Mullooly Asset Management
Fiduciary Fee-Only Financial Planner | Investment Advisor in Wall, NJ
Mullooly Asset Management
The Munger Effect: Unlocking Investment Wisdom and the Power of Simplicity
Unlock the wisdom of investment legend Charlie Munger as we explore his transformative influence on Warren Buffett and the investing world at large. Witness the powerful shift from 'cigar butt investing' to the pursuit of 'wonderful businesses at fair prices,' a principle that rocketed Berkshire Hathaway to unprecedented heights. Join us for a riveting discussion that dives into the heart of investment strategy, simplicity versus complexity, and the profound impact of high school algebra on the world of finance.
Are you tired of wading through the murky waters of financial products, dense with jargon and hidden fees? You're not alone. In this revealing episode, we pull back the curtain on the opaque world of complex investment vehicles to spotlight the elegance of simplicity in growing your wealth. From my inbox to your ears, we'll dissect real-life examples of the convoluted offerings that cloud the industry and share how to steer clear of them, armed with Munger's invaluable insights and a commitment to keeping your investment strategy straightforward and successful.
Welcome back to the podcast. This is episode number 473. Today we want to talk about complex math versus keeping things simple. Charlie Munger has arguably been one of the best investors in history. He even convinced Warren Buffett to change his approach to investing in the late 1970s. Munger joined Buffett at Berkshire Hathaway in 1979 and well into the 80s and beyond for the better, and he was able to accomplish this turnaround with Buffett by teaching Buffett about keeping things simple.
Speaker 1:Buffett's approach previously was based on what we call the cigar, what we call the cigar butt theory, and the idea goes something like this you buy something, you buy a company, at such a low price it was practically free but the intrinsic value of the company was still there. What Buffett meant by the intrinsic value was, even if the company went out of business and you sold the assets, it would be worth far more than what the stock was trading at. When Buffett would talk about examples like this, he would speak of a cigar butt that he would find laying on the sidewalk. The theory was you could pick it up for free and get one or two free puffs out of what's left of the cigar. That's the cigar butt theory, and this was value investing, as he learned from his professor at Columbia university, benjamin Graham. What Munger was able to convince Warren Buffett to do was, instead of buying fair businesses at wonderful prices the cigar butt theory he turned Buffett around to focus on buying wonderful businesses at fair prices. That's a huge difference in approach and you can see, while Berkshire Hathaway was doing very well in the 60s and through the 70s, things really started to take off when they took this approach Just keeping things simple. Munger always talked about avoiding complex math, and we agree, but keeping things simple sometimes is hard to do.
Speaker 1:Here's examples of information that was in two emails that I received recently from wholesalers. I can't share the exact details with you because they're internal use only. I will say that I get nearly a dozen of these emails every day, so I'll just read you the highlights from one of them. This is someone who's offering a product that we would then show or buy for our clients, which we would not do. The headlines we offer zero market risk. That's a red flag right there. We offer zero market risk, earn up to 11% based on the S&P 500, with zero internal fees to the clients. These are three points that they're making in their email, three misleading points. It really gives our industry a bad name.
Speaker 1:Here's another one. We offer a unit investment trust, which advisors and brokers should be able to easily understand, but most individual investors couldn't tell you what a unit investment trust is. So we offer unit investment trusts with flex options. Here's three examples of the unit investment trusts that they're offering. The first one has a 30% buffer and it's tied to the S&P 500. The second one that projects a 20% return offers a 10% buffer tied to the NASDAQ index QQQ. The third product that they're selling offers a two times upside to the S&P 500, with a 15% buffer. They also add in very, very small font at the bottom of the email that the buffer is before sales charges, costs and any associated fees, and then right below that it also offers an even smaller print. The objective is, they hope, to return capped upside and defined downside protection. I will say that both of these email examples came with almost invisible ink in the bottom of their, the footers of their emails, with close to three pages of legal disclaimers.
Speaker 1:This is highly complex math that individual investors do not need and shouldn't be anywhere close to, but yet people come in to meet with us for the first time and they will show us statements from their investment accounts at other brokerage firms. We find these products, that's what they are. We find these products littered through client statements and they cannot explain what they are or how they work. These are just two emails of the dozen that I receive daily of complex math. That's not keeping things simple. So let's continue to talk about how to. How keeping things simple is really important for you.
Speaker 1:So Charlie Munger learned they rely on high school algebra. At Harvard Business School, munger is quoted as saying students were amazed that algebra works in real life problems. Remember when you took high school algebra, we always talked about solve for X and the way that you would solve for X is. Sometimes they would tell you X equals one, and you had to back your way into it. And so what Munger is trying to tell you is that if you understand how algebra works, you can solve a formula four words, like we normally do, from left to right, but you can also solve from right to left. That's how algebra works. So you need to understand how algebra works to keep things relatively simple.
Speaker 1:Munger goes on to say, by and large, as it works out, people can't naturally and automatically do this. He's talking about algebra, so you have to learn. If you don't get this elementary but mildly unnatural mathematics of probability into your repertoire, then you go through life like a one-legged man in a butt kicking contest. He closes that quote by saying you're giving a huge advantage to everyone else. What's Buffett? What Buffett and Munger really understood by capitalizing on basic things like high school algebra in the quest of keeping things simple is that this shouldn't be a complicated business investing but you need to understand how things work, backwards and forwards. One of the very famous quotes that Munger said and it's his whole episode is about famous quotes from Charlie Munger. He talks about invert, always invert. It's the same way when we say in algebra class solve for X. So it's important to understand how math works, what the probabilities are and how to solve for X, because if you can solve for X, you can back your way into what things ought to look like. So what's a few examples of keeping things simple? Well, the first one. Again another quote from Charlie Munger, and we've used this on several videos and several podcasts.
Speaker 1:Don't interrupt the compounding. People want to tear up the script because of a lot of different reasons, because their guy didn't get elected to the White House, or because taxes are going up, or because the Fed seems to be changing their policy on interest rates, or some other let's just call them cooked up catastrophes. In 40 years in the business, I've seen one time where it may have paid to bail on stocks, and we're talking about a five or six month window in 2008 where it may have been to your benefit to bail out on stocks. And if you didn't do anything, if you just sat there and held on throughout, you were fine. Don't interrupt the compounding. That's one way of keeping things simple.
Speaker 1:Another example of keeping things simple the market is going to do its thing. 2008 was a perfect example. From time to time, the market is going to do its thing. Make sure that money you are going to need over the next three months, six months, nine months, 12 months is not at risk. This is how we keep things simple and for some folks that might be two years of expenses that you need to keep out of market volatility. The market is going to do its thing from time to time. We need to keep things simple. So this money over here that's at risk, that's going to go up and down. We know it's for the future. The money that we're going to need in the short term three months, six months, nine months, 12 months needs to be sitting in something completely safe.
Speaker 1:What's another example of keeping things simple? One of the lines that we say here around the office is most people retire once in their lives. We retire people every day of the week around here. It doesn't need to be complicated, but it does involve some math. The main thing about retirement is not necessarily that your expenses, your spending, needs to go on a diet. It usually doesn't. The main thing is that there's usually less income coming in through the normal channels, like by a paycheck. So we have to adjust, and for some people that's a huge adjustment.
Speaker 1:What's another example of keeping things simple? Well, number four the silent killer is not heart disease or veganism, it's inflation. When you retire, you trade your old paycheck for new streams of income. If you have nothing, that is to say, no asset that will keep pace with inflation, you will eventually fall behind and that can lead to your expenses needing to go on a diet. The issue, the big problem that we face on a daily basis in our line of work is that many people getting ready to retire, they want to reduce the risk in their investments upon retiring. Too much allocating in the wrong way is going to hurt you. If you're going for a fixed or safer way of earning money on your investments, you're gonna fall behind with inflation. And that leads to number five, the fifth example of keeping things simple, and that is losing sight of what is the real rate of return. I'm a little stunned that more people don't seem to grasp this concept.
Speaker 1:Let's walk through an example. If inflation is three and a half percent and you are earning four and a half or five percent risk-free on short-term treasuries or in a bank account, your real rate of return is somewhere between one and one and a half percent. That's your real rate of return. It's the return after subtracting inflation. You have to find a way to keep your investments growing faster than the rate of inflation. So now let's take a walk back a year ago. If inflation were, say, 6% and you're earning 5% at the bank for the first time in 15 years, you're pretty happy that you can get 5% of the bank. But if inflation is 6%, your real rate of return is negative one. You're actually losing money because you're not keeping up with inflation. I'll give you another example From the years 2011 through 2016,. Those five or six years there, if inflation was averaging between one and one and a half percent, what were you earning on risk-free investments like Treasury bills, or short-term investments at the bank, like a short-term CD? Inflation was one between between one and one and a half percent, you were likely earning zero at the bank or on your short-term Treasuries, and we can go back to history during that period of time and see that happening. So the last example that I want to share with you on keeping things simple.
Speaker 1:The sixth example of this again, we're going back to another quote from Charlie Munger, and this is a little brutal, but it's true. Munger said if you can't handle two or three market drops of over 50% in a century, you're not cut out for investing. You'll only achieve mediocre investment returns compared to those who can rationally handle market fluctuations. That's a tough pill to swallow, but it's realistic. We have to focus on keeping things simple when it comes to investing. We have to let the market do what it's going to do and, yes, there will be times where you'll pull up your account online or look at your statements and see you're down 10%. That can happen. On average that happens one time a year for almost 100 years now.
Speaker 1:A 5% drop in the market can happen without any rhyme or reason. We also see drops of 20% 25% routinely. If that bothers you, if you can't handle that, you're probably not cut out for investing. You've got to keep things simple. You have to keep money that is for the long term invested. It's going to go up down sideways. Money that you're going to need in the short term needs to stay in something secure. So this is we should probably call this one the Charlie Munger episode because of all the quotes that we used. But I appreciate you listening to podcast episode number 473.
Speaker 2:We'll catch up with you on the next episode May maintain positions and securities discussed in this podcast.