The Logic of Being Logical and Rational
Charlie Munger advocates for a concentrated investment strategy (e.g., Berkshire Hathaway, Costco, Asian fund) over conventional diversification, arguing that sufficient wealth makes broad diversification unnecessary and that industry pressure to match benchmarks leads to irrational behavior.
THE IDEA
The Logic of Being Logical and Rational
Mr. Brown: “How much investment risk did you take personally once you had made enough money to live well?”
Charlie: “Most of the Munger money—I don’t count the Daily Journal; it’s just a little asterisk (laughter)—is in Berkshire Hathaway, Costco, and an Asian fund. Now, you could go to the rest of finance—they think they know how to handle money—and they’d say it’s totally unthinkable, Munger doesn’t know what the hell he’s doing. Doesn’t fit our morals. But I’m right and they’re wrong. You are shrewd enough to choose well; three holdings—only one of which would support your family in perpetuity—is enough security. What difference does it make if somebody else in some year goes up 10 percent and you go down 5 percent, when you’ve got a thousand firms more than you need anyway? The people who make these crazy decisions don’t actually have envy: what they have is clients who will fire them if they don’t get the same results as everybody else. That is a crazy system. Everybody gets on the same merry-go-round. I never had any interest. As I sit here, all my securities are making new highs every day. Am I doing it wrong lxii?”
When to use it
An investor evaluates how much a concentrated position could lose and whether their remaining assets would still meet their needs.
A fund manager assesses a popular stock on its merits and examines whether benchmark pressure is distorting the decision.
A business owner compares expanding a familiar product line with entering markets they know less well.
A professional athlete evaluates the risks and expertise required before committing a large share of their wealth to a venture.
FROM THEORY TO EVERYDAY LIFE
In practice
Munger's Concentrated Portfolio
In the excerpt, Charlie Munger says most of his personal wealth was in Berkshire Hathaway, Costco, and an Asian fund. He argues that these holdings provided enough security for his family given his wealth and judgment. He also criticizes managers’ pressure to match their peers.
The Merry-Go-Round of Finance
Munger describes a system where fund managers are compelled to achieve similar returns to their peers because clients will fire them if they deviate, leading to herd behavior and suboptimal outcomes for those who have already accumulated sufficient wealth.
A MOMENT TO REFLECT
Put it to work.
When making investment decisions, are you influenced by the fear of underperforming your peers or by the pressure to match market benchmarks?
How would your resources, knowledge of the holdings, and ability to absorb losses affect whether a concentrated portfolio suited your circumstances?
In what other areas of life does the pressure to conform lead to decisions that are less logical or rational?
CONTINUE THE CONVERSATION
Source texts
- The Art of Being Rational Charlie Munger