Charlie Munger on Concentration

At the 2019 Daily Journal meeting, Munger offered his most compact summary of why Berkshire and the Daily Journal had outperformed. The answer, he said, was pretty simple. They tried to do less. They had never had the illusion they could just hire a bunch of bright young people and have them know more than anybody about canned soup and aerospace and utilities. They had never thought they could get really useful information on all subjects the way Jim Cramer pretends to have it. They had always realized that if they worked very hard, they could find a few things where they were right, and the few things were enough. He tied the point to expectations. If you had asked Warren Buffett for his single best idea in a given year, Munger said, and you had just followed it, you would have found that it worked beautifully. Buffett would not have tried to give you a whole heap of names - he would have given you one or two stocks, because he had more limited ambitions than the typical mutual fund manager. The discipline was not to know a lot, but to know a few things very well and to act on them only when the conviction was high. Munger closed the thought with the kicker: that is a very different way to approach the process than the way mutual funds approach it. The fund industry's job, structurally, is to be in everything so that no benchmark-relative argument can ever be made against it. Munger's job was to be in very few things so that the few things he was in were the ones where he had an edge. The two philosophies produce very different long-run returns.

Munger attacked the diversification orthodoxy head-on at DJCO 2019. The whole idea of wide diversification when you are looking for excellence, he said, is totally ridiculous. It doesn't work. It gives you an impossible task. He asked the room what fun it could possibly be to do an impossible task over and over again. He was making a deliberately provocative point - the conventional finance-theory counsel to diversify away idiosyncratic risk was, in Munger's view, the counsel to dilute the very edge that an investor was supposed to be hunting for. He paired the diversification critique with a concentration positive. The whole trick of the game, he said, is to have a few times when you know that something is better than average and invest only where you have that extra knowledge. And then if you get a few opportunities that is enough. He cited Buffett's line: in a growing town, if you owned stock in three of the best enterprises in the town, that was diversified enough. The answer, of course, is that it is. Owning three excellent businesses you genuinely understand is more diversification than most investors need. He then turned to fees. People don't realize, because they are so mathematically illiterate, that if you make five percent and pay two of it to your advisers, you are not losing forty percent of your future. You are losing ninety percent. Over a long period of time that little difference becomes a ninety percent disadvantage to you. The arithmetic of compounding punishes fee drag far more than intuition suggests. Munger's conclusion was that for a long-term holder, not paying a big annual toll out of performance is hugely important - it is the difference between an acceptable and a catastrophic long-run return.

Munger used the 1997 platform to restate what he considered Berkshire's single most underappreciated advantage: the willingness to do less. He had tried, he said, never to operate under the illusion that he could hire a bunch of bright young people and have them know more than anybody about every industry under the sun. The honest framing was that with very hard work he and Buffett could find a few things where they were right, and the few things were enough. That was a reasonable expectation. Anything more ambitious than that, Munger suggested, was self-flattery. He contrasted Berkshire's approach with the institutional investor's approach. The fund manager was paid to be in the market, paid to have a view, paid to look active. Berkshire was paid by no one to be active. It could sit. It could go years without a serious move, then move aggressively when the rare opportunity arrived. The structural asymmetry - Berkshire had no benchmark to defend, no client to appease, no quarterly questionnaire to answer - was, in Munger's view, the single most underrated edge in long-term investing. He connected the do-less philosophy to position sizing. When the rare opportunity did arrive, the discipline was to size it correctly. A great idea deserves serious capital. Munger told the room that the temptation, when the world is calm, was to spread bets in the name of safety; the temptation, when the world is in crisis, was to small-size the great opportunity in the name of risk management. Both temptations were to be resisted. The whole trick was recognizing the rare fat pitch and then swinging hard.