What Warren Buffett’s Right Hand Man Can Teach You About Success (and Avoiding Costly Mistakes)

While Warren Buffett is known for making large investments that have paid off in multiples, his business partner at Berkshire Hathaway Inc. (BRK.A, BRK.B) And the right-hand man, Charlie Munger, took a calmer approach.

Instead of resorting to limits, Munger called for a little caution: avoid those big mistakes that could completely destroy you. As he said in his sarcastic phrase: “It is better to avoid stupidity than to seek intelligence.”

Basic philosophy: avoid catastrophic losses

While some investors chase headlines for the next big thing, Munger, who died in 2023 at the age of 99, consistently called for maintaining a margin of safety. While “don’t lose money” sounds like a trivial lesson taught to new investors, Munger has elevated it to an art form.

The idea is deceptively simple: Wealth accumulates over time, but only if you protect your capital from permanent impairment. Just one catastrophic loss can wipe out years, or even decades, of investment gains. Consider the long-term shareholders of Enron or Lehman Brothers before they collapsed spectacularly.

Simple mathematics reveals why avoiding losses is preferable to seeking gains. If your portfolio declines by 50%, you only need 100% returns to break even. A 75% drawdown requires a 300% gain to recover.

The psychology behind it: inversion

How to achieve this? Munger pioneered the mental model that became known as “reflection.” “Instead of looking for success, make a list of how to fail instead,” Munger said. For stocks, this means identifying risks and red flags for the company, and thinking about worst-case scenarios. What could go wrong, and can it be overcome? In this way, minimizing potential losses should be the primary focus of investors.

However, this model derives its name from the way it upends the way humans typically process information and make judgments. Our brains are hardwired to tell stories, making us susceptible to narratives about revolutionary companies and vulnerable to hype and fear of missing out. This natural human tendency can lead investors to chase high prices, ignore fundamentals, take advantage of leverage, and get in over their heads – putting them at increased risk of catastrophic loss.

Invest in what you know

At the same time, you need to develop the knowledge and competence to make good assessments. Munger always advises to “invest in what you know,” which means you should avoid putting money into companies, projects or assets where you don’t really understand how the investment will pay off in the end.

Surround yourself with experts and expand your “circle of competence.” “When a person with money meets a person with experience, the person with the experience ends up getting the money and the person with the money ends up with the experience,” Buffett said in a 2016 letter to shareholders.

Be humble enough to recognize when you have reached the limits of your knowledge or skill, and then tap that circle.

Avoid mistakes at work

Take, for example, the dot-com bubble of the late 1990s. While many investors bought hot Internet stocks, Munger and Buffett publicly avoided jumping into technology companies whose value propositions and business models they did not understand. This allowed them to emerge unscathed from the 2001 collapse.

The same discipline paid off again in 2008, when Berkshire avoided the toxic securities that decimated Bear Stearns and Lehman Brothers. While competitors chased returns with complex tools they didn’t fully understand, Munger and Buffett stuck to simple companies with enduring competitive advantages.

Today, the same principle may once again produce results: The hype around AI stocks, the rise of cryptocurrencies, and meme stocks continues to make headlines, pushing market prices to high levels above fundamentals. If you don’t “get it,” according to Munger, you’ll probably have to leave some of these things out.

How to put this into practice

Following Munger’s rule means avoiding catastrophic losses that may be difficult or even impossible to recover from. Some practical ideas for investors:

• Focus on the margin of safety. Make sure you have enough liquidity to withstand short-term losses.
• Invest in what you understand. If you can’t explain the value proposition of a business or asset in plain language, stay away.
• Think in decades, not quarters. The power of compounding rewards long-term investors who can take advantage of occasional pullbacks to accumulate positions when they are “on sale.”
• Embrace boredom and discipline. Staying alert and ignoring the noise can go against our natural inclinations. This means sticking to the plan, even if it seems a little boring. If your portfolio looks exciting, you’re probably taking on more risk than you realize.