A Blueprint for Being a Lousy Investor

In 1986, Charlie Munger gave the commencement speech at the Harvard School, a prep school that five of his sons attended. Munger took his inspiration from a prior commencement speech given by Johnny Carson in which Carson, using inversion, told the students how they could guarantee a miserable life. Here’s Carson’s prescription:

  1. “Ingesting chemicals in an effort to alter mood or perception;
  2. Envy; and
  3. Resentment”

Munger offered his own reflections on Carson’s prescription, and added four more of his own:

  1. Be unreliable;
  2. Ignore the experience of others, both living and dead;
  3. If you get knocked down in life, stay down; and
  4. Ignore the advice of the rustic who said, “I wish I knew where I was going to die, and I’d never go there.”

Inversion allows you to see a problem or situation from a different perspective in order to gain fresh insights that you did not previously notice or that you took for granted. It is in that spirit that I offer the following advice for how to be a poor investor.

1. First, don’t spend much time looking for new investment ideas. Don’t look for ideas off the beaten path, but rather stick with ideas and themes that enjoy a strong consensus. Also, be inconsistent in searching for investment ideas and lose interest when the market is going down and everyone is negative and afraid.

2. Second, be content with superficial analysis of your investment ideas and count on being able to quickly dump your stocks if things go wrong. Don’t do your homework like you would if you were investing substantially all of your net worth in a local business or farm.  Save yourself a lot of time by making your purchase decision based on a write-up in a business magazine, analyst report or blog post.

3. Third, don’t limit yourself to simple, boring investments that are easy to understand. Look for ideas in more exotic, “fast-moving” sectors – biotech, commodities, options, alternative energy, and emerging markets – where you have little experience or competence. Ignore the examples of others – including sophisticated institutions – who have lost their capital by speculating in areas they did not understand.

4. Fourth, invest in businesses with mediocre or poor returns on invested capital that do not enjoy any durable competitive advantages. Reach for more speculative returns by betting on the turnarounds of poorly performing businesses. Count on the fact that, even though you have no expertise in a given industry, you’ll be able to predict if a struggling company will be able to turn around. Ignore the advice of investors like Buffett and Greenblatt who have found that good businesses have a much better chance of delivering satisfactory investment results.

5. Fifth, don’t take the time to investigate the track record of a company’s management. That way you won’t be troubled if management has a poor record of allocating capital, if they will be highly compensated regardless of how the business performs, or if there is evidence that they have been dishonest or unethical in their prior dealings.

6. Sixth, don’t worry about the price you pay for an investment as long as the company’s story is sufficiently exciting, loved by the media or a consensus winner. If you do decide to look at how much you’re paying, don’t spend a lot of time thinking about valuation, normalizing earnings power, and future growth prospects. Instead, rely on simple (simplistic) metrics like price-earnings ratios or price-to-book ratios where you don’t have to think too much or that don’t require as much research. Be content with a superficial valuation and assume that the factors that led to the business’ past success will be firmly in place for the next five to ten years.

7. Seventh, buy a lot of small positions. That way, you’ll never miss out on the excitement of betting on your latest hunch, and you’ll never need to worry too much about a position because it won’t overly matter if the investment works out or not. You’ll always have plenty of action and you can hedge against not really knowing much about any of your investments.

8. Eighth, embrace the newer short-term oriented approach to investing and don’t fall for an out-of-fashion strategy like patiently buying and holding an investment. Who wants to wait three to five years for an investment to work? Focus on investments that will be up big in the next six to twelve months – or sooner. Ignore the fact that there is no rational basis for consistently making short term predictions of prices.

9. Ninth, ignore the lessons of your past mistakes. It’s psychologically painful to go back over your failed investments and it takes time. Ignore developments in behavioral finance and assume that you’re above all that anyway – that you already know what you’re doing. Assume that you’ll get better results in the future without changing any of the methods and behaviors that led to your past results.

10. Finally, take pride in the fact that you already know what you need to know and that learning the lessons of financial history are a waste of time. Also, don’t take the time to study all the great investors who have generously shared their investing methods. Ignore the fact that business is an evolving, complex reality and that investing is a highly competitive endeavor where you go up against the best and the brightest. Ignore the examples of investors like Munger and Buffett – and most successful investors – who are life-long learners.

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9 thoughts on “A Blueprint for Being a Lousy Investor

  1. Justin

    Great site, thanks for sharing all your thoughts.

    I wanted to point out that number seven on your list is perhaps a bit more complex than you make it out to be. While taking small positions simply in order to do something or be sloppy about your ideas and research is not a good idea (as pointed out in your list), I don’t think there is anything inherently wrong with an approach that relies on larger numbers of small positions. This is contrary to what Buffet, Fisher, and others advocate, but this approach is followed by other value disciples, for example, Lynch and more recently, Pabrai. This is also the approach Joel Greenblatt is inherently advocating in his Magic Formula approach to rotating MFI stocks.

    Clearly, taking small positions for the reasons discussed in your post is not a good idea. However, there is some merit to an alternative allocation strategy, especially in a time (such as the past 2-3 years) when there have been so many great companies on sale at one point or another.

    Again, I enjoy the blog, lots of great insights. Keep them coming.

    Reply
  2. Greg Speicher Post author

    Justin, thanks for the comment. I believe you make a valid point. In general, I think focus investing makes most sense if you do deep research and develop a true insight into a company’s prospects. This type of edge is rare and should not, in my view, be diluted through unnecessary diversification. This has generally been Buffett, Munger, Li Lu and Greenberg’s approach. It is was/is also practiced by Greenblatt in his own fund. My sense is that they invest in magic formula type stocks after having done a deep research dive. I believe I’ve seen that he would hold as few as half a dozen stocks.

    In more quantitative value investing, such as that practiced by Graham and the Magic Formula, it makes sense to diversify more broadly becuase there is a lack of conviction about any one position but a high level of confidence that the portfolio will work. Buffett also takes this approach when underwriting insurance and investing in arbitrage situations.

    Reply
  3. Jim Allen

    A clever adaptation of Munger’s points!

    With regard to No. 7, some fairly successful and celebrated value investors have taken the path of lots of small positions, one notable example being the now retired Walter Schloss who worked with Buffett at Graham and Newman. From what I have read about Schloss, he knew what he was doing, did his own research, avoided talking to companies and analysts, for fear of being talked into doing something foolish, and kept things very simple.

    The important point is that while the positions may be been numerous and small, he did not merely shoot from the hip, or buy the stories of salesmen, etc but made up his mind after careful analysis, exactly what Graham defined as “investing.” Also, not all of his positions were small. He loaded up on some in which he had particular confidence.

    Few things beat knowing what you are doing!

    Reply
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