You only need to get rich once. If you've worked hard or just got lucky and now find yourself in the top 1%, stop trying to hit home runs, you've already won.
Notes
1. Patricia Sullivan, “William ‘Bud’ Post III; Unhappy Lottery Winner,” Washington Post, January 20, 2006.
2. Deborah L. Jacobs, “Winning the Lottery Isn't Always a Happy Ending,” Forbes, November 28, 2012.
3. Ric Edelman, “Why So Many Lottery Winners Go Broke,” Fortune, January 15, 2016.
4. Michael Mauboussin, The Success Equation (Boston: Harvard Business Review, 2012), 17.
5. Mike Weiss and Katharine Burton, “John Paulson Is Struggling to Hold On to Client Money,” Bloomberg.com, June 5, 2017.
6. Peter S. Goodman and Gretchen Morgenson, “Saying Yes, WaMu Built an Empire on Shaky Loans,” New York Times, December 27, 2008.
7. Carol Lloyd, “Minorities Are the Emerging Face of the Subprime Mortgage Crisis,” San Francisco Gate, April 13, 2007.
8. Gregory Zuckerman, The Greatest Trade Ever (New York: Crown Business, 2010), 42–50.
9. Ibid., 107.
10. Ibid., 72.
11. S&P/Case‐Shiller U.S. National Home Price Index Y/O/Y % change.
12. Ibid., 126.
13. Ibid., 209.
14. Ibid., 261.
15. Quoted in Zuckerman, The Greatest Trade Ever, 282.
16. Alexandra Stevenson and Matthew Goldstein, “Paulson's Fall from Hedge Fund Stardom,” New York Times, May 1, 2017.
17. Katya Wachtel, “The Top 25 Hedge Fund Earners In 2010,” Business Insider, April 4, 2011.
18. Forbes, “Most Valuable Athletes and Teams,” July 21, 2010.
19. Charles D. Ellis. The Index Revolution (Hoboken, NJ: Wiley, 2016).
CHAPTER 14
Charlie Munger
Handling Big Losses
You need patience, discipline, and an ability to take losses without going crazy.
—Charlie Munger Kiplinger, 2005
Netflix, Amazon, and Google are three of the most successful companies over the past decade. Their products have changed the way we live, and their shareholders have in turn been rewarded with tremendous profits. That is, assuming their shareholders had the discipline to stick around. One of the oldest tenets of finance is that risk is tied with reward. If you want big rewards, you can be sure that big risk is never far behind.
Amazon is up a whopping 38,600% since its 1997 IPO, compounding at 35.5% annually. This would have grown a $1,000 investment into $387,000 today. But the degree of difficulty of actually turning that $1,000 into $387,000 20 years later cannot be overstated. See, Amazon got cut in half three separate times. On one of those occasions, from December 1999 through October 2001, it lost 95% of its value! Over that time, the hypothetical $1,000 investment would have shrunk from a high of $54,433 down to $3,045, a $51,388 loss. So you see why looking at a long‐term winner and wishing you had bought in is a fool's errand. “Man I should have known Amazon was going to change the world.” Fine, perhaps you should have. But even if you had that information, it would not have made it any easier to hang on for the ride.
Netflix, another revolutionary company, compounded at 38% since its IPO in May 2002. But this too required an almost inhuman amount of discipline to stay invested. Netflix got cut in half four times and fell 82% between July 2011 and September 2012. A $1,000 investment would have grown to $36,792, and then shrank to $6,629 over this time. Could an investor have watched their initial investment fall by thirty times over? A 500% gain over the previous 20 months went up in smoke in just 14 months!
Google, the youngest of the three companies, has compounded at more than 25% a year since it went public in 2004, delivering investors a smoother ride than in either Amazon or Netflix. Shares “only” got cut in half once, losing 65% of their value from November 2007 to November 2008. And when they did, many investors were unable to weather the storm that all of these great companies experience. Over the 265 days it took to bottom, nearly $845 billion worth of stock was bought and sold. The average market cap for Google over this time was just under $153 billion. In other words, the stock was turned over five and a half times, robbing many investors of the 515% return over the next eight years.
Charlie Munger was never interested in investing in highfliers like Amazon, Netflix, or Google. But he, like those companies, has produced tremendous long‐term results, even if he also experienced incredible short‐term pain. Munger, vice chairman of Berkshire Hathaway, is famous for being the longtime partner of Warren Buffett, and he's infamous for his tremendous intellect and his aphorisms colloquially known as “Mungerisms.” He is fond of inverting the problem, reverse engineering, and thinking things backward. For example, “All I want to know is where I'm going to die so I'll never go there.” At the 2002 annual Berkshire Hathaway shareholder's meeting he said, “People calculate too much and think too little.”
One of the traits that separates Munger from the rest of us plebeians is that he was never distracted by opportunities that were outside his circle of competence. He once said that “we have three baskets: in, out, and too tough.”1 Investors would be wise to follow his advice: “If something is hard, we move onto something else. What could be simpler than that?”2
In today's world where new products are coming to the market daily, it would serve investors well to recognize the purple and green lures:
I think the reason why we got into such idiocy in investment management is best illustrated by a story that I tell about the guy who sold fishing tackle. I asked him, “My god, they're purple and green. Do fish really take these lures?” And he said, ”Mister, I don't sell to fish.”3
In 1948, more than a decade prior to meeting Buffett, Munger graduated from Harvard Law School and went onto a successful law career, following in his father's footsteps. While he was practicing, he got into real estate development projects and earned his first million dollars. His passion for investing exploded when Ed Davis, one of Buffett's first investors, introduced the two young men in 1959. Buffett asked Davis for an investment of $100,000 and was surprised to get it. Davis hadn't seemed to pay very much attention to Buffett's explanation of his investment strategy, so Buffett was surprised when Davis agreed so easily. The reason was that Buffett reminded Davis of another investor, one that Davis trusted wholeheartedly: Charlie Munger. Buffett reminded Davis of Munger so much, that he even accidentally made Buffett's checks out in Munger's name!4
Munger and Buffett hit it off right away. After years of speaking with Buffett, learning and sharing ideas of his own, in 1962, the same year that he founded a new law firm (Munger, Tolles & Olson, still around today; Charlie left in 1965), he also established what would become an incredibly successful hedge fund, Wheeler, Munger & Company.
Munger came out of the gate scalding hot. From 1962 to 1969, before fees, the fund's average annual return was a mind boggling 37.1%.5 This is even more incredible when you think about the environment at the time. Over those eight years, picking stocks was hardly like shooting fish in a barrel. In fact, the S&P 500, including dividends, gained 6.6% over the same time. Over the fund's entire 14‐year existence, Munger averaged 24% returns, compounding at 19.82% annually, well above the indexes, which gained just 5.2% over the same time, including dividends (S&P 500). Munger's limited partners would have done very well if they rode with him through thick and thin. But sticking with Munger, like sticking with Amazon, would prove no easy feat.
The best lesson investors can learn from one of the best to ever do it is that there are no good times without the bad times. Big losses are in the fabric of long‐term investing. And if you're not willing to accept them, you will not harvest the long‐term returns that the market has to offer. Munger once said:
If you're not willing to react with equanimity to a market price decline of 50 percent or more two or three times a century, you're not fit to be a common shareholder and you deserve the mediocre result you're going to get compa
red to the people who do have the temperament, who can be more philosophical about these market fluctuations.6
Warren Buffett once said of Munger: “He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with results shown.”7 Concentration was an understatement; Munger would make most focused investors look diversified. By the end of 1974, 61% of the fund was in Blue Chip Stamps.8 In the bear market, the worst since the Great Depression, Blue Chip got crushed and the huge position that Munger had inflicted serious damage on his portfolio. Trading stamp revenues peaked at $124,180,000 and by 1982 sales fell to $9 million. By 2006, sales were just $25,000. “As for the original business of Blue Chip Stamps: ‘I presided over a reduction in trading stamp sales from over $120 million down to less than $100,000. So I presided over a failure of 99.99 percent.’”9)
Blue Chip Stamps would recover and would go on to be an extremely important asset that would purchase See's Candies, the Buffalo Evening News, and Wesco Financial, before eventually being folded into Berkshire Hathaway in 1983.10
Wheeler, Munger lost 31.9% in 1973 (versus a negative 13.1% for the Dow Jones Industrial Average) and another 31.5% in 1974 (compared to a –23.1% for the Dow). Munger said: “We got drubbed by the 1973 to 1974 crash, not in terms of true underlying value, but by quoted market value, as our publicly traded securities had to be marked down to below half of what they were really worth. “It was a tough stretch – 1973 to 1974 was a very unpleasant stretch.”11 Munger wasn't alone, it was a tough stretch for many great investors. Shares of Buffett's Berkshire Hathaway fell from $80 in December 1972 to $40 in December 1974. The bear market of 1973–1974 sent the S&P 500 down 50% (the Dow Jones Industrial Average fell 46.6%, back to 1958 levels).
An investment of $1,000 with the great Charlie Munger on January 1, 1973, would have been worth just $467 on January 1, 1975. Munger quickly bounced back – earning 73.2% in 1975 – but not soon enough. He lost a big investor, which left him feeling mentally and emotionally depleted. He decided it was time to liquidate the partnership.
Even with the brutal performance from 1973 to 1974, the fund earned 24.3% before fees over its lifetime.
It's not just the highfliers that get cut in half. Anything that compounds for a long time must decompound at some point in time. The Dow is up 26, 400% since 1914, but it lost 30% on nine separate occasions. It lost 90% of its value during the Great Depression, and it wouldn't break through the 1929 highs until 1955. Talk about stocks for the long run! The Dow, which is the blue chip index, has suffered two massive drawdowns in the first decade of the twenty‐first century (–38% in the tech bubble and –54% in the great financial crisis).
The takeaway for mere mortals like you and me is that if you seek big returns, whether they're compressed into a few years or over our investing lifetime, big losses are just part of the deal. Munger once said, “We have a passion for keeping things simple.”12 You can simplify all you want, but that still won't insulate you from large losses. Even a 50/50 stock and bond portfolio lost a quarter of its value in the Great Financial Recession.
There are several ways to think about losses. The first is absolute, how an investment stands on its own. And in Munger's case, he had quite a few absolute losses. He experienced a 53% loss while he was managing his hedge fund, and his shares in Berkshire Hathaway experienced six separate 20% drawdowns. A drawdown, for those unfamiliar, is how far an investment falls from its high. So in other words, Berkshire Hathaway has made an all‐time high and subsequently lost 20% six different times.
The second type of loss is relative, that is, what you could have earned elsewhere. In the late nineties, when Internet stocks gripped the country, Berkshire kept to its circle of competence. This cost them dearly. From June 1998 through March 2000, Berkshire lost 49% of its value. If that wasn't painful enough, Internet stocks were pouring barrels of salt in the wound. Over the same time, the NASDAQ 100 rose 270%! In the 1999 Berkshire Hathaway letter, Warren Buffett wrote, “Relative results are what concern us: Over time, bad relative numbers will produce unsatisfactory absolute results.”
Poor relative results are an inevitable part of investing, whether you're picking stocks or indexes. In the five years leading up to the peak of the Internet bubble, Berkshire Hathaway underperformed the S&P 500 by 117%! Charlie Munger didn't bail, but a lot of people questioned at the time whether Munger and Buffett were out of touch with the new world.
The reason why Munger's wealth has been able to compound over the past 55 years, in his own words:
Warren and I aren't prodigies. We can't play chess blindfolded or be concert pianists. But the results are prodigious, because we have a temperamental advantage that more than compensates for a lack of IQ points.13
You must react to losses with equanimity. The time to sell an investment is not after it has declined in price. If this how you invest, you're destined for a long life of disappointing returns. Learn from one of the best whoever did it, and do not attempt to avoid losses. It cannot be done. Instead, focus on making sure that you're not putting yourself in a position of being a forced seller. If you know that stocks have gotten cut in half before, and undoubtedly will again in the future, make sure you don't own more than you're comfortable with. How do you do that?
Here's how. Let's say you have a portfolio that's worth $100,000 and you know that you cannot stomach losing more than $30,000. Assuming that if stocks get cut in half and that bonds will retain their value (and that definitely is an assumption, nothing is guaranteed), do not put any more than 60% of your portfolio in stocks. If that 60% gets cut in half, you should still be okay.
Notes
1. Wesco Annual Meeting, 2002.
2. Berkshire Hathaway Annual Meeting, 2006.
3. USC Business School, 1994.
4. Janet Lowe, Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger (Hoboken, NJ: Wiley, 2000), 2.
5. Ibid., 103.
6. Interview with BBC, 2012.
7. Lowe, Damn Right!, 100.
8. Ibid., 105.
9. Superior Court of the State of California for the County of Los Angeles, Metropolitan News Company v. Daily Journal Corporation and Charles T. Munger, July 1, 1999, Vol. 12, p. 1815.
10. Charles Munger, “Blue Chip Stamps Shareholder Letters 1978–1982.
11. Lowe, Damn Right!, 103.
12. Wesco Annual Meeting, 2002.
13. Jason Zweig, “A Fireside Chat with Charlie Munger,” Wall Street Journal, September 12, 2014.
CHAPTER 15
Chris Sacca
Dealing with Regret
My intention was to minimize my future regret.
—Harry Markowitz
The point of this book was not to teach you how to avoid lousy investments. Rather, it is to show you that lousy investments cannot be avoided. Tough times are simply a part of the deal. There is not an investor alive who has hit 1,000%; in fact, nobody has come even close. One of the main reasons why consistent success eludes investors is because we simply don't have much experience making financial decisions. Homo sapiens have been around for thousands of generations, hunting and gathering and protecting the nest. Investing and saving for retirement, however, is something very foreign to us, and we're only now just learning some of the rules.
The New York Stock Exchange opened in 1817, less than 10 generations ago. Index funds are only 40 years old. If you were to plot the two‐million‐year‐old history of Homo sapiens on a single day, modern portfolio theory would appear at 11:59:58. Framing it this way, Michael Mauboussin asked, “What have you learned in the past two seconds?”1
Human beings' primary motivation over the past two million years has been to pass our genes onto the next generation. Simple rules of thumb like “if you hear something in the bushes, run” has aided our efforts in doing this. If it turned out that the noise wasn't a saber‐tooth tiger but only wind, no harm no foul. This “run
first, ask questions later” attitude is something that helped us survive in the field, but too many people have been unable to suppress this primal instinct from their investment decisions. This has and will continue to create a wedge between investment returns and investor returns. Running at the first sign of trouble in financial markets is dangerous because it's almost never a saber‐toothed tiger and the “no harm no foul” rules don't apply in financial markets.
The average intra‐year decline for US stocks is 14%, so a little wind in the bushes is to be expected.2 But saber‐toothed tigers, or backbreaking bear markets, are few and far between. Corrections occur all the time, but rarely do they turn into something worse, so selling every time stocks fall a little and waiting for the dust to settle is a great way to buy high and sell low. In the past 100 years, we've experienced just a handful of truly awful markets; the Great Depression, the post‐go‐go years meltdown, the 1973–1974 bear, the dot‐com bubble bursting, and most recently, the great financial crisis. Selling every time stocks fall a little is no way to invest because you'd live in a constant state of regret, and regret is one of the most destructive emotions in the cognitive‐bias tool kit.
Big Mistakes Page 14