The Timeless Investing Wisdom of Charlie Munger, Buffett’s No. 2

The investor Charlie Munger, who died last week at age 99, liked the word “lollapalooza.” The word appears 27 times in the new abridged edition of “Poor Charlie’s Almanack: The Essential Wit and Wisdom of Charles T. Munger.”

I think Munger’s fondness for that fanciful term — which he meant as either a big gain or a big loss — reveals a lot about his investing philosophy and that of his longtime partner, Warren Buffett. It’s worth pondering what he meant, even though the style of investing he did isn’t suitable for most of us.

Lollapalooza effects “can make you rich, or they can kill you,” Munger wrote in his Benjamin Franklin-style “almanack.” As I understand it, his advice is to minimize the risk of bad lollapaloozas because they destroy so much value that even good lollapaloozas won’t be enough to dig you out of the hole you’re in. Math is unforgiving that way: If you go down 80 percent and then up 80 percent, you will still be down 64 percent.

I had arranged with Munger’s book publicists to interview him a day or two after Christmas. I’m sorry to have missed that opportunity. Still, the book speaks for itself. It combines his own writings and speeches with observations about him from others.

There’s an impression that Buffett and Munger got rich by being good at picking stocks and entire companies to buy for Berkshire Hathaway, the Omaha-headquartered holding company of which Buffett is chairman and chief executive and Munger was vice chairman. They made their share of mistakes, though. In 2017, for example, Buffett and Munger told shareholders they had erred by loading up on IBM shares and giving Amazon, Google and Walmart a pass. Buying shares in USAir in 1989 was another famous misstep.

I think the real secret to their success — and it’s not really a secret, since they talked about it all the time — is everything else they did aside from their initial choices of what to buy. That includes, for companies that Berkshire Hathaway owns outright, choosing chief executives carefully and then leaving them alone.

But let’s focus on the lollapaloozas. Munger talked about “combinatorial effects” in which a variety of psychological forces, each mild enough in its own right, come together and reinforce one another to create good or bad lollapaloozas. The original success of Coca-Cola came from positive combinatorial effects, with the qualities of the product and the relentlessness of the advertising working together to habituate customers, he wrote. Conversely, he added, the ill-fated introduction of New Coke in 1985 suffered from a combination of several mistakes.

To get the good lollapaloozas and not the bad ones requires two things, from what I can glean from Munger’s book and Berkshire Hathaway’s famous annual shareholder letters. One is patience to wait for good opportunities, and the other is plentiful available cash when those opportunities finally present themselves.

Wise investors “bet heavily when the world offers them that opportunity” and sit on their hands the rest of the time, Munger said in the book. “But a huge majority of people have some other crazy construct in their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they’ll come to know everything about everything all the time. To me, that’s totally insane.” A few good calls is all anyone needs or should expect in a lifetime, he argued.

As for the second part of the formula, plentiful cash, that’s what makes it possible for Berkshire Hathaway to be “greedy when others are fearful,” in Buffett’s famous formulation. At the end of the third quarter this year, Berkshire Hathaway had $157 billion in cash, cash equivalents and Treasury bills. Those are low-yielding assets that most investors would consider an unacceptable drag on their performance, but they give Berkshire Hathaway the ability to pounce immediately on a promising investment.

Buffett and Munger discovered early that well-run insurance companies generate a lot of cash in the form of “float” — money that’s received in premiums and hasn’t been paid out yet in claims. They realized that while some of the float has to be kept in cash to meet immediate obligations to policyholders, some could also be deployed in higher-yielding investments. And that’s what they did.

I’ll pause here to say that what works for Berkshire Hathaway does not work for the average investor with a long-term perspective. If you lack the resources of Warren Buffett or Charlie Munger you’re probably better off keeping your money in broad-market index funds, riding the market up and down, and staying fully invested in stocks and bonds rather than trying to time the market by holding cash in reserve.

That said, I think the life lesson of protecting yourself from huge losses so you can stay in the game applies to everyone. Early last month I told Mark Spitznagel, the founder and chief investment officer of Universa Investments, that I was due to interview Munger. His eyes lit up. He is a huge admirer of Munger and Buffett.

This says something because Berkshire Hathaway is old school in a lot of ways. It owns Geico and BNSF Railway, among other large companies, and has big stakes in the likes of Apple, Bank of America, American Express, Coca-Cola and Chevron. Universa, meanwhile, is a Miami-based investment management firm with an edgy strategy of “tail risk hedging,” which produces blockbuster results when markets fall sharply. (I wrote about Spitznagel two years ago.)

Spitznagel said that Berkshire Hathaway’s cash pile serves the same function for that company as Universa’s strategy of using financial instruments to insure portfolios against losses: It turns crashes into opportunities. “They have dry powder when they need it and when it is most valuable, when the market is down,” he said.

This gets back to lollapaloozas. Let’s say there’s a strategy that has a 60 percent chance of giving you a huge win and a 40 percent chance of losing badly. If you could play that game 100 times and average your winnings, you’d do great (especially when that dry powder allows you to buy during the fire sales 40 percent of the time). But you have only one shot, so you should pass on the opportunity. Focus instead on building wealth over the long term by minimizing those bad lollapaloozas to “protect your capital base from which you compound each period,” as Mark Spitznagel says. And reinvest your gains. Eliminating really big losses gives compounding — i.e., reinvestment of gains — a chance to work its magic.

“Poor Charlie’s Almanack” cites Munger as having said, “‘Compound interest is the eighth wonder of the world’ (Einstein); never interrupt it unnecessarily.” There’s no evidence that Einstein actually said the part about the eighth wonder, but Munger definitely did say the part about not interrupting it unnecessarily. I wish I’d been able to ask him about it.

Elsewhere: Fewer Job Openings

The rate of job openings fell in October to its lowest level since February 2021, according to Bureau of Labor Statistics data released on Tuesday. That’s a sign the labor market is cooling off. The rate of layoffs and discharges remains low (1 percent in October), but when people do lose a job, it’s harder to find another. That’s apparent in claims for unemployment insurance. Initial claims for unemployment insurance rose only 2 percent over the 12 months through Nov. 25, but continued claims (by people who remain out of work) rose 24 percent in the 12 months through Nov. 18, according to the Employment and Training Administration.

Quote of the Day

“Just as economies can reap economic gains by specializing in what they are relatively good at, the world can reap environmental gains if economies specialize in activities that they are relatively green at.”

— Ngozi Okonjo-Iweala, director general of the World Trade Organization, foreword to “Trade Policy Tools for Climate Action” (Dec. 2, 2023)