In today’s Issue:
- How to choose your spouse and stocks
- Inversion therapy for your portfolio
- Asset allocation is the key to long-term returns
Not many secret weapons work if you fail to keep them a secret. One exception was Charlie Munger. He was Warren Buffett’s not-so-secret weapon at their wildly successful investment company, Berkshire Hathaway.
The strange thing about Charlie and Warren is that they gave away all their secrets. They told anyone who would listen what they were up to — in clear, carefully thought-out speeches, books, and written updates.
Yet few manage to emulate them.
Why?
Well, let me tell you about one of Charlie Munger’s secrets. And then we’ll find out if you decide to use it or not…
Stop looking on the bright side of life
Charlie Munger came up with lots of clever mantras. They are effective, efficient reminders for investors.
Behind each one is plenty of thought and science. But the ideas are intuitive enough that you only need to repeat the snappy mantra to recapture the essence of the idea — and act accordingly.
Most of these work well beyond investing, by the way.
My favourite Munger mantra is “always invert.” The idea is to look at a problem backwards.
Instead of trying to figure out what to seek, think about what to avoid.
Instead of looking for what’s “right,” look for what’s “wrong” and dodge it.
Don’t think about finding what’s “good,” think about markers for what’s “bad” and keep away.
And then watch your success pile up by virtue of avoiding pitfalls.
Most of us already do this when it comes to our health. Instead of figuring out how to be healthy, we think about what to avoid drinking, eating, and doing.
But there aren’t many other parts of our life where we intuitively invert. Humans tend to be proactive in their choices. We look for what we want, and then ponder how to achieve it. We think about what to do, not what not to do.
When we fail, we attribute it to not doing the right thing.
Charlie’s insight is that focusing on avoiding the wrong thing will often end up delivering a better outcome. That’s because it’s often easier to spot the bad than find the good.
Consider your search for a spouse. Instead of considering what you might want in a spouse, ponder what’s best avoided.
How many disastrous relationships might’ve been avoided if you’d listened to Charlie Munger’s dating advice?
I could tell you all about that! But perhaps I should stick to stocks…
Asset allocation is the key to long term returns
Enough academic research is done in finance that you can find a study proving just about anything. Academics will do anything for funding, after all.
But delivering stock market returns is what sets apart theory from practice.. And Charlie’s influence at the legendary Berkshire Hathaway proves that “always invert” is a useful tool.
Still, what academic theory explains his success?
One noticeable example is the idea that asset allocation is more important than stock picking. Avoiding the wrong sector of the stock market is more important than investing in the right one.
Avoiding bank stocks in 2008 was crucial. Avoiding bonds in 2021 was vital. And the need to avoid Russian stocks in January 2021 was a painful lesson I won’t forget.
A key part of this theory is the awkward truth that investors need to own something. Even cash in the bank is an asset allocation choice. As bond owners discovered in 2022, even “risk-free” government bonds can crash.
Your portfolio should be diversified — within reason — because you won’t always be right.
Combine these two considerations and you come to the conclusion that avoiding the bad sector of the market is more important than picking the right one. After all, you need to own several sectors to be diversified.
Get rid of the dogs in your portfolio and your overall performance spikes.
Returns are defined by when you buy and sell, not what
Another academic theory backing Munger’s mantra is the claim that risk management is more important than the stocks you pick. When you buy and sell matters more than what you buy and sell.
This is a different investment strategy to Berkshire Hathaway’s traditional value investing approach, but it applies the same inversion principle. Investing based on risk management is about discarding the traps as much as spotting the opportunities.
If you find that idea enticing, we have some rather good news for you.
Few investors are taught about risk management beyond basic diversification. It’s seen as the domain of active traders.
But not anymore. Our team is working on a way to bring active risk management analysis to all of your stocks and your portfolio as a whole— not just our recommendations.
You’ll discover when risk management systems suggest buying, selling, and holding your positions. And how those positions interact with each other.
Stay tuned to find out more.
Until next time,
Nick Hubble
Editor at Large, Investor’s Daily
