4 Charlie Munger Secrets to Make the Most of a Beaten-Down Market

The stock market can be a scary place when it starts to decline rapidly. It can have you questioning if it’s even worth it to invest in stocks.

And yet, despite the dozens of bear markets throughout history, stocks have created over $47 trillion in wealth for shareholders dating back to 1926.

An investor who has been a huge recipient of that wealth creation is vice chairman of Berkshire Hathaway, Charlie Munger. Consider these four Munger anecdotes to help you be a better investor during this beaten-down market.

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1. Avoid making dumb mistakes instead of trying to be smart

Most investors try to make money by outsmarting the market, but in most cases that’s a lowercase-fool’s errand. After all, some of the smartest people in the world work on Wall Street with seemingly unlimited resources at their disposal and have a hard time doing it.

Charlie Munger, however, understands that successful investing has more to do with avoiding dumb mistakes, saying, “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid instead of trying to be very intelligent.”

The stock market is one of the few places where you can be above average by simply making average, level-headed decisions over a long period of time. You don’t need to be a genius; you just need to avoid mistakes, especially in a bear market.

If you can avoid errors like selling stocks at the bottom, chasing hype stocks without doing research, or trying to time the market, you’ll set yourself up for exceptional returns over the long run.

2. The quality of the business is more important than the price

In 1994, Munger delivered a speech at the University of Southern California Marshall School of Business, saying:

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return — even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you’ll end up with one hell of a result.

With the market punishing richly priced stocks as of late, it’s easy to become overly focused on the fair-value price while ignoring the quality of the underlying asset.

Apple exemplifies this perfectly. The tech giant has rarely traded at a “cheap” price and yet has rewarded investors handsomely over the years, largely due to its impressive return on invested capital (ROIC), which has hovered around 20% for over a decade.

The price of stocks certainly matters, but it needs to be analyzed in the context of other performance metrics like ROIC. High-ROIC stocks at an expensive price will likely outperform low-ROIC stocks that are cheap. Remember, a cheap price doesn’t automatically equal a good investment. Oftentimes, stocks trade at a discount for a reason.

3. Diversification is great up to a point

Another Munger quote to glean wisdom from in this bear market is, “The idea of excessive diversification is madness.”

The topic of diversification can be a confusing one. Most of us tend to think of it as a universally good practice. And don’t get me wrong — it’s incredibly important for successful investing. But there is a danger in over-diversifying.

As you add more stocks to your portfolio, it becomes increasingly difficult to keep track of them. You also lower your potential upside, eventually approaching the average returns of the market.

If your risk tolerance is such that you need to own hundreds of stocks in your portfolio to sleep at night, you’re probably better off foregoing individual stock picking and investing in low-cost index funds instead.

Diversifying your portfolio is still one of the pillars of long-term investing, but Munger is warning about the cost of using over-diversification as a crutch. You shouldn’t simply buy numerous stocks to avoid being knowledgeable on the companies you own.

4. Focus on the micro instead of the macro

Both Warren Buffett and Charlie Munger have consistently stated their lack of interest in making investment decisions around the macroeconomic environment.

Over the years, they’ve made dozens of statements like this one from Munger: “Gigantic macroeconomic predictions are something I’ve never made any money on, and neither has Warren.”

The macro environment is incredibly difficult to predict and can change on a dime. Even the best economists in the world consistently get their forecasts and predictions wrong.

Even the International Monetary Fund (IMF) concluded this in a 2018 study of how well economists forecast recessions, where they found experts missed their predications “by a wide margin.”

However, regardless of the macroeconomic conditions, great businesses will continue to execute at a high level and return profits to investors over the long run.

Stay consistent

These four Mungerisms are good advice for all market environments but especially relevant right now as investors tend to make catastrophic errors during bearish periods. If you can simply avoid big mistakes such as over-diversification, focusing solely on price, or timing the market around the macroeconomy, you will do incredibly well over the long run.

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Mark Blank has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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