Charlie Munger: How to Invest for 2021

I remember that I did not make my fortune, such as it is, by predicting macroeconomic changes better than other people. What Bubba and I did was we bought things that were promising, and then we just—sometimes we had a tailwind from the economy and sometimes we had a headwind—and either way, we just kept swimming. That's our system.

And without further ado, here again is the distinguished economic historian and HSS division chair, Jean-Laurent Rosenthal.

"You, Tom, it is a true honor to have a conversation with Charlie Munger, and also a rare one. I thought I might anchor my questions around time: past, present, and future. But in fact, a good conversation runs through and around time. It's also true of investing, since most of the evidence comes from the past. One has to make a decision today but only earn the reward or punishment in the future as an investment.

As an investor, Charlie, if you would like to come on screen now. You have been phenomenally successful over the very long run."

"No, I’ve done that. But perhaps we could try to start by looking back at the time when you left the Army, which brought you to Caltech. What was Caltech like in 1944?"

"Well, the main campus looked very much the way it does now, and the Athenian was exactly the way it is now. And how connected was the meteorology program to the rest of what was going on on campus?"

"Yes, I was in the part of the campus where Thomas and Morgan was, and of course, he was the world's greatest geneticist. And he used fruit flies, and they stank. So my whole part of the campus had the odor of dying fruit flies the whole time I was there. By the way, I liked the camp, but I got used to the fruit fly odor."

"Presumably, you didn't spend all your time with fruit flies, or were they part of the way you did the weather?"

"In 1944, I was so ignorant in those days I could have walked over and introduced myself, and he would have been quite courteous with me. And he was a very great man, and I was too dumb to do it. It didn't occur to me."

"So at the end of the war, you decided not to return to mathematics in Michigan or to stay and go to college somewhere else. Instead, you went to law school. So what can you guess?"

"My father had gone to the Harvard Law School, and my grandfather was a distinguished judge in Nebraska, so that was a natural course of activity for me."

"So what kind of—sort of in thinking about these career changes, which a lot of people go through over the course of their lifetime—what could our fellow alumni, and in particular, our soon-to-be new alumni, borrow from your experiences in those early days of your life when you were choosing a career that still has resonance today?"

"Well, it's very important when you choose a career—if you go into a career that's very tough, you're not going to do very well. And if you go in one where you have special advantages, and you like the work, you're gonna do pretty well. So I went into law because I didn’t want to be a surgeon; I didn’t want to be a doctor; I didn’t want to be a college professor. I finally got through—there was only one—I just went down the family path, and it wasn't the wisest decision I ever made."

"And you didn’t—once you started to get into investment, your legal training, your mathematical background, your experiences—so what came to resonate for you?"

"Well, what happened was there were things I didn't like about law practice, but I had an army of children to support, and no family money or anything to start with. So I had to make my way in life for this army of children, and it was going to be a little difficult. There were things about law practice I saw were quite limiting. And what happened was my pitifully small earnings as a young man—I kept underspending them, and I kept investing fairly boldly and fairly smartly. At the end of my first 13 years of law practice, I had more liquid investments than I made in all those years of law practice pre-tax. I'd done that in my spare time with these little tiny sums. So it was natural for me, partly prompted by Warren Buffett's success, to think I should just start working for myself instead of for other people."

"So another connection with my spare time, I thought, well, what will happen if I do it full-time? One of the things that connects my career to Caltech and investing is, of course, the process of discovery, which creates new technologies. For an economic historian, one thing that we're very aware of is that technological change has driven a lot of the growth of the American economy over the last several centuries. But from your perspective as an investor, what have been the most dramatic transformations you've seen over those 75 years?"

"Tom Rosenbaum reminded us that you've been connected to us, but also been like ourselves. There have been huge booms and huge busts, and that has been very interesting. And of course, the government has tried to do things that will dampen down the fluctuations and make recoveries from the busts happen faster. And of course, that's caused a fair amount of inflation in a life that's been as long as mine."

"What's happened in the investment field is, of course, that so many people have gone into it, and people have made so much money, and it's driven an almost frenzy of activity in the investment field. When I was young, there was probably nobody, and they weren't very smart. And now almost everybody's smart—even a Caltech graduate—a good proportion of them are sucked into finance by the money. So that's been a hugely important development. I don't welcome it myself at all. I don’t think we want the whole world trying to get rich by outsmarting the rest of the world in marketable securities, but that's what's happened. And there's been frenzies of speculation and so on. So it's been very interesting, but it's not been all good."

"But at some level, once you make an investment, you're putting your money into the hands of an entrepreneur who is going to actually produce something. I at least it seems that the value investment that you practice has that characteristic relative to a pure arbitrage approach to trying to make money in finance."

"Well, I did not make my fortune by and large on the cutting edge of technology. My first investment with my pitiful savings of adventures—some sort I invested in a company right in Pasadena, and it was called William Miller Instruments, and I damn near lost all my money. It was hell on earth—we just barely squeaked out with a substantial outcome. The oscillograph that we'd invented and were so proud of, and we thought it was gonna knock the world flat—somebody invented magnetic tape without telling me. And by the time we got that cellograph ready to go to market, we sold three—three total—in the whole world, whole country. So it's—this technology is a killer as well as an opportunity, and my first experience that damn near killed me."

"And so, but that's sort of the other part, right? Over the 75 years that you've been involved in investing for a long time—what kept me out of venture capital on the edge of technology. But even so, I try to avoid it. But even so, in the companies that you deal with, some of them are market leaders at one point in time. And as you just suggested, some technological change or change in preferences will lead those companies to be without—less of a market than they used to have for their products."

"And so how does one think about this over the long term? Because, over the long term, the companies of America behave more like biology than they do anything else. In biology, all the individuals die, and so do all the species. It's just a question of time. And that's pretty well what happens in the economy too: all the things that were really great when I was young have receded enormously and new things have come up, and some of them started to die. That is what the long-term investment climate is, and it does make it very interesting. Look at what's died: all the department stores, all the newspapers, U.S. Steel, John D. Rockefeller's Standard Oil—the pale out of his former self. You know, it's just like biology—they have their little power; they have their little time, and then they get clobbered."

"And so how does one, as sort of a witness or sort of—in a certain way, one lives longer than the life of some of these companies—sort of deal with change? Right? So you could think about an investment portfolio that you create at a point in time will only have validity for a certain amount of time. And so how does one learn to deal with change? It's a question that I always ask my students. And I would just—how does one—how does somebody who has to take the resources of very large numbers of people deal with change? Any thoughts on that matter?"

"Well, some people try to get on the cutting edge of change so they're destroying other people instead of being destroyed themselves, and those are the Googles and the Apples and so forth. Other people, like me, do some of that—joining things like Apple—and in some ways we just try to avoid big change that we just might be to hurt us. And so Berkshire, for instance, owns the Burlington Northern Railroad. You can hardly think of a more old-fashioned business than a railroad business. But who in hell's ever going to create another trunk railroad? So it's a very good asset for us."

"And we made that success not by conquering change but by avoiding it. Now, Burlington Northern itself has been quite clever at adapting technology to their railroad. Imagine the good luck of being able to take an existing railroad and double-deck all the trains and raise the heights of the tunnels a little and so forth, and all of a sudden, you've got twice the capacity at very little incremental cost, which is what that railroad has done. So that is—everybody uses new technology, but it really helps to have a position that almost can't be taken away by technology. How else are you going to carry goods from the port of Los Angeles to Chicago except on our railroad?"

"So it's—innovation within an economy that continues to follow certain sets of rules rather than looking for the new economy. Is that another way one could think about it?"

"There are different ways. All successful investment involves trying to get into something worth more than you're paying. That's what successful investment is. There are a lot of different ways to find something that's worth more than you're paying. You can look for it right in the cutting edge of technology, the way Sequoia does. The most remarkable investment firm in America is probably Sequoia, that venture capital firm, which absolutely fanatically stays right on the cutting edge of modern technology. They made more money than anybody, and they have the best-recorded investment record of anybody. It's perfectly amazing what Sequoia has done."

"So you've also talked repeatedly about people's mental biases. As you said, you don't want to be the smartest person, but you want to avoid doing stupid things. So how does one guard against mental biases in one's decision-making?"

"Oh, I spent a lifetime trying to avoid my own mental biases. Hey, I rub myself—I rub my own nose in my own mistakes. B, I try and keep it simple and fundamental as much as I can. And I like the engineering concept of a margin of safety. I'm a very blocking and tackling kind of a thinker; I just try and avoid being stupid."

"So I have a way of handling a lot of problems—I put them on what I call my 'too hard' pile, and I just leave them there. I'm not trying to succeed in my 'too hard' pile."

"And do they sometimes come back and require for you to—?"

"Oh, I sometimes get things that are too hard! And when that happens, I fail. So one has to accept limitations. Is that one of the really important pieces of avoiding these biases?"

"What I would say is the single most important thing: if you want to avoid a lot of stupid errors, is knowing where you're competent and where you aren't—knowing the edge of your own competency. And that's very hard to do because the human mind naturally tries to make you think you're way smarter than you are."

"So as a question that's almost personal, given my research, I can’t resist asking about innovation in finance over the last half century. It's a sector that's gone through several upheavals—radical change. To go back to the time when you were born, there were 30,000 banks in the U.S. None of them were very, very large. A few New York banks were big. And now the top 20 banks account for almost everything. But the range of innovation in finance has been huge, and there's a debate in academic finance—academic finance for sure—about how much of this innovation is helpful to the markets versus how much actually creates instability."

"I have a very clear opinion on that. I think the early innovation that the Bank of America did under Giannini, where he helped all these immigrants with these loans and knew which ones were good for it and which ones weren't, I think that was all of the good that broke banking to—and banking helped a lot of people that deserved it, helped the economy, helped everybody. But once banking got so they wanted to be in soft white hands and make zillions as speculators, I don’t think those developments have been a plus. In other words, I like banking when they're trying to avoid losses prudently."

"So I have one more question, which I think a lot of people have in mind. COVID has been extremely disruptive to American society and to the American economy. How do you think the economy is going to emerge over the next 12 months from this period of great difficulty? And how much of the change that we've seen start to happen is going to be persistent?"

"Well, my opinion on that is no better than anybody else's. But if you—I think it's quite likely that a year from now, the worst of that will be very, very thoroughly behind us. It's amazing. I watched the polio get totally killed by the vaccinations, and I think they’ll spread these vaccines over the world so fast it’ll make your head swim. So I think this horrible COVID thing is very likely to shrink to insignificance in the course of the next year."

"And what about the transformation to retail? As you said, department stores are gone, but there seems to be at work a quite massive transformation of retail. Are we going to go back to old town Pasadena, for example, or is the shift to online retail permanent?"

"Well, I don’t think retailing is going to go away. After all, it's been around for thousands of years. But certainly, it's been a very difficult place to make money because of what the internet has done. Recently, I had a friend send me a blue blazer made in China, bought on the Chinese internet, and it cost 42 dollars delivered. It was—it may not have been a perfect blazer, but it was an amazing blazer for 42. The person who created that blazer gave it to some little factory in order for a hundred thousand at once, and those have been pre-sold using the internet. So it's the most extreme kind of 'kill all the competitors' type of rate of selling I've ever seen. Of course, retailing hasn't coped with something like that. How good is it for Brooks Brothers when somebody can deliver a thing to the internet from China for 42 dollars? It didn't look like that bad a blazer to me either!"

"It's something, you know—retailing has gotten very tough, and I think this online stuff is here to stay and will get more and more efficient. So that could be actually good for the consumer but more difficult for certain sets of investors, in particular, sort of commercial retail. Of course, these changes are always bad for some investors and good for others, but when they're bad, they're very bad in the full brunt of the changes that are coming in terms of this online shopping."

"Well, but there's also—I’m a director of Costco, and in the last reporting period, their online sales were up 86% over the same quarter last year. Now, that is a significant development. Is it good for other retailers? No, it's good for Costco, but it isn't good for them."

"But how much of their sort of brick-and-mortar stores have—how much of this is people who would have shopped at Costco in the department stores are already doing well? But their brick-and-mortar stores have been enormously destructive because of their low prices and efficiency to other retailers. And now they're doing all this internet thing. The last thing I would want to do in retail is compete with Costco."

"So we’ve talked a bit about retail, and the reorganization of the American labor force is also going to—do you think that is going to be a more transitory phenomenon? That once we get vaccinated, the jobs are going to return, or are we likely to see a slow return of employment in the same way that we did after 2001, 2002?"

"Remember that I did not make my fortune, such as it is, by predicting macroeconomic changes better than other people. What Bubba and I did was we bought things that were promising, and then we just—sometimes we had a tailwind from the economy and sometimes we had a headwind—and either way, we just kept swimming. That's our system, and after all, that's the system Caltech has too. Caltech just gets up in the morning and keeps swimming, and pretty soon they're eminent. Caltech's not trying to play the game of getting a big advantage out of the booms and busts—we're just like Caltech. Well, we do hope that we are committed to our path of discovery and not the victims of the current fashion for—and that we have our own decisions about what we think is really important research. So in that sense, absolutely! Oh no, you're trying to get the right answers, but you're not really trying to predict what the economy is going to be like 18 months from now."