This is the last in my three-part series excerpting what were the highlights for me from Charlie Munger’s extemporaneous comments and responses to questions at the Daily Journal shareholders’ meeting. Most financial professionals recommend diversifying your investments to avoid being wiped out financially and/or emotionally. This cannot only leave devastating scars for those affected, but if severe enough, may lead to directional changes socially, economically, and politically.
Diversifying Your Investments – Steve Bannon
Now that may sound dramatic but I don’t think I’m spouting fake news here, especially after reading a fascinating article about Steve Bannon in the Wall Street Journal in which he attributes his shift to becoming an aggressive economic nationalist to his dad (who is now 95 years old) almost being wiped out in 2008 because he had almost all of his wealth in AT&T stock. Marty Bannon worked at the company for 50 years and gave his heart and soul to Ma Bell and put all of his savings into the stock, including borrowing against his life insurance. Steve Bannon now has the ear of Donald Trump and some say he is his most influential advisor. He was clearly instrumental in helping to get Trump elected and Trump values loyalty and success (in that order) so Bannon is someone’s whose thoughts, beliefs, and how he sees the world should be studied and paid attention to. In short, because his dad almost got wiped out in 2008 he wants to pursue an America first, economic nationalist agenda.
This is how Bannon saw the financial collapse and his reaction to it based on the impact of his father’s experience.
“The only net worth my father had beside his tiny little house was that AT&T stock. And nobody is held accountable?” Steve Bannon, 63, said in a recent interview. “All these firms get bailed out. There’s no equity taken from anybody. There’s no one in jail. These companies are all overleveraged, and everyone looked the other way.”
Two weeks ago I discussed Munger and the benefits of delayed gratification. Bannon, who clearly idolizes his father, says he has lived his life in that way. It’s also interesting to see how Bannon believes the country would be much better with many more people like his dad and a very small percentage of people like him.
“He’s the backbone of the country, the everyman who plays by the rules, the hardworking dad that delays his own gratification for the family,” Steve Bannon says. “The world is probably 95% Marty Bannons, and 5% Steve Bannons. And that’s probably the right metric for a stable society.”
So what happened?
Marty Bannon says he lost more than $100,000 because he sold the shares for less than he paid for them. It was a decision he made without consulting a broker or his family, including his two sons with investment backgrounds, who only learned about the sale days after it was finished. The shares subsequently regained much of their value.
“It wasn’t a winner, so…” he says, trailing off. “Shame on me that I made that decision.”
Bannon had direct experience with how devastating the bear market was for his father as a result of the financial excesses that had taken place.
Steve Bannon was in daily contact with his father when Lehman Brothers Holding Inc. filed for bankruptcy and Washington politicians worked to put together a bailout package for Wall Street banks.
That Oct. 6, financial analyst Jim Cramer told “Today” show viewers to pull money from the stock market if they needed any cash for the next five years. Steve Bannon says the warning spooked his father.
“I could see his confidence in the system was shattered,” Steve Bannon recalls. “He was older, in his 80s. But all these guys from the Depression, it’s a risk-averse generation because of the horrible things they saw in their youth. He was rattled.”
It’s a little frightening that because his dad had all of his eggs in one basket at age 86 and paid the price for it that Steve Bannon not only wants the United States to withdraw from the globally interconnected economy in which the dollar is the reserve currency of the world and all of the benefits that entail but, more importantly, he has the influence to help make it happen.
Diversifying – Where Munger Fits In
So what does this have to do with Charlie Munger? Charlie Munger is one who believes in a highly concentrated investment strategy and, if you’re going to pursue that way of investing, then you need to have the cajones to live through the inevitable bear markets. Before discussing the reasons as to why and how he came upon that approach, Munger answered a question at the meeting that is directly applicable to Marty Bannon’s situation. One of the attendees queried Munger about the dismal performance of his partnership during the 1973-74 bear market and this is how he replied:
What happened is the value of my partnership where I was running, went down by 50% in one year. Now the market went down by 40% or something. It was a once in 30-year recession. I mean monopoly newspapers are selling at 3 or 4 times earnings. At the bottom tick, I was down from the peak, 50%. You’re right about that. That has happened to me three times in my Berkshire stock. So I regard it as part of manhood. If you’re going to be in this game for the long pull, which is the way to do it, you better be able to handle a 50% decline without fussing too much about it. And so my lesson to all of you is conduct your life so that you can handle the 50% decline with aplomb and grace. Don’t try to avoid it. (applause) It will come. In fact, I would say if it doesn’t come, you’re not being aggressive enough.
Let’s take a look at AT&T’s stock chart going back 10 years and see if it tested the manhood of its shareholders during the carnage of 2008 and early 2009.
The stock peaked on December 28, 2007, at $42.44 and held up pretty well through May 19, 2008, when it hit $40.51, representing a 4.5% drop despite a very weak overall market. And then all hell broke loose over the next three months and the stock price hit a bottom on March 9, 2009, at $21.72, representing a drop of 48.8% from its peak. While this is not quite manhood territory, it was pretty darned close. As a side note, when I ran this chart the stock price was at $42.43, almost reclaiming its 2008 high, albeit nine years later.
Munger would argue that Bannon’s father made the right move loading the boat in AT&T stock. His problem was he couldn’t stomach the downturn and wasn’t financially prepared for it. At his age, temperament, and lacking other financial resources, he was not prepared to handle a nearly 50% drop with “aplomb and grace.” Munger’s approach is designed to create a large amount of wealth, versus allocating one’s savings to provide a personal safety net. So clearly it is not for everybody. In fact, it’s for very few people, but Munger would probably argue that there are more people who should be following this approach.
So what led Munger to conclude that the way to meaningful wealth accumulation was through a concentrated investment strategy? He first learned of it through the success of his great grandfather who he never met. He came out to Iowa with no money and ended up the richest person in the town and owning the local bank. He did it by concentrating on his business and betting aggressively when the odds were in his favor. This is what he said at the meeting.
What Grandpa Ingham use to tell her is, ‘there’s just a few opportunities you get in a whole life’. This guy took over Iowa when the black topsoil in Iowa was cheap. But he didn’t get that many opportunities. It was just a few that enabled him to become prosperous. He bought a few farms every time there was a panic you know. And leased them to thrifty Germans, you couldn’t lose money with leasing a farm to a German in Iowa. But he only did a few things. And I’m afraid that’s the case…you’re not going to find a million wonderful ideas.
So how did Munger practically put this insight into action? Through math, confidence, and independent thought.
That’s one of the good ideas I had when I was young. When I started investing my little piddly savings as a lawyer, I tried to figure out how much diversification I would need if I had a 10% advantage every year over stocks generally. I just worked it out. I didn’t have any formula, I just worked it out with my high school algebra. And I realized that if I was going to be there for thirty or forty years, I’d be about 99% sure to do just fine if I never owned more than three stocks and my average holding period is 3 or 4 years. Once I’d done that with my little pencil, I just…I never for a moment believed this balderdash they keep…why diversification…diversification is a rule for those who don’t know anything. Warren calls them ‘know-nothing investors’. If you’re a ‘know-nothing investor’ of course you’re going to own the average. But if you’re not a know-nothing investor, if you’re actually capable of figuring out something that will work better, you’re just hurting yourselves looking for fifty when three will suffice. Hell one will suffice if you do it right. One. If you have one cinch, what else do you need in life?
Munger then goes on to blast mainstream financial theory that is taught in schools about how everyone needs to diversify. I think Munger is being a bit harsh here. Not everyone has the time, talent, and inclination to be able to analyze companies, industry direction, competitive advantages and disadvantages, and then determine what a compelling valuation is. Marty Bannon believed in AT&T because he worked there for 50 years and Munger would say he was smart to concentrate his financial resources in a strong, well-established company with enormous financial resources. Equally important it was a company he knew very well. What he didn’t know so well, however, is how macro forces can subsume great companies via a dramatic decline in their stock prices. The world went to hell in a handbasket and took virtually every stock down with it and Bannon got caught in the violent storm and he wasn’t able to batten down the hatches. Too bad for him. It turned out, as these situations often do, that this was a temporary dislocation and represented a very good buying opportunity. Or, said differently, it was a terrible time to have to sell.
And so the whole idea that the ‘know-something’ investor needs a lot of diversification. To think that we’re paying these investors to teach this crap to our young. And people think they should be paid for telling us to diversify. Where it’s right, it’s an idiot decision. And where it’s wrong, you shouldn’t be teaching what’s wrong. What’s gone on in corporate finance teaching is that people are getting paid for dispensing balderdash. And since I never believed that it was a great help to me, it helps if you’re out in the market and the other people are believing balderdash and you know what the hell’s going on. It’s a big help. So, of course, you don’t want a lot…
Munger points out that those rare, great opportunities don’t have to just be in the stock market. Being offered a job in an enterprise that can offer wealth-building potential is even better because you have more control over your own destiny.
if you’re Uncle Horace who has no children has an immense business which is immensely secured and powerful. And he’s going to leave it all to you if you come to work in the business. You don’t need any diversification. You don’t need any corporate finance professors, you should go to work for Uncle Horace. It’s a cinch.
You only need one cinch! And sometimes the market gives you the equivalent of an Uncle Horace. And when it does, step up to the pie-cart with a big pan. Pie carts like that don’t come very often. When they do you have to have the gumption and the determination to seize the opportunity shrewdly.
I would hate to manage a trillion dollars in the big stocks and try and beat the indexes. I don’t think I could do it. In fact if you look at Berkshire, take out a hundred decisions, which is like two a year. The success of Berkshire came from two decisions a year over 50 years.
You know the good ideas that I’ve had in my life are quite a few. But the lesson I can give you is a few is all you need and don’t be disappointed. When you find the few of course, you’ve got to act aggressively. That’s the Munger system.
So there you have it. When you see something in life that’s the equivalent of shooting fish in a barrel, then load up on it, prepare yourself for the ride, and man up when the roller coaster starts going down fast because if it’s really a good long-term opportunity, it will go back up again.
Over to You:
Diversifying – Are you Marty Bannon (95%) or Steve Bannon (5%)? Have you found a good thing that you loaded up on? Was it like shooting fish in a barrel or did if backfire? Do you believe in the Munger system?