Charlie Munger on How to Become Rich

Simple lessons from a great investor.

Morgan Housel
Morgan Housel
Jan 19, 2010 at 12:00AM

If you don't know who Charlie Munger is, you're missing out. Let's just say that if it weren't for Warren Buffett, Munger might hold the title of the world's most famous investor.

And not just because Munger -- Buffett's right-hand man, and Berkshire Hathaway's co-chairman -- is an extraordinary investor. He is, of course, and he's a multibillionaire. But what makes both Buffett and Munger so appealing to everyday investors is their ability to distill complex investing topics into simple sentences.

Buffett's words of wisdom have been repeated endlessly. But Munger doesn't get enough face time. One of his most overlooked contributions is a very simple 10-point list called the "investing principals checklist," spelled out in his book Poor Charlie's Almanack. Without further ado:

1. Measure risk 
All investment evaluations should begin by measuring risk, especially reputational.

Circa 2003-2007, investors loved banks because they were big and made lots of money. What few asked was how much risk they were taking. Right now, investors love companies like (NASDAQ:AMZN) and Bank of America (NYSE:BAC) because shares have gone gangbusters. Those who properly analyze how much risk the run-ups have added will end up happiest.

2. Be independent
Only in fairy tales are emperors told they're naked.

Maybe the hardest part of investing is that the greatest odds of being right come when most think you're wrong, and vice versa. If your plan is to watch CNBC and invest in what the most talking heads like, you'll likely end up with average results at best. Some of the biggest winners of 2009 were companies like Las Vegas Sands (NASDAQ:LVS) and Beazer Homes  (NYSE: BZH) -- both of which elicited nothing but giggles and blank stares one year ago. 

3. Plan ahead
The only way to win is to work, work, work, and hope to have a few insights.

The past decade was defined by delusions of success: Buy a house, and you'll be rich. Have a credit card, and you'll be rich. Buy penny stocks, and you'll be rich. Live in America, and you'll be rich. None of it was true. But this fact is as true today as it has been for eons: The best way to become financially successful is to work hard, save harder, learn a lot, and invest patiently and prudently. That, or work at Goldman Sachs (NYSE:GS). 

Related Articles

4. Have intellectual humility
Acknowledging what you don't know is the dawning of wisdom.

A related Munger quote: "The iron rule of life is that only 20% of the people can be in the top fifth." Sad, but true. You're not Warren Buffett. You don't know what's going to happen next year. Most people probably can't fully comprehend what Cisco  (NASDAQ: CSCO) does -- though its business may seem simple on the face of it. You might not even know what a balance sheet is. It's OK. And it's not just OK, but vital to admit it, and either pass on things you don't understand, or learn from someone who does. The alternative is going at investing roulette-style. Las Vegas exists for that. (The food's better there, too.) 

5. Analyze rigorously
Use effective checklists to minimize errors and omissions.

There's truth to the adage that people spend a month researching a new dishwasher, but 10 minutes researching a new stock. Take your time. Be patient. Be selective. Read annual reports. Crunch numbers. Get other people's opinions. This is your hard-earned money we're talking about.

6. Allocate assets wisely
Proper allocation of capital is an investor's No. 1 job.

Last fall, stock funds were liquidated en masse while money market funds were inundated with demand. No doubt this was because investors feared the worst was ahead. But it also took a big, scary event to make people realize their allocation was dangerously skewed. Too many stocks, too little cash. The worst part is that most of these investors had to either sell or increase cash savings at precisely the same time stocks were cheapest.

7. Have patience
Resist the natural human bias to act.

Last fall, I interviewed famed value investor Mohnish Pabrai. I asked Pabrai what his edge as an investor was. "Control over my emotions" was his succinct answer. "That's it?" I asked. "It's huge. You'd be surprised," he responded. He couldn't be more right. It all comes back to one of Buffett's most famous sayings: "The market is there to serve you, not instruct you."

8. Be decisive
When proper circumstances present themselves, act with decisiveness and conviction.

Related to the previous quote, Pabrai began scooping up shares of cratering companies like PotashCorp  (NYSE: POT) when markets hit the fan in late 2008 and early 2009. Shares later exploded in value. Pabrai's main fund rose by more than 100% as of late last year. His decisive actions speak for themselves. 

9. Be ready for change
Live with change and accept unremovable complexity.

If the past two years taught us anything, it's that what you don't think can happen not only can, but probably will. In both personal finance and investing, there's no more dangerous place to be than relying 100% on a certain set of circumstances. That's just not how life works.

10. Stay focused
Keep it simple and remember what you set out to do.

As Dale Carnegie said, "Success is getting what you want. Happiness is wanting what you get." It doesn't get better than that.

Munger teaches us that investing is simple, but hardly easy. He's also an example of how much you can learn from a great teacher. If you're new to investing, looking to hone your skills, or interested in learning from two phenomenal investors -- David and Tom Gardner -- I encourage you to try a free 30-day trial of Motley Fool Stock Advisor. Since the service's inception in 2002, the average Stock Advisor recommendation has outperformed the market by more than 50 percentage points. Click here for more information. There's no obligation to subscribe.

This article was first published on Dec. 19, 2009. It has been updated.

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Inside Value selection. Amazon and Berkshire Hathaway are Motley Fool Stock Advisor recommendations. The Fool owns shares of Berkshire Hathaway, and has a disclosure policy.