Forget Warren Buffett — to smash the market, emulate Charlie Munger

If you’d invested only £1,000 in Warren Buffett’s conglomerate, Berkshire Hathaway (NYSE: BRK.A), at inception you’d be sitting on more than £11m today. But Warren didn’t build Berkshire on his own; he’s simply the most the vocal member of the Buffett-Munger dynamic duo. 

I love The Sage of Omaha as much as the next Fool, but I reckon you can learn just as much, if not more, from the calm and concise foil to Buffett’s endless enthusiasm, Charlie Munger. 

Sanguine selectivity

Buffett often reminds we do-it-yourself investors that we aren’t playing baseball. Unlike his favourite sport, we can let literally thousands of (investment) pitches pass us by without being penalised.

But it would seem Buffett himself gets a little tetchy when he’s inactive too long. Warren refers to Munger as “The Abominable No Man,” because he’s always knocking back his ideas. The key to successful investing, Munger claims, is the ability to do nothing 99% of the time, combined with an ability to aggressively seize that 1% opportunity, of which the average investor can expect to encounter only a few in their lifetime. 

How do we know when we’ve found that fateful investment, however? Well, Munger advises you only invest when you are certain you have the advantage. Otherwise, its back to doing nothing for you.

That means avoiding sectors and companies you don’t fully understand, while spending your downtime growing your “circle of competence,” or areas of expertise. Continuous learning is essential to the long-term investor, so stop reading broker forecasts and sit down with a book.

The Importance of Scale

Scale is important, as every investor knows. I won’t teach you to suck eggs but there are a few benefits beyond cheaper materials that some investors miss. 

Firstly, the larger a company is the more money it can afford to dedicate to marketing spend, meaning size alone acts as a barrier to entry; without significant funding, a start-up brand can’t get adverts on mainstream TV, but the big boys can. 

Similarly, an independent shop must trial one strategy at a time, whereas shopping empires like Tesco can treat its empire like a laboratory, simultaneously testing a number of new ideas or formats while leaving other stores unchanged to act as a control. 

But, for all its advantages, Munger points out scale itself just isn’t enough. After all, even the larger airlines are often heavily lossmaking. Munger advises we ask who benefits from scale: the customers or the shareholders? 

He learnt this lesson through then-textiles business Berkshire Hathaway. He recalls a breakthrough loom that could potentially double the output of the business. Rather than viewing it as an advantage, Munger and Buffett considered shutting the place down there and then. 

Anyone can sell textiles, which meant the only way to compete was by lowering price. This new loom would increase productivity for everyone involved in the industry, which would inevitably lead to a slew of price cutting as each business once again struggled to differentiate itself. 

Besides, the new technology was seriously expensive. In this instance, the customer reaped the reward of heavy investment, not the company itself. Therefore, Munger advises against investing in commodities, or products that any man and his dog can produce. The inevitable race to the bottom on price will erode your wealth.