Should we go all in or not? Buffett and Munger interpret it this way.

Comprehensive analysis from the Minority Investment.

In 1984, Columbia Business School held a large seminar to celebrate the 50th anniversary of the publication of "Security Analysis" co-authored by Benjamin Graham and David Dodd. Graham hoped that Buffett could revise and republish his book "The Intelligent Investor" with Buffett's reputation at the time, the book revised by him would undoubtedly have good sales. However, Buffett and his mentor had difficulty reaching a consensus on many issues, especially in asset allocation. Buffett's belief in concentrated investment and Graham's advocacy of diversified investment formed a strong contrast. Therefore, Buffett did not complete the revision of this book, but only wrote a preface for it.

—Chapter 46 "A Dilemma" from "The Snowball"

To invest heavily or not?

If you are an "ignorant investor," Buffett would strongly recommend you to buy index funds. But if you are a "value investor," you should invest heavily because the premise of "value investing" is that you have a certain understanding of the "value" behind the price. Do you still remember Buffett's card with only 20 holes? You need to be careful and cautious with each hole, rather than using up all your punching opportunities for a lifetime in a very short time.

I. Q&A on Diversification at the 1996 Berkshire Hathaway Shareholders Meeting

Q: I am very interested in how you view diversification and how you conduct concentrated investments. I have studied many years of your annual reports. In some years, your investment portfolio held many publicly traded securities, while in 1987, you only had 3 stocks.

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It seems that for a newly established stock, your position is never less than 5% or more than 10% of the overall position. I want to know if my conclusion is correct?

Buffett: This is definitely incorrect. Some of our positions cannot be obtained from the annual report because our latest annual report only lists stocks with a market value of over $600 million. Obviously, the positions of stocks not listed will be smaller. Sometimes, this is because the unlisted companies are small companies, and we cannot buy enough shares; sometimes it is because the stock price of a company we bought has risen; sometimes it is even because we are selling some shares of a company. So, there is no magic in this part of the portfolio. And this brings us back to your question about "diversification."

We believe that for people who truly know what they are doing, the practical significance of diversification is very small.

Diversification is to prevent ignorance. What I mean is, if you buy all stocks to protect yourself from being defeated by the market, there is nothing wrong with that. For those who do not know how to analyze companies, this is a perfectly effective strategy.

However, for those who know how to analyze and evaluate companies, owning 50, 40, or 30 stocks is simply crazy. Because there are not that many outstanding companies, and it is also unlikely for a single person to understand so many companies. However, if you have one super outstanding company, but at the same time you invest money in the 30th or 35th company on your attractive list, this approach is considered neurotic by Charlie and me. This (diversification) is a traditional approach. If all you want is to achieve an average level, this method might help you keep your job. However, in our view, diversification actually means admitting that you don't understand the companies you hold.

In terms of my personal investment portfolio, I actually only hold one stock (Berkshire), but I understand this stock. This makes me very comfortable. Do I need to hold 28 stocks to achieve "moderate diversification"? That would be absurd.

Within Berkshire Hathaway, I can select three businesses. If we only own these three businesses (or subsidiaries anyway) and all my money is in Berkshire, I would be very happy. I love the reality that we can find more good companies, continuously add good businesses, but three excellent businesses are enough to provide you with good returns in your lifetime.

In reality, not even one person can find three such businesses. If you observe how wealth is created in this country, it is not by grasping wealth through a portfolio of 50 stocks, but by identifying an excellent company. Coca-Cola is a famous case, where many people have gained their wealth from it.

Moreover, the world does not have 50 Coca-Colas, in fact, not even 20. If there were 20, that would be great, and we could crazily diversify among them and get returns equal to the real Coca-Cola.

But in reality, you can't find that many; and in fact, you don't need that many either. Truly outstanding companies, even after enduring long economic changes and competition, can be well protected, I mean those companies that can withstand strong competitors. Holding three such companies is much better than holding 100 mediocre companies.

Furthermore, holding three such companies is also safer. I mean, holding three easily identifiable excellent companies carries much less actual risk than holding 50 well-known large companies.

It's shocking that financial professors teach people to diversify their investments.

If I had to bet on the economic foundation that my family relies on for the next 30 years, I would rather pick out three from my portfolio than diversify among 50 companies.

Is there anything Charlie wants to add?

Munger: What he (Buffett) wants to say is that many things taught in modern investment courses are nonsense! (Oh, you can see Munger's proud smile and head shake~)

Buffett: Haha, would you like to elaborate more?

Munger: You can't trust these things... modern portfolio theory...

Buffett: It's useless. It can teach you how to achieve average returns, but I think any fifth-grade elementary student can figure out how to achieve average returns.

The theory is described in more detail, including many Greek letters (difficult concepts), adding a lot of things to make you feel like you're in an advanced competition, but in reality, it adds no value.

Munger: I am very confused about modern portfolio theory because in a sense, I learn rationality from others' irrationality.

Buffett: Haha, we often hang out together (learning how to become irrational). (Irony)

Munger: I usually use some theoretical models to classify irrationality. But I find that I can't even classify modern portfolio theory.

It contains some very strange things.

Buffett (summarizing): If you find three outstanding companies, you will become very wealthy. If you understand them, bad things won't happen to them, that's their characteristic.

Munger: By the way, if you truly understand what Buffett is saying, you can finish this course within a week, which may be why (modern portfolio theory) is so irrational.

Buffett: Then the high priest is no different from the common people.

II. 2017 Daily Journal Shareholders Meeting: Uncle Ho's Fable

Question: My question is about your speech for the Foundation of Financial Officer in California in 1998. In that speech, you criticized the complexity and high fees of many foundation investment portfolios, and you explicitly said, "Investing all the foundation's funds in three outstanding domestic companies for the long term is safe and rewarding enough." You used the Wicker Foundation and Coca-Cola as examples. So, if you have a $1 billion foundation now, would you be comfortable investing in only 3 stocks?

Munger: Let me modify your question. Does a non-diversified investment portfolio make me comfortable?

The Munger Foundation holds three stocks. Part of it is Berkshire, another part is Costco, and there is also a part of Li Lu's fund, with the rest being just some miscellaneous positions. Am I comfortable? Is the portfolio safe and rewarding enough? I am very comfortable. My portfolio has few stocks, not many names, can others feel as comfortable as I do? Neither holders nor investors will understand many stocks in a large portfolio. If they did as I do, their results would be better. Are three stocks enough? What is the likelihood of Costco failing? What is the likelihood of Berkshire Hathaway failing? What is the likelihood of Li Lu's investment portfolio failing in China? The likelihood of any of them failing is almost zero. So, what is the likelihood of all three failing?

This is a good idea I came up with when I was young. When I was a lawyer, starting to invest with my meager savings, I tried to figure out how diversified my portfolio should be if I wanted to outperform the market by 10% annually. I solved this problem, without using any formulas, I calculated it with high school algebra. And I realized that if my investment horizon was 30 to 40 years, and my portfolio never exceeded three stocks, with an average holding period of 3 to 4 years, I had a 99% probability of doing well.

From the moment I calculated this result with my little pencil, I never believed in their nonsense for a second. Why diversify? Diversification is for those who know nothing. Buffett calls them "ignorant investors." If you are an "ignorant investor," (through diversification) you will reach the average level. However, if you are not an ignorant investor, if you truly have the ability to find more effective methods, three is enough, choosing 50 stocks will actually harm your returns. Forget it, one is enough. If you find one definite opportunity, why do you need others?

We pay these professors to teach this nonsense to young people. The problem with corporate finance courses is that these people are rewarded for talking nonsense. The help for you in this (course) is that you know they are talking nonsense, but others believe their nonsense (so, you can easily outperform the market).

If you have an Uncle Horace, whose business is very secure and strong. He tells you that as long as you work at his company, he will leave everything to you. You don't need any diversification. You don't need guidance from any corporate finance professors; you should work with Uncle Horace. It's certain, you only need one definite opportunity! Sometimes the market will give you an opportunity equivalent to Uncle Horace. When such an opportunity arises, grab a big frying pan and walk up to the pie cart. Opportunities like this don't come often. When such an opportunity arises, you must have the determination and courage to seize it. I was lucky to learn this from my deceased great-grandfather at a very young age. I spent my life with the dead. They are much better than most people living on earth now. You can learn a lot from the deceased. You can pick up any book and communicate with the deceased, there is no communication barrier. So I highly recommend making friends with the deceased, it has been very helpful to me.

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When you find those rare opportunities, you must take aggressive action. That's the Munger way.

I indirectly learned this from someone I never met. He was my mother's grandfather. He was a pioneer in Iowa and participated in the Black Hawk War (the war to move the Indians westward). After experiencing great setbacks, he eventually became the wealthiest man in town, owning industries like banks. My mother knew him because she visited his residence in Algona, Iowa, the big house in the town center, with iron fences, spacious lawns, and large granaries. In his later years, Great-Grandfather Ehrman taught my mother, "You only have a few opportunities in your life." Only a few opportunities made him wealthy. When the black soil of Iowa was cheap, this guy took over the farmland in Iowa. Every time there was a panic, he would buy a few farms and rent them out to thrifty Germans. Renting farms to Germans in Iowa was a profitable deal. But he only seized a few opportunities, and that's probably how it is in the real world... you won't have a million brilliant ideas.

Chapter Three: Mount Everest

"In late 1951, I still invested about 75% of my assets in GEICO."

Starting from November 1958, Buffett invested one-third of the assets of his partnership in Sanborn Map Company.

By November 1964, Buffett's partnership owned over $4.3 million worth of American Express Company stock. He also placed big bets on two other companies: $4.6 million in Texas Gulf Producing Company and $3.5 million in Pure Oil Company, both considered as "cigar butts." These three investments accounted for more than half of the entire portfolio. By 1965, the investment in American Express alone made up one-third.

When the partnership was established in 1962, it only had $7.2 million in funds. Buffett was not afraid to concentrate his positions, continuously buying American Express stock, and by 1966, he had spent $13 million on the stock. He believed that the partners should understand a new "fundamental principle": "We are far from diversified like most investment institutions. Perhaps we will invest up to 40% of our net asset value in a single stock, based on two conditions: our facts and reasoning are highly likely to be correct, and the possibility of any significant change in the investment's intrinsic value is small."

Investment Brain Teaser: If Buffett had to comply with the new regulations that restrict a single stock position to no more than 25% during his private equity career, he would likely have faced accusations from the Fund Industry Association or the Securities Regulatory Commission for most of the time.

Entering the Berkshire era, Buffett's strategy actually became more aggressive, rather than conservative. While in the private equity era Buffett still had a rough framework for the overall portfolio, in the Berkshire era, Buffett's investment strategy was simple: buy until you can't buy anymore.

Either he had already acquired 100% of the shares (Berkshire, Nebraska Furniture Mart, Borsheims Fine Jewelry, See's Candies, FlightSafety, etc.), or the sellers refused to sell anymore (in the acquisition of Berkshire Hathaway Energy, Buffett could only increase his stake by one percentage point at a time), or the price exceeded Buffett's psychological threshold after purchase, like Western Oil:

Chapter Four: What is the Strategy of Value Investing?

In the eyes of Buffett and Munger, there is actually no concept of "heavy positions."

What they do is simply seize the few opportunities in front of them at all costs.

My view is even more extreme. I believe that in certain situations, it can be a rational choice for a family or a fund to invest 90% of its assets in a single stock. In fact, I hope that the Munger family can roughly follow this investment path. And I have found that so far, 90% of the assets of the Woodruff Foundation are still held in the Coca-Cola stock provided by its founder, proving that this approach is very wise. ——"Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger" —