Seeking Charlie Munger's advice: How to understand and deal with adversity, and what to do when investments decline

Source: Munger Academy
Author: Ranran

Below is the main text.

In a company’s 2020 annual report, management stated that shortly after the Lunar New Year, following the outbreak of the pandemic, the first question they discussed in a meeting was, “If sales dropped to zero, how long could our company survive?” Management added, “Witnessing many friends around us lose their jobs, businesses—even composure—and fall into despair, caution seemed like the most practical stance to take.”

Undoubtedly, the pandemic has been the single most impactful macro event affecting investments in recent years. Compounding this hardship, multiple other external factors have nearly obliterated the profitability of certain industries and companies. Many individuals, investors, and listed companies are feeling the pressure and encountering difficulties.

From 1958 to 1970, Buffett wrote partnership letters for 13 years without mentioning in any of them how macroeconomic trends affected investing. Even in his shareholder letters over subsequent decades, Buffett never followed the common practice of many listed companies—discussing everything from international to domestic developments, or from GDP growth rates to industry output figures in annual reports. Macroeconomics is simply too vast and distant; even someone as perceptive as Buffett, leading a behemoth like Berkshire Hathaway, refrains from speculating about it. Most listed companies and investors certainly lack the standing to opine on macro trends.

Although the shock brought by this pandemic is macroeconomic in nature, the current hardship is not fundamentally different from past difficulties. Experience gained from overcoming previous challenges can instill confidence.

This time, the burden still feels heavy, breathing still feels labored, and occasionally it even feels hard to catch one’s breath—but all of this is deeply familiar. Gone is the suffocating anxiety and tension experienced during one’s first encounter with adversity.

The current difficulty may be greater than before, but having already navigated past hardships—and knowing this situation is not fundamentally different—we can respond with greater composure. There’s no need for empty motivational platitudes. Yet, having persevered for so long and endured hardship for such an extended period, it might be worthwhile to consult the wise Charlie Munger on how to view adversity—particularly from an investor’s perspective—and how he approaches market downturns and acts during them. Such insights may offer us valuable guidance for our present circumstances.

Why consult Munger on how to deal with adversity?

Why consult Munger on how to deal with adversity? Why not turn to Graham, Buffett, or Schloss instead?

Because Munger has endured far too many hardships throughout his life.

He once walked down the streets of Pasadena weeping openly after losing his young son;

He once exhausted himself physically and mentally after a failed factory venture and a disastrous business deal;

He once suffered excruciating pain like a trapped beast in the corner after a failed eye surgery.

Here’s a specific, small example. In 1953, after the end of Munger’s first marriage, the house went to his ex-wife, and he moved into a student apartment. Every weekend, he would cheerfully take his children out—to parks, amusement centers, or friends’ homes.

At that time, Charlie still dressed very neatly, yet he drove an old, dilapidated Pontiac. Anyone who saw the car immediately assumed he was destitute. His daughter once asked him, “Dad, this car is so beat-up! How can you drive something like this?” Charlie replied, “That way, I won’t attract gold-diggers.” In truth, he really had no money then—he was practicing law, and lawyers didn’t earn much at the time.

Whenever I recall this small episode, I always feel deeply moved. It encapsulates one of the many setbacks Munger has faced in his life.

Next, we seek wisdom from Munger himself—listening to his perspective on adversity and learning how a disciplined investor should think and act amid headwinds in the market. The following excerpts are drawn from Q&A sessions at shareholder meetings of Daily Journal Corporation and Wesco Financial Corporation.

How does Munger understand hardship?

First, difficulty is normal.

1. Difficulty is the norm.

(1) Shareholder: Could I ask for your view on American Express? Has American Express’s economic moat narrowed?

Munger: It was truly unfortunate that American Express lost Costco as a major client. That’s how fierce competition is under capitalism—other banks offered more attractive terms and took the business away. In today’s intensely competitive markets, even the strongest companies can be overtaken if they let their guard down for even a moment. Such is the harsh reality of modern capitalist markets: without relentless focus and effort, survival is impossible.

…The management at American Express would surely say that competition is tough and that they’ve been working hard all along. Isn’t that also true for Daily Journal Corporation? We’ve worked hard too, yet our newspaper business has clearly seen its day. Gary, tell me—haven’t we tried our best?

Gary Salzman: We did try, but the competition was simply too intense.

Munger: Indeed, all we can do is retreat step by step. Life as an adult is just this difficult. (2015)

(2) Shareholder: Over a person’s lifetime, the world changes dramatically. By the time I reach your age, what remains unchanged? What do good businesses of the future have in common with good businesses today?

Munger: The only constant is ‘difficulty.’ You will experience the loss of loved ones, endure severe setbacks, and taste profound suffering. Life presents you with 81 trials, so to speak. Only at life’s end do you realize that everything is ultimately empty. No matter how hard you strive, life inevitably ends in failure. Once you grasp this truth, you understand the phrase ‘life is but a dream.’ Animals like cats and dogs don’t comprehend fate—but we humans do; we can perceive the dreamlike, fated nature of existence.

Some say the law of energy conservation in thermodynamics simply doesn’t apply to life. In life, victory is never the final outcome—everyone is destined for failure. This is the ultimate challenge we must all confront. (2017)

2. When times are tough, everyone finds it tough.

Shareholder: If Daily Journal Corporation were to suddenly realize a large profit, what would management do? Given the current low interest rates and low inflation, how should the company invest?

Munger: In the current environment, stock markets are at high levels, and many segments of the real estate market are also highly priced. It is very difficult to find suitable investments for idle cash. We can only do our best. There is no magic pill that instantly solves every problem when difficulties arise. When challenges come, I feel I share in them—it’s perfectly normal. (2021)

3. Understanding how difficult something truly is makes success more likely than believing it is simple.

Shareholder: Berkshire Hathaway’s long-term goal is to increase its intrinsic value by 15% annually.

Munger: Fifteen percent is about the highest we can expect. We would like Berkshire to grow faster, but we believe 15% is already the upper limit of what we can achieve. This target is extremely challenging, and we cannot guarantee we will meet it.

Shareholder: Berkshire’s net worth is $57 billion, and Mr. Buffett has stated that Berkshire’s intrinsic value is significantly higher than its book value.

Munger: Yes.

Shareholder: Intrinsic value depends on the return on capital and the discount rate. For the sake of discussion, let’s assume Berkshire’s current intrinsic value lies between $80 billion and $100 billion. Based on this range and a 15% annual growth rate, Berkshire’s intrinsic value in ten years would be between $320 billion and $400 billion.

Munger: Your math is correct.

Shareholder: Three or four hundred billion dollars—that’s no small figure.

Munger: You’re absolutely right.

Shareholder: You and Mr. Buffett have repeatedly stated that the investment environment is fraught with difficulties. In such a challenging environment, how can Berkshire achieve significant growth given its enormous size? I find it quite difficult—what’s your view?

Munger: Of course it’s difficult. Put another way, it’s always better to clearly recognize the difficulty than to think it’s easy. Acknowledging the challenges makes achieving your goals more likely. (1999)

Second, difficulty has its benefits.

Munger: …If we accept our circumstances with equanimity, we can face life with a positive attitude and fulfill our own worth within the limited span of our lives. This is something everyone should be able to understand. If, over a lifetime, you start from nothing and gradually build something substantial through persistent effort—if you use your abilities and wisdom to help others and set a good example—you’ll feel immense pride and fulfillment. Precisely because it’s difficult, there is great joy in it, and you can truly savor the satisfaction of overcoming adversity.

There’s another benefit to life’s difficulties. Earlier this morning, before the shareholder meeting, we held a board meeting and discussed software implementation issues. Implementing complex software systems in a new region always leads to various problems—frequent failures, repeated restarts, and constant stress. I’ve observed throughout my life that friendships forged through shared hardship and struggle, through building something together against the odds, are the closest and most enduring. Such bonds simply cannot be formed during times of comfort and prosperity.

In adversity, we’re overwhelmed and suffer greatly—but it is precisely in such conditions that our will is most strengthened, friendships are most deeply formed, and success is ultimately nurtured. Only by striving together through tough times can people develop a bond of mutual support and shared experience, a connection that is truly precious.

I have another perspective on facing difficulties. Life presents one challenge after another; each is a test and an opportunity to demonstrate who we are. I recommend approaching difficulties with this mindset—especially as you grow older. In old age, many challenges become insurmountable, and without a sound attitude, you simply won’t manage. (2017)

Third, compared to others, we are not afraid of difficulty.

(1) Simpson: I believe competition in the property and casualty insurance industry will intensify over the next five years. As Charlie just mentioned, the performance of property and casualty insurers is likely to decline.

Munger: I’m not at all afraid of fiercer industry competition or potentially declining performance. I am optimistic about GEICO’s prospects. Over the next 20 years, the entire industry may face tough times, but we could very well outperform despite the headwinds. When the industry struggles, everyone suffers—it’s a matter of who has greater resilience. (1999)

(2) Whether in our savings and loan operations or our real estate business in Santa Barbara, we maintain ample margins of safety. It won’t be easy for us to incur substantial losses—unless society as a whole suffers a catastrophic collapse so severe that people can no longer survive, only then would we find ourselves in serious trouble.

On one occasion, someone posed the same question to Derek Bok, then president of Harvard University. At that time, Harvard’s endowment was the largest in the world, and the university enjoyed peak academic prestige and social influence. The questioner asked Professor Bok how Harvard would be affected if the government continued cutting education funding to universities. After a moment’s reflection, Bok replied, 'We won’t be the first university to go under.'

When making loans, we have always exercised great caution and maintained sufficient margins of safety. Our loan-to-value ratios are kept low. We set very high credit standards for lending. Of the long-term loans we hold, 99.999% are secure. Many of our loans involve properties with high values and low loan amounts—for example, a property worth $400,000 with a loan of only $20,000. (1990)

Fourth, if you embrace difficulty, succeed at it, and others can’t take it away from you.

1. Endure hardship before others do; hardship now leads to rewards later.

Munger: That’s simply how business works. Whoever enters first, endures the hardship first, and succeeds first gains a strategic advantage. Latecomers not only have to endure all the same hardships again but must also contend with NetJets, which has already secured its lead. We’re suffering now, but future competitors will suffer even more.

Precisely for this reason, many companies prefer to endure hardship early on. Coca-Cola entered global markets by pushing through adversity in every new country it entered. Now, after years of struggle, Coca-Cola is finally reaping the rewards. The same logic applies to NetJets’ expansion into Europe—we’re enduring hardship today so we won’t have to tomorrow. (2000)

2. Embrace difficulty, succeed at it, and others can’t take it away from you.

Munger: If Daily Journal Corporation succeeds, not only will shareholders make money, but we will also contribute to society. The systems currently used by government agencies are inefficient and require extensive automation. We develop software and provide services—we do the dirty, hard work. Precisely because it’s dirty and hard, others are unwilling to do it, which gives us this opportunity. Microsoft doesn’t want to earn money this way; it can easily make money elsewhere, so why endure such hardship?

The harder it is, the more I like it. Because it’s difficult, once we actually succeed, others won’t be able to take it away from us easily. (2015)

Fifth, face difficulties with humor.

(1) Shareholder: Have you ever considered becoming a xiangsheng (Chinese comedic performance) actor? Your frequency of delivering punchlines is exceptionally rare. (Laughter)

Munger: You understand me well. I’m not Jewish, but I deeply admire Jewish humor. Jews constitute only 2% of the world’s population, yet they’ve created 60% of the world’s humor. Despite enduring so much suffering, they still manage to laugh in the face of life—it’s truly admirable. I hold Jews in very high regard. I recommend that you, too, adopt their attitude of laughing through hardship, just as I have. (2018)

(2) Shareholder: You’ve observed many foolish behaviors among humans, yet you don’t seem disappointed by human folly. Have you always been this way? Is it right to maintain such an open-minded outlook, as you do?

Munger: Absolutely correct. This is the attitude toward life I learned from the Jews. Despite all the suffering they’ve endured, they still laugh in the face of life—I deeply respect them for it. This ability to laugh through hardship also aligns very well with my own personality. Humor truly is an excellent remedy for pain. (2019)

What should you do when your investments face a market downturn?

Above is Munger’s wisdom on understanding adversity. Next, let us ask Munger specifically about investing: what should one do when encountering a market decline?

First, long-term investors must be able to withstand a 50% decline.

Shareholder: In 1973, while managing your partners’ capital, you incurred a 30% loss. In 1974, you lost another 30%. Over two years, you lost more than half. What happened at the time? And what did you learn from it?

Munger: That’s an easy question to answer. At the time, I was managing capital for my partners, and the partnership fund I ran dropped by 50% within a year, while the broader market fell by roughly 40%. A once-in-about-thirty-years economic recession occurred, during which even dominant newspaper companies traded at price-to-earnings ratios of just three or four times. By the time the market hit its lowest point, my portfolio had declined 50% from its peak.

My holdings in Berkshire Hathaway stock alone have experienced 50% declines on three separate occasions. Investing requires a certain degree of resilience. Investing is a long-term endeavor. If you’ve prepared yourself for long-term investing, then when you face a 50% drawdown, you must hold firm—don’t panic and flee in terror.

I’m telling you this from personal experience: cultivate your character so that when you encounter a 50% decline, you remain as calm as if 'Mount Tai were collapsing before your eyes.' (Applause) Don’t waste energy trying to avoid major downturns. They will come eventually. If they haven’t arrived yet, it probably means you haven’t taken enough risk. (2017)

Second, experiencing pain is part of investing.

Munger: I certainly felt the pain of volatility. Look up the returns of Wheeler, Munger & Co. for 1973 and 1974, and you’ll see just how badly I fared back then. In truth, those two years of steep losses were actually a period of accumulation—without that hardship, there would have been no explosive growth later. At the depths of the 1973–1974 market collapse, I was fully confident that the intrinsic value of the stocks I held was three times their prevailing market prices.

As long as I could stay the course, the market couldn’t do anything to me. Although the market plunged sharply, I needed to persevere—but I was nowhere near bankruptcy. That period was genuinely tough. I believe young people should embrace ambition and be willing to endure hardship to gain real-world experience. If you’re afraid to take risks or unwilling to suffer, isn’t that just being too timid? (1995)

Third, over the long journey of investing, there are different phases—and sometimes, you simply need to wait and exercise patience.

Shareholder: I’m a complete novice shareholder. I haven’t accumulated significant wealth yet, but I do aspire to live comfortably. You just mentioned that opportunities today are scarce, which has frightened me a bit. Do beginners like us still have hope?

Munger: You newcomers represent the next generation of investors, and throughout your lifetimes, you will encounter your own unique opportunities. However, if you expect to get rich easily within the next five years, that may not be realistic. Compared with the more experienced investors around you, your investment path might prove somewhat more challenging.

It may be difficult—let it be difficult. Don’t lose heart.

Shareholder: I’m still young; I have 10 or 20 years ahead of me.

Munger: You young people still have a long investment journey ahead. Sometimes you need to sow seeds, sometimes you reap the harvest, and sometimes you must endure harsh winters and simply survive. A child once asked his grandfather what he did during the French Revolution. His grandfather replied, ‘I survived.’

Sometimes, merely surviving is an achievement. Do what is appropriate for the time. Anticipate all possible scenarios and prepare in advance. (1997)

At this point, how to view adversity and market crashes has already been fully articulated by the wise Munger. I don’t believe I have anything worth adding, so nearly everything above consists of direct quotations from Munger.

In today’s market, some large listed companies—truly national champions—carry credit ratings equivalent to China’s sovereign credit rating, yet their share prices trade significantly below book value. Some small and mid-sized listed companies, with sound operations and even improving earnings, now see their stock prices fall to levels typical of bankruptcy liquidation—and in some cases, even below net cash per share.

When Munger faced a major market decline in the 1970s, he remarked, ‘The intrinsic value of the stocks I held was three times their market price.’ In today’s market, any investment failing to meet that standard might not truly qualify as cheap. If Buffett were here, would he be as ecstatic as a lecher entering a land populated only by women? And what about us? Is it really that hard? Regardless, listening to Munger’s perspective on handling adversity offers at least some inspiration for our current situation.

By the way, the aforementioned listed company proactively prepared for potential disruptions from the pandemic. Yet, during the pandemic, both its revenue and net profit reached record highs. It found the right business strategy and benefits from excellent management.

The pandemic was indeed challenging, but good companies remain good companies. Nevertheless, its stock price was not spared—it continued hitting new lows at the time of writing, trading at less than one-third of its prior peak. Unfortunately, even after such a decline, it appears to have merely reached a fair valuation. Truly good companies rarely become genuinely cheap.

Editor/Jayden