This is the sixth in an ongoing series that analyzes investing from an entrepreneur’s point of view. At the end of the series, the collected columns will be available as a consolidated white paper at www.sbnonline.com
I’ve said before, investing isn’t rocket science — but it’s not easy either. Charlie Munger, Warren Buffett’s partner, has defined a number of rules that he lives by when it comes to approaching investing.
In his book review of Janet Lowe’s “Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger,” Joseph Dancy outlines Munger’s 10 Rules for Investment Success. He states that several themes appear in the book, helping to explain Munger’s incredible success accumulating wealth as an investor:
- Live below your means — The most difficult part of building wealth is “accumulating the first $100,000 from a standing start, with no seed money,” according to Munger. Making the first million is the next big hurdle.
- Understand your risk tolerance — Investors need to know the level of risk they can comfortably assume. Behavioral finance studies indicate that losses are three times as painful as gains for most investors, so many investors may want to adopt a relatively conservative strategy.
- Research opportunities — Investors must be able to process a massive amount of information effectively to evaluate the risks and rewards of potential investments.
- Invest for the long term — A long-term focus is essential when ignoring the volatility of markets and individual.
- Funds are no substitute — Americans are oversold on the benefit they receive from money managers, especially mutual fund managers. Transaction costs, taxes and fees can significantly reduce total returns. Munger advocates buying index funds or alternatively buying high quality stocks that are not overvalued and holding them for the long term.
- Patience, coupled with decisive action — Investors should continually search and evaluate opportunities. Utmost patience is required, until one is found that has extremely favorable odds of success. Extreme decisiveness, once the commitment is made, dramatically improves financial results over a lifetime.
- Tax planning —As a lawyer drawing an income, Munger was subject to relatively high income tax rates, significantly above what he paid on capital gains, which reduces the ability to build wealth. The recognition of any capital gains on investments many times can be delayed or offset by investment losses, allowing the investment to compound at an accelerated rate.
- Love the process — Because investors must initially be willing to live below their means and do a massive amounts of work, he or she must love the evaluation and investment process.
- Pay a reasonable price — While value is important, investors should buy good businesses that are in sectors that exhibit favorable business characteristics. Management can only do so much with a company in a declining industry.
- Choose good partners — Every investor relies on the advice of others in making investment decisions. Successful investors will have top quality investment partners.
In the end, investors benefit from developing their own checklists based on their own criteria, experiences and circles of competence.
Next month: Part 7 — Five areas to consider for value investing
Umberto P. Fedeli is the president and CEO, The Fedeli Group. He is an investor in numerous ventures. He is on the boards of directors of the Cleveland Clinic Foundation, John Carroll University, the Cleveland chapter of the Young Presidents’ Organization and The 50 Club. Visit www.thefedeligroup.com