This is Part 2 of Charlie Munger (Trades, Portfolio)'s 2018 Daily Journal shareholder meeting. Read Part 1 of the meeting notes here.
Question 24: Question regarding margin trading for Charlie and Rick Gueren. With the recent decline in the stock market, there were a lot of margin calls to customers. I know back in your partnership days, there was a big bear market and a lot of big declines in your portfolio. Would you care to comment on the productivity of margin trading?
Charlie: Well of course it's dangerous when you have a margin account because the person whose giving you credit can wipe you out at the bottom tick just because he feels nervous. And therefore of course, people like Berkshire just totally avoid any position where anybody else would start selling our securities because he felt nervous. And of course there are a lot of people now that are pushing margin trading very, very hard. And…the minute you got weird new instruments like these VIX contracts that triggered new selling because existing selling happens. So you get a feedback effect that were a little decline becomes a big one and then a big one becomes and bigger one, and so on. And it rapidly goes down a lot in a short time. I'm afraid that under modern conditions the risk of what happened recently with the VIX is just part of the modern conditions. And of course we'll always have margin traders who want to push life hard and we'll always have catastrophes. Neiderhoffer (link 1, 2) was just wiped out by the VIX, and that's the second time he's been wiped out. And he's a very talented man. Neiderhoffer was famous at Harvard. His name became a verb. He learned to what was called “to Neiderhoffer the curriculum”. He was a great card player and a great squash player, and a good national champion, and he was a scholarship student. He didn't have much money. So he had to get very high grades, and he didn't want to do any work. So he figured out how to “Neiderhoffer” the curriculum of Harvard. He signed up for nothing but the toughest graduate courses in economics. And the economics students in those advanced courses were doing a lot of the scut work for the professors, and so nobody ever gave them anything less than an A. And for a while Neiderhoffer didn't even go to class. They thought they had a new John Maynard Keynes at Harvard. And he was just signing up for courses where you couldn't get a low grade. Interesting story. Interesting man. Wiped out a second time. He's very brilliant. He was a very talented man. Pushing life that hard is a mistake. It's maybe a less of a mistake when you're trying to get out of the mire of mediocrity and get your head a little above the crowd. But when you're already rich, it's insane. Why would you risk what you have and need in order to get what you don't have and don't need? It really is stupid.
Question 25: Question about the U.S. high-speed rail system. As you know the high-speed rail act was introduced back in 1965 when Berkshire had their first annual meeting. What is your thinking, or outlook, or comments about the U.S. high speed rail system. Including the one that's being built here in California, as well as the possibility for a national high speed rail system.
Charlie: Well that's a very interest question. The high speed rail system which was aggressively create in China is a huge success and very desirable. So it's not like it's intrinsically a dumb idea. However in the…(inaudible)…we actually have in America, getting a big high speed rail system is really difficult, including having one even in California. And I'm not at all sure that trying to have a high speed rail system in California was wise all factors considered. But I'm not sure that it isn't on the other hand. Just put me down as skeptical, but not determinedly opposed. And I know it will cost a fortune, that I'm sure of. The trouble with it is that it's competing with something that works pretty well called the airplane. So, I can't answer your question except as I have. I know we need a big grid. I'm not sure the United States needs a high speed rail system for passengers. I would say that may have passed us by.
Question 26: Could you comment on whether you ever considered investments in Hershey's or Tiffany's over the long term and have offered attractive entry points?
Charlie: Well I'd be delighted to own either Hershey's or Tiffany's at the right price, wouldn't you? It's just a question of price. Of course they're great companies. But that's not enough, you have to have great companies available at a price you're willing to pay. Hershey's is a private company. Nobody's offering me Hershey's. I can buy the candy, but I can't buy the company.
Question 27: I'm here with my 92 year old Grandma whose spent the past 50 years investing for our family. As a college senior with a passion for value investing, it keeps me up at night knowing that I will eventually be entrusted with a portfolio she built for a lifetime. Based on the successful decisions that you've made for your large family here today, what advice do you have in regards to seizing the few opportunities when I will have to act decisively for my family without jeopardizing her life's work?
Charlie: Well of course I like any 92 year old person. (laughter) Particularly if it's a good looking woman whose also rich. (laughter) And whose descendants admire her. Instead of being eager to have her gone. (laughter) I'd say you have a big winner there in your family. Try to live your life so that you can be a big winner too.
Question 28: It looks like the A.I. will have a much bigger impact on society than the internet revolution, so would you mind maybe sharing some of your thoughts on how artificial intelligence will impact different industries in general and who it will impact the future of the human race?
Charlie: Well, that's a nice question. (laughter) The people who studied artificial intelligence don't really know the answer to that question. I'm not studying artificial intelligence because I wouldn't be able to learn much about it. I can see that artificial intelligence is working in the marketing arrangements of Facebook and Google, so I think it is working in some places very well. But it's a very complicated subject. And what its exact consequences are going to be, I don't know. I've done so well in life by just using organized common sense, that I never wanted to get into these fields like artificial intelligence. If you can walk around the shores and pick up boulders of gold, as long as the boulders keep being found and picked up, I don't want to go to the placer mining sifting vast amounts of data for some little edge. So you're just talking to the wrong person. And I'm not at all sure how great…I don't think artificial intelligence is at all sure to create an economic revolution. I'm sure we'll use more of it, but what are the consequence of using artificial intelligence to become the world's best (golden boy)? There may be places where it works, but we've thought about it at Geico for years and years and years, but we're still using the old fashion intelligence. So I don't know enough about it to say more than that.
Question 29: Questions about culture. How can an outsider really know a company's culture? And for that matter, how can an insider, at the top of an organization, really be certain about the culture of the company beneath him? And how would you go about assessing the culture of giants like Wells Fargo or General Electric? What is it that you look at that helps you understand culture?
Charlie: Well, you understand culture best where it's really down (low) in a place like Costco. And there the culture is a vast and constructive force. Which will probably continue for a very, very long time. The minute you get into General Electric, partly decentralized, partly not. Multi-business instead of one business. It gets very complicated. What is the culture of General Electric when the businesses can be so radically different? Maybe headquarters can have a certain kind of culture. And maybe the culture will be a little wrong. And maybe it's wrong to shift people around from business to business as much as they do. Which I strongly suspect. I do think…there are very few businesses like Costco that have a very extreme culture where everybody's bought into. And where they stay in one basic business all the way. I love a business like Costco because of the strong culture and how much can be achieved if the culture is right. But the minute you get into the bigger and more complicated places…I mean you can talk about the culture of General Motors or the culture of AT&T, it's a very difficult subject. What big businesses have in common by and large is that they get very bureaucratic. That's the one norm in culture is that they get very bureaucratic. And of course it happens to the government too. A big governmental body. And basically I don't like bureaucracy, it creates a lot of error. I don't have a substitute for it. I don't have a better way of running the U.S. government than the way they've been doing it. But I basically don't personally like big bureaucratic cultures and so I don't think very much about big bureaucratic cultures. I don't know how to fix bureaucracy in a big place. I would regard it as a sentence to hell if they gave me some company with a million employees to change the culture. I think it's hard to change the culture in a restaurant. A place that's already bureaucratic, how do you make it un-bureaucratic? It's a very hard problem. Berkshire has solved the problem as best it can…of bureaucracy. You can't have too much bureaucracy at headquarters if there's no bodies at headquarters. (laughter) That's our system. I don't think it arose because we were geniuses or anything. I think partly it was an accident. But once we saw what was working, we kept it. But I don't have a solution for corporate culture at monstrous places.
Question 30: What's your current view of climate change today?
Munger: Well, I'm deeply skeptical of the conventional wisdom of the people who call themselves climate scientists. I strongly suspect that they're more alarmed than the facts call for. And that they kind of like the fact that they can prattle about something they find alarming. I am not nearly as afraid as the typical so called climate scientist is, and I think the difficulties of what they urge as a remedy are under-estimated by these people. And besides, just because you're smart enough…suppose you, by knowing a lot of physics and so forth, could actively figure out that climate change was a huge problem, you were right. That would not automatically mean that you know how to fix it. Fixing it would be a vast complicated problem involving geo-politics, political science, all kinds of things, that just because you understood the chemistry of climate say, you wouldn't have any expertise as…So I think there's a hell of a lot of nonsense being prattled on the climate change things. But no, there's no doubt that the CO2 does cause some global warming. But just because you accept that doesn't mean that the world is absolutely going to hell in a hand-basket. Or that the seas are going to rise by 200 feet any time soon and so on. So I'm deeply skeptical of a lot of these people, and yet I don't want to be identified with the no-nothings who really are vastly ignorant and wouldn't even recognize that CO2 does have some influence on temperature. Now I've tried to offend everybody…(laughter)
Question 31: In an age that's very different than the one you grew up in, if you're a young guy like me with a lot of runway like Peter talked about, where would you focus your attention?
Munger: Well, I'd approach life a lot like Carlyle. I would just get up every morning and do the best I could in every way and I'd expect over time to do pretty well. And it's not very hard. I'd try to marry the right person instead of the wrong person. Everything would be quite (trite). I would guess that practically everybody your age in this room is going to do pretty well. You're not that mad at the world here. You're trying to figure out how to cope with it a little better. You're going to do alright. People like that succeed. But if you all came in here with placards, sure you were right on every subject and wanted to shout back? You wouldn't have such a bright future. Those people are pounding their idiocy in instead of (shutting it out).
Question 32: Which cognitive biases are particularly at scale on a national scale these days?
Charlie: Well its hard, with so many cockroaches in the kitchen it's hard to identify each… (laughter) I would say every bias that man is prone to is always working. That's the nature of the system. It's amazing what people have come to believe. And it's amazing how polarized our parties are becoming. And now you turn on TV, and you can even turn to channel A and you've got your kind of idiot, or you click channel B and you got the other fellow's kind of idiot. What they have in common is that they're both idiots. They're playing to an audience that is mentally defective. (laughter) Of course it's a little disquieting. I was use to a different world. I liked Walter Cronkite. This choose your idiot form of news gathering, I don't much like. What do you do? I flip back and forth between idiot types. I will not stay with just one type of idiot. (laughter) So that's my system. But you're right. It's weird. Now the world has always had weird idiots. Hitler was an idiot…a smart idiot, but an idiot. We're always going to have crazy people and crazy people who follow crazy people. Part of what I like about that situation is…it gives you more incentive to think correctly yourself. I find life works best when you are trying to stay rational all the time. And I must say, these idiots are giving me more incentive. I don't want to be like any of them. Don't you feel that way when you turn on the TV and here's one idiot mouthing this way, and the other one mouthing this way, and misrepresenting the facts? I don't want to be like either of them! I don't know whether we're going to have more of what's developed or whether we're going to go back to something that's more pleasant. But it's kind of interesting to watch, I will say that.
Question 33: What do you think of the critical challenges that business models relying heavily on advertising as a source of revenue in a digital age?
Charlie: Well if I'm following that correctly, you do live in an age where people using computer science to sift out correlations that might be predictive and then to try trading on those algorithms on an instant basis, in and out. Where large amounts of money have been made, by say, Renaissance Technologies. And there's way more of that and its worked for those people. And I don't consider it a good development. I don't see any big contributions to civilization, having a lot of people using computer algorithms to out-trade each other on a short-term basis. Some people think it creates more liquidity in the markets and therefore it's constructive. But I could just as soon do without it. I would rather make my money in some other way than short-term trading based off of computer algorithms, but there is more of it, you're right about that. And by and large, the one thing they have in common is that they can't take infinite amounts of money. You try and file too much money into an algorithm and it's self-defeating. And thank God it's self-defeating.
Question 34: I was hoping to gain some insight regarding your and Warren's discussions into airlines. Whether or not it was a light-bulb that went off in a certain year. Or whether it morphed over time. Just trying to get an idea about when you got open minded about maybe investing into airlines and how you changed your mind.
Charlie: Well, we did change our mind. For a long time, Warren and I (painted over) the railroad because there were too many of them, and it was too competitive, and union rules were too crazy. They were lousy investments for about 75 years. And then they finally…the world changed and they double decked all the trains and they got down to four big rail systems in all the United States in terms of freight and all of a sudden we liked railroads. It took about 75 years. Warren and I never looked at railroads for about 50 years, and then we bought one. (link)
Now airlines, Warren use to joke about them. He'd say that the investing class would have done better if the Wright Brothers would never have invented flight. But given the conditions that were present when the stock was purchased and given the conditions of Berkshire Hathaway where it was drowning in money, we thought it was ok to buy a bunch of airline stocks. What more can I say? Certainly it's ok to change your mind when the facts change. And to some extent the facts had changed, and to some extent they haven't. It is harder to create the little competing airlines than it was. And the industry has maybe learned something. I hope it works better, but I don't think its…I think the chances of us buying airlines and holding them for 100 years is going to work that well. I think that's pretty low.
Question 35: Question about DJCO. The auditor's report discussed material weakness in segregated duties. I was curious if that was something you could speak on. If it's something you're fixing. Or not if not, whether or not it's rational.
Charlie: Well, all auditors are now paid to find some kind of weakness and then fix it. So there's very few companies that don't have some little material weakness that needs fixing. I am not that worried about the accounting at the Daily Journal. Basically it's more conservative than other people in our industry. And basically we're not trying to mislead anybody. And basically we've got a couple hundred million dollars in marketable securities and we're not mismanaging those, they just sit there. So I don't think we have big accounting problems at the Daily Journal. I think it's typical of the modern developments in accounting that the accountants have gotten… (inaudible)…and they've gotten new responsibilities and they're amorphous. Like “weakness”. Well everybody has weakness, you, me. And I don't think there's some wonderful accounting standard where all the accountants know what's weak and what isn't and exactly how much and how dangerous it is. And so I am not much worried about the accounting at the Daily Journal. But I think this business of…everybody in America is worried about somebody hacking in and getting a lot of data, and everybody has some weakness, meaning they're all afraid of, and they're right to be afraid of it. You've got these amorphous terms. I'm just doing the best we can, and taking the blows as they come. Or the benefits too. But I'm not worried about material weaknesses in accounting.
There was a guy name B.B. Robinson when I came to Los Angeles, and he had gotten out of the pools, the stock pools of the 20's, as a young man with 10 or so million dollars, which was a lot of money to come out here in the 30's. When he got here with all this money, he spent his time drinking heavily and chasing movie starlets. And in those days the bankers were more pompous and old fashioned. And one of them called him in and said, ‘Mr. Robinson, I'm terribly worried about your drinking all this whisky and chasing all these movie starlets. This is not the kind of thing our sound banks likes.' What B.B. Robinson said to the banker, he said, ‘Listen. My Municipal Bonds don't drink.' (laughter) That's basically the answer to the material weakness problem with the Daily Journal. Our lovely marketable securities aren't drinking.
Question 36: If you're not willing to put the work into investigating specific stock investments, that you should perhaps put your money into a passive index fund. One of my advisers is very concerned about the move of capital into index funds for three reasons. First he says, there's an inadvertent concentration into (few) stocks because similar investments in different indexes. Second, he thinks long term, the concentration of capital into preferred companies that are in the index fund…that they're able to raise money easily despite poor performance. And third, he's also concerned long-term that the concentration of the management of these index funds into three institutions which is detrimental to the market place. I'd appreciate your comments.
Charlie: I think that a lot of people who are in the business of selling investment advice, hate the fact that the indexes have been outperforming them. And of course, they can't say, “I hate it, because it's ruining my life.” But they say, “I hate it because it's too concentrated.” Well the index contains 75% of the market capitalization. It's hardly so small. Index investing will work for quite a while when it's so broad. I don't think it's ruining the world or anything like that. It is peculiar that we lived a long time without this. I think it'll keep running a long time forward, and I think it'll work pretty well for a long time. And I suspect most money-managers just hate it. It's making their life hard. But you see I don't mind if people are having a hard life.
Question 37: History doesn't repeat itself, but it certainly rhymes. And we're seeing this mania in Bitcoin, that is often akin to the Tulip mania, and I'd like to see your views on how you and Warren navigated through these waters in your several decades of investing. And what it says about the human condition that we tend to keep constantly falling for these things despite what history teaches us otherwise.
Charlie: Well you're of course right to suspect that I regard the Bitcoin craze as totally asinine. To create some manufactured currency…A different payment system could happen like WeChat in China. It's a better payment system than the one we have in America. So something like that could happen. But Bitcoin where they're creating an alternative to gold…and then make a big speculative vehicle?…I never considered for one second having anything to do with it. I detested it the moment it was raised, and the more popular it got, the more I hated it. On the other hand, I expect the world to do insane things from time to time. Everybody wants easy money. And of course the people who are peddling things and taking money off the top for promoting the investment, they like it too. And so these crazies just keep coming and coming and coming. But who would want their children buying things like Bitcoin? I just hope to God that doesn't happen to my family. It's just disgusting that people would be taken in by something like this. It's crazy. I'm not saying that some different payment system might not be a good thing like WeChat. That could come and be constructive. But Bitcoin is noxious poison. Partly they love it because the computer science is quite intriguing to people with mathematical brains. It's quite a feat what they've done as a matter of pure computer science. But, you know, I'm sure you can get terribly good at torture if you spend a lot of time at it. (laughter) It's not a good development. And the government of China which is stepping on it pretty hard is right and our government's more lax approach to it is wrong. The right answer to stuff like that is to step on it hard, and it's the government's job.
Question 38: What are the qualities you look for in a life partner?
Charlie: In a life partner? Well I've been quoted on that. I think what you really need in a life-partner, if you're constructed the way I am, is somebody with low expectations.
Well I think it's 12 o'clock and that should probably do for this group. I know you…I'm use to the groupies, but standing up for two hours? I wouldn't stand up for two hours to listen to Isaac Newton if he came back. (laughter) So I guess our meeting is adjourned. I certainly wish you all well, you're my kind of people.
Charlie: Gerry, is there anything else that I'm suppose to do?
Gerry Salzman: That's it Charlie.
Charlie: It's very burdensome. (laughter) So many of you have come from such great distances (that) I'm going to speak briefly on a number of topics that may interest you and then I'm going to take questions.
It's amazing the number of people at the meeting of the little Daily Journal Corporation which after all is a pretty small operation. We've got two businesses one a steadily declining legal newspaper which now earns about a million in a year pre-tax and shrinking, and a computer software business where we're trying to automate courts and justice agencies and various other governmental departments. And that is now bigger by far in terms of prospects and customers and employees and so forth than our shrinking newspaper business. It hardly can be imagined how hard it is to deal with a whole bunch of different courts in different states and their advisers and the RFP process and the bureaucracy. This is a part of the software business that the giants tend to hate. They like a business where you just stamp out an extra copy of something and 98 percent of the revenues go immediately into the till as cash and there's no extra work. And that is not handling a bunch of justice agencies, attorney generals, state courts, federal courts, and so forth all over the country with different requirements, different consultants, and of course steady and aggressive competition. The nature of our business it's more like technical consulting than it is just stamping out software. It's a very high service business. It's very difficult. The computer science is time consuming and difficult. But just dealing with that much bureaucracy over that many different fields with the political realities…it's just immensely difficult. So it's a very slow grinding business and that's the nature of the game. We have always liked it because a business like this requires a company that's very rich and very determined and is willing to keep plugging. And of course that's what the Daily Journal has done.
How are we doing? Well that's hard to judge, but I would say watching it quite closely that it's like a pharmaceutical company with seven wonderful drugs in the pipeline. We have a lot in the pipeline that is very very important to us. Australia, Canada, California. We're talking big big markets.
Our main competitor is Tyler Technologies which is listed on the New York Stock Exchange and of course they've been at it a long time and are way bigger, but we are getting some significant volume and we have some very pleased customers. How in the hell does the little Daily Journal Corporation attract the Government of Australia? Australia is a big place. But I've gotten to love the Australians and I think it's going to succeed in Australia, mightily. And so it takes a long time and it's hard work and it's also very difficult work. Not everybody can do this. Just the mass of complexity. We would never be where we are if we didn't have Gerry Salzman to do everything he's done over the last ten years. Anybody else would have failed at this. Now Gerry is 80 and he and I have one thing in common, we both use canes. When I'm not in a wheelchair I use a cane. So the idea of taking on the whole world when the chairman is 95 and the vice chairman is 89 and the chief executive that does all the work is 80 and uses a cane…It's a very peculiar place that you people have come a long way to. What the hell are you thinking about?
It's weird and what's happened of course is that we're standing a bit for some combination of basic morality and sturdy common sense. And it's amazing how well Berkshire Hathaway, and the Daily Journal for that matter, have succeeded with nothing more than basic morality and sturdy common sense. But of course when people talk about common sense they mean ‘uncommon sense'. Every time you hear that somebody has a lot of common sense it means he's got uncommon sense. And it is much harder to have common sense than it is generally thought.
Let me give you an interesting example. The investment world involves an enormous amount of high IQ people trying to be more skillful than normal. You can hardly imagine another activity that gets so much attention. And weird things have happened. Years ago one of our local investment counseling shops, a very big one, they were looking for a way to get an advantage over other investment counseling shops. And they reasoned as follows. We've got all these brilliant young people from Wharton and Harvard and so forth and they work so hard trying to understand business and market trends and everything else. And if we just ask each one of our most brilliant men for their single best idea then created a formula with this collection of best ideas, we would outperform averages by a big amount. And that seem plausible to them because they were ill-educated. That's what happens when you go to Harvard and Wharton. So they tried it out, and of course it failed utterly. So they tried it again and it failed utterly. And they tried it a third time and it also failed. Of course what they were looking for is the equivalent of the alchemists of centuries ago who wanted to turn lead into gold. They thought if you could just buy a lot of led and waive your magic wand over and it turned into gold, that would be a good way to make money. This counseling shop was looking for the equivalent of turning lead into gold and of course it didn't work. I could've told them but they didn't ask me. Nothing.
The interesting thing about this situation is that this is a very intelligent group of people that's come from all over the world. You've got a lot of bright people from China where people tend to average out a little smarter. And the issue is very simple. It's a simple question. Why did that plausible idea fail? Just think about it for a minute. You've all been to fancy educational institutions. I'll bet you there's hardly one in the audience who knows why that thing failed. That's a pretty ridiculous demonstration I'm making. How could you not know that? It's one of the main activity of America with an obvious and important failure. Surely we can explain it! You have to have stayed awake in your freshman college courses to answer that question. But if you ask that question at a Department of Finance at a leading place, the professors wouldn't answer it right. Now I'm going to leave you that question because I want you perplexed. And I will go on to another issue.
But that's one you should be able to answer. It shows how hard it is to be rational on something very simple. How hard it is…How many kind of crazy ideas people have and don't work, and you don't even know why they don't work even though it's perfectly obvious if you've been properly educated. And by the way my definition of being properly educated is being right when the professor is wrong. Anybody can spit back what the professor tells you. The trick is to know when he's right and when he's wrong. That's the properly educated person. And ofcourse they're frequently wrong particularly in the soft sciences. In fact if you look at a modern elite institution, it's fair to say that a lot of the faculty are a little crazy. It's so left wing now in the humanities and it's very peculiar. That's another thing. Why should 90 percent of the college professors in the humanities be very left wing? I leave that question for you too. But it happens.
Another issue of course that's happened in the world of stock picking, where all this money and effort goes into trying to be rational, is that we've had a really horrible thing happen to the investment counseling class. And that is these index funds have come along and they basically beat everybody. And not only that, the amount by which they beat everybody is roughly the amount of cost of running the operation and making the changes in investments. So you have a whole profession that is basically being paid for accomplishing practically nothing. This is very peculiar. This is not the case with bowel surgery or even the criminal defense bar in the law or something. They have a whole profession where the chosen activity they've selected they can't do anything.
Now in the old days the people in the profession always had some of this problem and they rationalized as follows. ‘We are saving our clients from the insurance salesman and the stock broker, the standard stock broker that serves the active trader.' And they were saving people from the life insurance salesman and the hustling stockbroker who liked active trading. And I suppose in a sense that the investing class is still saving those people from an even worse fate.
But it is very peculiar when a whole profession that works so hard, and is so admirable, and the members of which we are delighted when they marry into our families, and they just can't do what their profession is really trying to do, which is get better than average results. How is that profession handling this terrible situation, as index investing gets more and more popular and including a lot of fancy places?
Well it's a very simple answer, they're handling it with denial. They have a horrible problem they can't fix, so they just treat it as nonexistent. This is a very stupid way to handle a problem. Now it may be good when you're thinking about your own death which you can't fix and it's just denial all the way to the end. But in all the practical fields of life, this problem thoroughly understood is half solved or better coped with.
So it's wrong to have all these people in just a state of denial and doing what they always did year after year and hoping that the world would keep paying them for it even though an unmanaged index is virtually certain to do better. It's a very serious problem. And think of how much New York say needs a flow of money from finance. Think what would happen to Manhattan if there weren't any fees for investment management or trading spreads and so on. So it's a weird situation and of course it's unpleasant. Big investment counseling shops, some of them shrink and some go out of business. And the value investors, of course who many of I know because we came from that tradition, the value investors who were honorable are quitting. Boom. Boom. Boom. And what worked for them for years stopped working and they're honorable people they just quit. And they're also rich which makes it easy. But those who aren't rich have a hell of a problem. And it costs about fifty thousand dollars in the city of Manhattan to send your kid to pre-school. Non-deductible. And that's just the start of an endless procession of years of vast expanse. So if your game is money management you have a serious problem. I don't have any solution for this problem. I do think that index investing, if everybody did it won't work. But for another considerable period, index investing is going to work better than active stock picking where you try and know a lot.
Now at a place like Berkshire Hathaway or even the Daily Journal, we've done better than average. And now there's a question, why has that happened? Why has that happened? And the answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on and so on. We never had that dream. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. (laughter) We always realized that if we worked very hard we can find a few things where we were right. And that a few things were enough. And that that was a reasonable expectation. That is a very different way to approach the process. And if you had asked WarrenBuffett the same thing that this investment counseling did, “Give me your best idea this year.”, and you had just followed Warren's best idea, you would find it worked beautifully. But he wasn't trying to know the whole…he would give you one or two stocks. He had more limited ambitions.
I had a grandfather who was very useful to me, my mother's grandfather, and he was a pioneer. He came out to Iowa with no money but youth and health and took it away from the Indians. He fought in the Black Hawk…he was a Captain in the Black Hawk Wars, and he stayed there and he bought cheap land and he was aggressive and intelligent and so forth and eventually he was the richest man in the town and owned the bank, and highly regarded, and a huge family, and a very happy life. He had the attitude…having come out to Iowa when the land was not much more than a dollar an acre, and having stayed there until that black topsoil created a modern rich civilization, and some of the best land in the world…His attitude was that in a favored life like his, when you were located in the right place, you just got a few opportunities if you lived to be about 90. And that the trick in coming out well was seizing a few opportunities that were your fair share that came along when they did. And he told that story over and over again to the grandchildren that hung around him all summer, and my mother who had no interest in money remembered the story and told it to me. But I'm not my mother's natural imitator and I knew Grandpa Ingham was right. And so I always knew from…when I was a little boy that the opportunities that were important…that were gonna come to me…were few and the trick was to prepare myself for seizing the few that came. This is not the attitude that they have at a big investment counseling thing. They think if they study a million things they can know a million things. And of course the result is that almost nobody can outperform an index. Whereas I sit here with my Daily Journal stock, my Berkshire Hathaway stock, my holdings in Li Lu (Trades, Portfolio)'s Asian fund, my Costco stock, and of course I'm outperforming everybody. (laughter) And I'm ninety-five years old. And I practically never have a transaction. And the answer is that I'm right and they're wrong. And that's why it's worked for me and not for them. And now the question is do you want to be more like me or more like them?
The idea of diversification makes sense to a point if you don't know what you're doing and you want the standard result and not be embarrassed, why course you can widely diverse. Nobody's entitled to a lot of money for recognizing that because it's a truism it's like knowing that two and two equals four. But the investment professionals think they're helping you by arranging diversification. An idiot could diversify a portfolio! Or a computer for that matter. But the whole trick of the game is to have a few times when you know that something is better than average and to invest only where you have that extra knowledge. And then if you get just a few opportunities that's enough. What the hell do you care if you own three securities and J.P. Morgan Chase owns a hundred? What's wrong with owning a few securities? Warren always says that if you lived in a growing town and you owned stock inthree of the best enterprises in the town, isn't that diversified enough? The answer is of course it is…if they're all wonderful places. And that Fortune's formula which got so famous which was a formula to tell people how much to bet on each transaction if you had an edge. And of course the bigger your edge, the more close the transaction was to a certain winner, the more you should bet…And of course there's mathematics behind it…But of course it's true. It's perfectly possible to buy only one thing because the opportunity is so great and it's such a cinch. There are only two or three. So the whole idea of diversification when you're looking for excellence, is totally ridiculous. It doesn't work. It gives you an impossible task. What fun is it to do an impossible task over and over again? I find it agony. Who would want to do it?And I don't see a way…
My father had a client, he was a lawyer in Omaha, he had a client whose husband had a little soap company. The guy died and my father's sold the soap company. This woman was one of the richest people in town in the middle of the depression, and what she had was a little soap company and the biggest mansion in Omaha's best neighborhood. When they sold the soap company she had a mansion in the best neighborhood and three hundred thousand dollars. But three hundred thousand dollars in nineteen thirty something was an incredible amount of money. A little hamburger it was a nickel a big hamburger was a dime, and the all you can eat cafe in Omaha would feed you all needed to stay alive for two bits a day. I mean 300,000… Well she didn't hire an investment counselor, she didn't do anything, she's a wonderful old woman. She just took that, she divided it into five chunks, and she bought five stocks. I remember three of them because I probated her estate. One of them was General Electric, one was Dow, one was Dupont, and I forget the other two. Then she never changed those stocks. She never paid any adviser. She never did anything, and she bought some municipal bonds, she never spent her income, and she bought some municipal bonds from time to time with the (inaudible). By the time she died in the 50s she had a million and a half dollars. No cost. No expenses. I said, “How did you decide to do that?” And “Well…” she said, “I thought electricity and chemistry were the coming things.” She just chucked it all in and sat on her ass. I always liked that little old woman. My kind of a girl. But it's rare!
But if you stop to think about it, think of all the expense and palaver that she didn't have to listen to and all the trouble she avoided, and zero costs. And of course what people don't realize, because they're so mathematically illiterate, is if you make 5 percent and pay 2 of it to your advisors, you're not losing 40 percent of your future you're losing 90 percent. Because over a long period of time that little difference causes a 90 percent disadvantage to you. So it's hugely important for somebody who's a long term holder not to be paying a big annual toll out of the performance. And of course there are a few big time advisors now who are using indexation very heavily. And of course they're prospering mightily. And of course every time they get somebody it's just agony for the rest of the investment counseling business. This is a very serious problem. And I think these people who were used to winning as old-time value investors who are now just quitting the profession. That's a very understandable thing to do. I regarded it as more noble than staying in…you know…playing along with the denial. It's an interesting problem.
You can see I'm not trying to make your morning. I'm just trying to describe things the way they are. But this business… Why does Li Lu (Trades, Portfolio) succeed so mightily? Well partly he's sort of a Chinese Warren Buffet. That really helps. And partly he's fishing in China! Not in this over-searched, over-populated, highly competitive American market, and there's still pockets of ignorance and lassitude in China that gave him so unusual opportunities. Thefirst rule in fishing has always been fish where the fish are. And the second rule of fishing has always been ‘Don't forget rule number one'. And Li Lu (Trades, Portfolio) just went where the fishing was good and the rest of us are like cod fishermen who are trying to catch cod where the fish have been fished out. It doesn't matter how much you work, when there's that much competition. Every little idea I see in the world some are going after. I sat once on aninvestment committee at the University of Michigan and in came one of their successful investors located in London. And what had this investor done in London? He decided to invest in sub-Saharan Africa. And the only marginal securities were a few banks that traded in the Pink Sheets, so he would buy very tiny quantities of these banks. And every time some poor person got tired of having their money in the mattress and put it in a bank he did a little better. And of course he made a lot of money. Nobody else was investing in little tiny banks in Africa. But the niche was soon filled. What the hell do you do for an encore after you put your client's money in a bunch of little tiny banks in sub-Saharan Africa? The niche gets filled quickly. How many wonderful niches are there going to be when some guy in London is buying all these tiny little bank stocks in Africa? It's hard.
Then if you take the modern world where people are trying to teach you how to come in and trade actively in stocks. Well I regard that as roughly equivalent to trying to induce a bunch of young people to start off on heroin. It is really stupid. And when you're already rich to make your money by encouraging people to get rich by trading? And then there are people on the TV, another wonderful place, and they say, “I have this book that will teach you how to make 300 percent a year. All you have to do is pay for shipping and I will mail it to you!” (laughter) How likely is it that a person who suddenly found a way to make 300 percent a year would be trying to sell books on the internet to you! (laughter) It's ridiculous. And yet I've described modern commerce. And the people who do this all day think they're useful citizens. The advertising agents who invent the lingo. In insurance they say, “Well” they say, “the two people who shifted from Geico to the Glotz insurance company save four hundred dollars each.” But what they don't tell is that there are only two such people in the whole United States and they were both nuts. But they mislead you on purpose. I get tired of it and I don't think it's right that we deliberately mislead people as much as we do.
Let me tell you another story that I think is an interesting one about the modern life, but this goes back to a different time. This man has this wonderful horse. And it's just a marvelous horse. It's got an easy gait, good looking, and everything. It just works wonderfully. But also occasionally it just gets so he's dangerous and vicious and causes enormous damage and trouble and breaks arms and legs for his rider and so on. And he goes to vet and says, “What can I do about this horse?” And the vet says, “That's a very easy problem and I'm glad to help you.” And he says, “What should I do?” And the man says, “The next time your horse is behaving well, sell it.” (laughter) Think about it immoral that is. And haven't I just described what private equity has to do? (laughter) When private equity has to sell something that's really troublesome, they hire an investment banker. And what does investment banker do? He makes a projection! I have never seen such expertise in my whole life, as is created in making projections in investment banking. There is no business so lousy that it can't get a wonderful projection. But is thata great way to make a living to have phony projections and use it to make money out of people you look right into their eyes of? I would say no.
By and large Warren and I, we never tried to make money out…stupidity of our dumb buyers. We tried to make money by buying, and if we were selling horseshit we didn't want to pretend it was a cure for arthritis. (laughter) And I think it's better to go through life our wayinstead of theirs. I think it's always been this way, I think there's always been chicanery. Think of the carnivals, the carny operator. Think of how much trickery there is in a carny operation. People just seek out the weaknesses of their fellow man and take advantage. And you have to get wise enough so you avoid them all. And you can't avoid them if they'rein your family. I have no solution to that one. (laughter) But where you have a fair choice, there are just so many people that should be avoided.
My father had this best friend and client and he also had this other client who is a big blowhard and he was always working for the big blowhard and he wasn't ever working for his wonderful client whom I admired. And I said, “Why do you do this?” And he said, “Charlie you idiot…” He says, “the big blowhard is an endless source of legal troubles. He's always in trouble.
Overreaching and misbehaving and so forth. Whereas Grant McFadden treats everybody right. The employees, the customers, everything. And if he gets involved with some psychotic he walks over there and makes a graceful exit immediately. A man like that doesn't need a lawyer.” My father was trying to teach me something and it really worked. I spent my whole life trying to be like Grant McFadden and I want to tell you it works. It really works. Peter Kaufman is always telling me if the crooks only knew how much money you could make by being honest, they'd all behave differently. Warren has a wonderful saying that I like, he says, “You take the high road. It's never crowded.” And it's worked.
Take the Daily Journal Corporation. We made quite a few millions of dollars out of the foreclosure boom because we published legal notices and we dominated the publication of foreclosure notices in the worst real estate depression in the history of modern times. And we could have raised our prices at the time and made more tens of millions of dollars. But we didn't do it. You know what your fellow citizens are losing their damn houses in the worst recession…'Charlie Munger (Trades, Portfolio) billionaire raises prices'. It would look lousy on the front page of the paper (if people read the story). Should you do it? And the answer is no of course not. Warren always said it's probably always a mistake to marry for money and it's really stupid if you're already rich.
And it's really stupid when you're already rich to get a reputation of being a total nogoodnik. Rick Guerin always loved the story about the guy who had been a total miscreant all his life, and (when) he died the minister said, “Now is the time in the funeral ceremony when somebody says something nice about the deceased.” And nobody came forward and nobody came forward and nobody came forward. Finally one guy stood up and he said, “Well” he said, “His brother was worse.” (laughter) Well you can laugh but there are people like that. When Harry Cohn died here the saying was that everybody went to the funeral to make sure he was dead.
So there are a few simple truths that really work. And when it gets to this difficult business the Daily Journal is in, I wouldn't say it is a real pleasure to be serving these courts and agencies. They need the automation. Other people are trying to take advantage of them in ways that we aren't. And we're struggling against the odds (being) a little tiny company. And we're taking a lot of territory. It's slow going but the prospects are good. And of course the nice thing about being rich is that it doesn't matter if it's a little slow. And how do we get rich? Well we remembered Grandpa Ingham, and when one of the few opportunities came along we reached out and seized it. Think of how your life works?
In my life, to give another example, the Mungers would have twice the assets they now have if I hadn't made one mistake of omission back in nineteen 70s. And…really stupid. I blew an opportunity that would have doubled my present net worth. That is a normal life. You get one or two. And how things work out…We all know people that are out married, I mean their spouses are so much better. Think of what a good decision that was for them. And what a lucky decision. Way more important than money. A lot of them did it when they were young, they just stumbled into it. Now you don't have to stumble into it, you can be very careful. A lot of people are wearing signs, “Danger. Danger. Do not touch.” And people just charged right ahead. (laughter) That's a mistake. Well you can laugh but it's still a horrible mistake.
It's been fun for the people on this board to know one another and work on these oddball things and handle life's vicissitudes. Of course it's very peculiar that we're so old. I mean imagine a place where Gary Wilcox is one of the young men. The guy's wife is still in golf champion. But that's (not because she's good when she's old.) I mean it's an amazing group. That's an interesting example too. Imagine me as an old and as impaired as I am and having a pretty good time. How does that happen? Well you…That is another story.
I'll tell a couple of other stories too because you like stories. Here's an apocryphal story that is very instructive. A young man comes to visit Mozart. And he says, “Mozart” he says, “I want to write symphonies”. And Mozart says, “How old are you?” The man says, “I'm 23.” And Mozart says, “You're too young to write symphonies.” And he says, “But Mozart you were writing symphonies when you were 10 years old.” And Mozart says, “Yes but I wasn't asking other people how to do it.” Now there's another Mozart story. Here's the greatest musical talent maybe that ever lived. And what was his life like? Well he was bitterly unhappy and he died young. That's the life of Mozart. What the hell did Mozart do to screw it up? Well he did two things that are guaranteed to create a lot of misery. He overspent his income scrupulously, that's number one. That is really stupid. And the other thing was he was full of jealousies and resentments. If you over-spend your income and be full of jealousy and resentments, you're going to have a lousy unhappy life and die young. All you've got to do is learn from Mozart. You can also learn from that young man who was asking Mozart how to write symphonies. The truth of the matter is that not everybody can learn everything. Some people are way they hell better. And of course no matter how hard you try there's always some guy who achieves more. Some guy or gal. My attitude is ‘so what?'. Does any of us need to be the very top of the whole world? It's ridiculous.
Another thing that people do that I regard as amazing is they build these enormous mausoleums. I think they figure they want people to walk by that mausoleum and say, “Gosh I wish I were in there!”.
Anyway. You can see we've have had some fun as we go along and it's worked so well. But if you actually figure out how many decisions were made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway it wasn't very many per year that were meaningful. It's a game of being there all the time and recognizing the rare opportunity when it comes and recognizing that the normal human allotment is to not have very many. Now it's a very competent bunch of people who sell securities who act as though they'vegot an endless supply of wonderful opportunities. Well those people are the equivalent of the race track tout. They're not even respectable. It's not a good way to live your life to pretend to know a lot of stuff you don't know and pretend to furnish a lot of opportunities you're not furnishing. And my advice to you is avoid those people, but not if you're running a stock brokerage firm. You need them. But it's not the right way to make money. This business of controlling the costs and living simply, that was the secret. Warren and I had tiny little bits of money. We always underspent our incomes and invested. And if you live long enough you end up rich. It's not very complicated.
Now there is a part of life which is, how do you scramble out of your mistakes without them costing too much? And we've done some of that too. If you look at Berkshire Hathaway, think of its founding businesses. A doomed department store, doomed New England textile company, and a doomed trading stamp company. Out of that came Berkshire Hathaway. Now we handled those losing hands pretty well when we bought into them very cheaply. But of course the success came from changing our ways and getting into the better businesses. It isn't that we were so good at doing things that were difficult. We were good at avoid things that were difficult. Finding things that are easy.
By the way, when we bought the Daily Journal that was easy. What we're doing now in this software business is difficult. But due to the accident of these good associations and the fact that these old colleagues have lived so long, we're doing pretty well in the new business. It has potential. And it's fun to do. How many declining newspapers have hundreds of millions of marketable securities lying around and a new business with some promise? We're like the last of the Mohicans.
Read Part 3 of the 2018 Daily Journal meeting notes here.
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