot understand its value. That’s why the underlying business is the only thing that matters when investing in a stock.

Munger spends no time on top-down factors. He ignores monetary policy, consumer confidence and market sentiment indicators.

According to Munger, you should always “be motivated when you’re buying and selling securities by reference to intrinsic value instead of price momentum.”

No. 2: Buy at a significant discount to intrinsic value to create a margin of safety.

The margin of safety reflects the difference between the intrinsic value and the current market price. This concept rises above all others in the mind of a value investor. The margin of safety will never become obsolete.

As Munger puts it, “No matter how wonderful a business is, it’s not worth an infinite price. We have to have a price that makes sense and gives a margin of safety considering the normal vicissitudes of life.”

That also explains why Munger would never invest in the latest, red-hot, expensive growth story.

No. 3: Make Mr. Market your servant rather than your master.

Developed by Graham, “Mr. Market” is a metaphor for market behavior. Graham treats the stock market like a manic-depressive who comes by your office every day. Some days, he’s willing to sell you his interest in a company for way less what than what you think it’s worth. Other days, he’s ready to buy your interest for much more than you think it’s worth.

Overall, Munger considers,”It is a blessing to be in a business with a manic-depressive who gives you this series of options all the time.”

No. 4: Be rational, objective and dispassionate.

Rationality is the essential quality of a successful investor. It is the best antidote to psychological and emotional errors. Much like the margin of safety, the idea of being objective and dispassionate will never be obsolete.

As Munger puts it, “Rationality is a binding principle. You must avoid the nonsense that is conventional in one’s own time. It requires developing systems of thought that improve your batting average over time.”

So what’s Munger’s overarching advice to investors?

Munger believes that it is “roughly right that the market is efficient.”

Still, the stock market is not totally efficient.

And it’s this difference between “totally efficient” and “somewhat efficient” that spells opportunity for disciplined investors.

As with many things, this approach sounds simple, but it’s not easy.

Good investing,

Nicholas


Interested in hearing more from Nicholas? Follow @NickVardy on Twitter.


About

A widely recognized expert on the exploding asset class of exchange-traded funds (ETFs), Nicholas has been a regular commentator on CNN International and Fox Business Network. He has also been cited in The Wall Street JournalFinancial TimesNewsweek, Fox Business News, CBS, MarketWatch, Yahoo Finance and MSN Money Central. Nicholas holds a bachelor’s and master’s degree from Stanford University and a J.D. from Harvard Law School. It’s no wonder his groundbreaking ETF content is published regularly in the free daily e-letter Liberty Through Wealth.

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