Charlie Munger: A Simple Strategy Can Outperform the Stock Market

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– By Robert Stephens, CFA

Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) has recorded a 20% compounded annual return since it was formed in 1965. Therefore, $1,000 invested in Berkshire Hathaway 55 years ago is now worth around $22.6 million.

Over the same time period, the S&P 500 has recorded a 10% annualized return. This means that a $1,000 investment made in 1965 is now worth around $189,000.

This highlights the value of outperforming the market over a sustained period of time. In my view, following Berkshire vice chairman Charlie Munger (Trades, Portfolio)’s simple investment philosophy could thus increase your chances of beating the S&P 500 in the long run.

Waiting for the right investing opportunities

It is difficult to hold cash and wait for the best investing opportunities to come along when stock prices are rising. For instance, at the moment, the stock market is experiencing a bull run that has propelled the S&P 500 around 50% higher since its three-year low was recorded in March 2020.

Therefore, investors who have waited for cheaper stock prices in recent months may be feeling disappointed. Their situation is made even more difficult by the low returns that are available on cash savings at the moment.

However, holding cash in the short run can allow you to allocate your capital efficiently in the long run. It may mean that you are in a strong position to capitalize on low valuations when stock prices fall. No bull market has ever lasted forever, with their average length being around three years. Therefore, better investing opportunities are likely to appear in the long run.

As Munger once said, “The big money is not in the buying or the selling, but in the waiting.”

Focusing on the investing basics

Some investors may aim to accurately predict the future when seeking to outperform the stock market. For instance, they may try to second-guess how the stock market will perform, or determine which sectors will benefit from future economic or political events.

However, predicting the future movements of stocks or the stock market is an impossible task. There are an infinite number of variables that can determine how stock prices perform.

A more productive use of your time may be to focus on the investing basics. This may mean purchasing companies with sound financial positions and wide economic moats when they offer a margin of safety. This may lead to modest outperformance of the stock market that leads to high relative returns over the long run.

As Munger once said, “You don’t have to be brilliant, only a little bit wiser than the other guys, on average, for a long time.”

Keeping it simple

It is tempting to use a complicated investment strategy when trying to beat the market. For example, you may use complex formulas when allocating your capital. Or, you may invest in companies with business models that are difficult to understand.

In my opinion, a simple approach may be more productive. It could end up with a more efficient capital allocation. This may mean that you miss out on stocks that go on to produce high returns if they are not within your circle of competence. However, it could also lead to you avoiding losses through fully understanding the risks and rewards of specific investments.

Munger has always favored a simple investment strategy. As he once said, “We [at Berkshire] have a passion for keeping things simple.”

Disclosure: The author has no position in any stocks mentioned.

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This article first appeared on GuruFocus.