Sage Advice From an Investing Wizard

As investors, we are constantly in search of wise advice. Many of us have read the staples, but there is always more to learn. That one pearl of wisdom could make us see the light and become true masters of our craft. It's a lofty goal, but every little bit helps.

The host of the Santangel's Investor Forum in New York City this week recently provided us with a transcript of a phenomenal speech by the value-investing extraordinaire and Berkshire Hathaway curmudgeon-in-residence: Charlie Munger. Speaking at the Harvard-Westlake prep school where he is a trustee, Munger shed light on the failures of our financial system and what the individual investor can do to avoid the pitfalls facing the masses. The speech is worth reading in its entirety, but below are the main points you can use to be a better investor, student, and member of society.

Charles, the Wise One
Charlie Munger, for those who of us who may not be value-philes, is the less-quoted but equally integral co-head of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) . Munger is known for his entertaining quips at the annual investors meeting, and though he's not as widely known for his investing prowess as Mr. Buffett, he's an incredibly talented stock picker.

Munger's speech at the prep school is partially about where we went wrong, partially about investing, and partially an angry rant. As usual, the former lawyer speaks in a way that anyone can understand, using examples you could teach a second-grader while proving points that some of the smartest people in finance often miss. So let's get to it.

It's all wrong
The speech kicks off with an explanation of why seemingly smart people are so unsuccessful in investing, operating a business, and managing a nation's economy. For one thing, Munger says, academia failed us. With a myriad of examples from efficient-market theory to the capital-asset pricing model, Munger explains that securities (and capitalism, for that matter) do not always follow mathematical logic, and therefore we should never solely rely on models, equations, or those who employ them.

We are so indoctrinated in our economic theories and textbook explanations that it is simply too hard for institutional-level change. We've spent decades refining our models and theorems, even though they are wrong, and we just can't find the strength to turn our back on all of that "progress." This situation is one of the root causes of the savings and loan crisis, derivatives hysteria, the daily trading of billions of shares, and the failure of brilliant people to beat an index in the market.

Munger is right on the money here, folks. And you can apply this to your investing, regardless of whether you follow value philosophies.

Opportunity cost
Without getting professorial, let's take a look at Facebook (Nasdaq: FB  ) to demonstrate another point made in the speech. Facebook has been the talk of Wall Street this year. Dozens of analysts ran their models on the company, calculating a multitude of price points and then disseminating the information to hungry, get-rich-quick investors. I don't need to recount what happened, but isn't it obvious that Facebook wasn't the place for your money at that point in time? Munger talks about "opportunity cost," something rarely mentioned in academic finance. Investing opportunities have always, and will always, come knocking on the door. That doesn't mean you have to take them.

Let's say you have a position in Coca-Cola (NYSE: KO  ) . You've owned Coke for years, and you know why it's a great long-term investment -- a wide moat, a cash-generating business, adept management, etc. So when Facebook comes along, why would you feel the need to buy another stock? Diversification? With that cash, why take on risk in a company with no proven business model? Sure, it has an incredible user base and, arguably, a wide moat, but do you know that people will use Facebook in 10 years the same way that you know people will be drinking Coke in 100 years? You reach the decision to invest in Facebook the same way you bet on a hand at the tables.

With few to no limits on margin investing and an extremely liquid securities market, Munger argues that we have created the most attractive gambling table the world has ever known.

House of cards
The speech goes on with many more entertaining historical examples of why things seem so rigged for the average guy to lose. The conclusion lies somewhere between "because it is rigged" and "because you're a sucker." The lesson, though, is that we aren't slaves to this system. We participate simply because most of us don't know any better.

Good thing for you, Fool reader, that you do know better.

Fool contributor Michael B. Lewis has no positions in the stocks mentioned above. The Motley Fool owns shares of Berkshire Hathaway and Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Berkshire Hathaway, Facebook, and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On October 23, 2012, at 7:27 PM, NickD wrote:

    If you start investing in Coke at 18 and keep investing until retirement I would be amazed if you weren't rich.

  • Report this Comment On October 24, 2012, at 5:28 AM, Mathman6577 wrote:

    You'd get rich just from the dividend which has been paid since 1920 I believe.

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