Recently, an old video of Charlie Munger has been making waves online. Despite looking like it was shot with an iPhone 4, the content inside is absolutely mind-blowing. It's a video where Munger explains how to achieve 50% annual returns with small-scale investments, and after watching it, my entire perspective on investing completely changed.
The Truth Behind "It Takes Money to Make Money"
You've probably heard the saying "it takes money to make money" countless times. While this isn't entirely wrong, according to Munger, the amount of money needed to generate high returns isn't as much as you might think.
In the video, Munger said: "There are people who want to get rich fast, but there really aren't that many good ideas out there. The lesson I can give is that a few ideas are enough, so don't get discouraged. And when you find those few opportunities, you need to act aggressively."
He shared a story about his great-grandfather who moved to Iowa and even fought in the Black Hawk War. This man eventually became the wealthiest person in the region. But what he did was simple: every time there was a panic, he would buy a few farms and rent them out to German immigrants. He only did a few things, but that was enough.
First Principle: Target Inefficient Markets
Berkshire Hathaway is a massive company with a market cap of $800 billion. It's the 9th largest company in the world and the largest non-tech company in America. You'd think having this kind of scale would provide huge advantages when investing, but it's actually the complete opposite.
Charlie and Warren Buffett have consistently said that Berkshire's size actually hinders their ability to generate high investment returns. With so much money to deploy, they can only focus on large investment opportunities, and the probability of these large opportunities being mispriced is extremely low.
On the other hand, when your investment scale is small, the probability of inefficiencies occurring is much higher. Large investors like Munger are so focused on bigger opportunities that smaller ones don't even register on their radar. This is exactly where our opportunity lies.
Warren Buffett put it this way: "When working with very small amounts of money, I could scour through thousands of companies and find one or two ridiculously cheap companies where I could invest $10,000 or $15,000. But as the money grew, the range of possible ideas shrank dramatically."
Back when Warren and Charlie were investing small amounts, they would spend thousands of hours combing through tens of thousands of pages of financial statements just to find one idea. Fortunately, thanks to the internet, finding mispriced stocks has become much easier today.
All you need is a free stock screener. Set the market cap between $1-20 billion and P/E ratio between 3-15. Companies meeting these criteria are considered small by Wall Street standards. Most professional investors have constraints that prevent them from investing in stocks below a certain market cap. For example, the New York fund I worked at had a rule against investing in companies with market caps below $5 billion.
These constraints cause potentially excellent investment opportunities to be overlooked. Moreover, companies of this size don't receive attention from Wall Street analysts either. While Apple has 31 analysts covering it, smaller companies get no attention at all. This is exactly what increases the probability of finding stocks trading well below their intrinsic value.
Second Principle: Swing Big When Good Opportunities Come
Munger's second lesson is to bet big when good opportunities arise. Since excellent opportunities are rare, you need to maximize their potential when they do come along.
This concept is easier to understand through baseball. Ted Williams, one of the greatest baseball players in history, wrote a book called "The Science of Hitting." The book features a diagram dividing the strike zone into 77 different areas. Williams discovered that waiting for pitches in his sweet spot could increase his batting average to 40%. Conversely, swinging impatiently would drop his success rate to 23-25%.
Williams understood that even an average hitter could become great by waiting for good pitches, while even the best hitters would become mediocre by swinging at bad pitches.
Munger believes this concept applies directly to investing. Investors face thousands of potential investment opportunities every day. Think of these as baseballs. To invest successfully, you need to sit patiently with your bat on your shoulder, watching each pitch go by. You should only swing when you see an investment opportunity that's perfectly in your sweet spot.
The problem is that these perfect pitches aren't very common in investing. You might have to wait months, even years. That's why when the perfect pitch finally comes, you need to maximize it and swing for a home run.
Third Principle: Don't Fear Concentrated Investing
Conventional investment wisdom says investors should have highly diversified portfolios - meaning portfolios consisting of dozens, even hundreds of stocks. Munger believes this thinking is incredibly foolish if your goal is high investment returns.
Munger has concentrated most of his family's net worth in just three investments: Berkshire Hathaway stock, Costco stock, and a fund managed by Li Lu. Instead of diversification, Munger advocates for an approach that concentrates on a few outstanding companies that he completely understands. By thoroughly researching and understanding these companies, he believes you can make more informed decisions and consequently achieve superior returns.
Munger illustrates this point with the story of his friend John Arrillaga. John Arrillaga is a billionaire investor. You might assume that as a billionaire, his net worth would be composed of various types of assets - several businesses and numerous stocks. But this assumption would be completely wrong.
John Arrillaga built his wealth through real estate. Real estate itself is a very broad asset class. There are apartments, offices, factories, single-family homes, self-storage facilities, and many other types, in countless locations. In the US alone, there are 387 metropolitan statistical areas, and within each area are countless neighborhoods. There are plenty of ways to diversify a portfolio within real estate.
But John Arrillaga chose a different approach. He decided to be extremely focused in building his wealth. He chose to buy only real estate within one mile of Stanford University campus in California.
For 40 years, what Arrillaga did was simple: he never took on excessive debt, bought when the market was down, and sold when everyone else was being greedy. That was it.
While Arrillaga was building billions of dollars in wealth, he surely received offers for investment opportunities outside the one-mile radius of Stanford campus. But he ignored all other investment opportunities and focused only on the area he knew best. Staying true to his area of expertise and consequently having an overwhelming advantage over his competitors is what made him one of the wealthiest people in the world.
Munger says: "If I had followed traditional financial theory when investing, I would be much poorer than I am now."
Conclusion: The Real Power of Small-Scale Investing
To summarize Charlie Munger's three principles:
1.Target inefficient markets- Look for opportunities in small companies that large investors don't pay attention to
2.Swing big when good opportunities come- Since perfect investment opportunities are rare, maximize them when they arise
3.Don't fear concentrated investing- Rather than diversifying, concentrate on a few outstanding companies you completely understand
What I realized from these principles is that the real advantage small-scale investors have is being "small" itself. You can do things that institutional investors managing large amounts of money simply cannot do. You can capture small opportunities they ignore, move quickly, and truly concentrate your investments.
Of course, the prerequisite for all of this is sufficient study and patience. Like Munger's great-grandfather and John Arrillaga, only those who build expertise in their own domain and know how to wait for opportunities can succeed with this approach. But the rewards are definitely worth it.
Ultimately, Munger has once again shown us that what matters most in investing isn't size, but wisdom and patience. Along with the hopeful message that you can build substantial wealth even with small capital.