I recently had a dream, where I met the legends of investing – Warren Buffett, Charlie Munger, Peter Lynch and Jim Rogers.
Since you have the right to see anything in your dream, I saw these legends visiting my home to personally teach me the nuances of investing. As I remember, the year was 2003, and I had not yet started investing in stocks. I was confused then, and thus found their visit as a great opportunity to pick their brains on investing.
Here is the transcript of my dream based on what I remember.
Me: I am a small investor, have little money to invest, and I’m not an expert. Can I really make money from the stock market?
Warren Buffett: It’s a huge structural advantage not to have a lot of money.
Look at me. The universe I can’t play in i.e., small companies has become more attractive than the universe I can play in, that of large companies. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in.
Me: But what about the intelligence? Isn’t a high level of intelligence required to succeed as an investor?
Buffett: If you are in the investment business and have an IQ of 150, sell 30 points to someone else. You do have to have an emotional stability and an inner peace about your decisions. It is a game where you are bombarded by minute-by-minute opinions. It’s not a complicated game. It’s simple, but it’s not easy. You have to have an emotional stability.
Me: You are making it sound too easy! But isn’t investing a domain of the well-educated experts like fund managers and analysts?
Buffett: You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.
Me: Okay, but what about the emotional stability part? How can I cultivate that?
Charlie Munger: I have something to add here. You’ve got to have models in your head and you’ve got to array your experience – both vicarious and direct – on this latticework of models…. The first rule is that you’ve got to have multiple models because if you just have one or two that you’re using, the nature of human psychology is such that you’ll torture reality so that it fits your models, or at least you’ll think it does… And the models have to come from multiple disciplines because all the wisdom of the world is not to be found in one little academic department.
Me: Oops! That sounds like work reserved for the brilliant few! Isn’t it?
Munger: You don’t have to be brilliant, only a little bit wiser than the other guys, on average, for a long, long time.
Buffett: Indeed! It is not necessary to do extraordinary things to get extraordinary results.
Me: But extraordinary things happen in the stock market!
Buffett: Anything can happen in stock markets and you ought to conduct your affairs so that if the most extraordinary events happen, that you’re still around to play the next day.
Me: How do I deal with such high volatility in stock prices, which makes investing so risky? Sometimes it looks like one big casino!
Buffett: Volatility does not measure risk. Past volatility is not a measure of risk. It’s nice math, but it’s wrong.
Me: Wrong? But that’s what the financial professors teach…even the reputed ones! Are you saying they are all wrong?
Buffett: Because people who teach finance use the mathematics that they have learned, they translate volatility into all types of measures of risks — it’s nonsense. Risk comes from the nature of certain types of business, and from not knowing what you’re doing. If you understand the economics of the business that you’re engaged in and you trust the people you are partnering with, you’re not running significant risk.
Me: Simplify that, please!
Buffett: Volatility is a symptom that people have no idea of the underlying value. Risk comes from not knowing what you’re doing.
Me: So how do I know what I am doing?
Munger: Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.
In my whole life, I have known no wise people who did not read all the time-none, zero. You would be amazed at how much Warren reads-and at how much I read. My children laugh at me, they think I’m a book with a couple of legs sticking out.
Me: But what should I read?
Buffett: Read Ben Graham and Phil Fisher, read annual reports. Read The Intelligent Investor, by far the best book on investing ever written. What do you say, Charlie?
Munger: I have nothing to add.
Buffett: Jim, you have been silent all this while. You want to add something here?
Jim Rogers: Well, the best advice I ever got was – read everything. If you get interested in a company and you read the annual report, you will have done more than 98% of the people on Wall Street. And if you read the footnotes in the annual report you will have done more than 100% of the people on Wall Street. I realized right away that if I just literally read a company’s annual report and the notes — or better yet, two or three years of reports — that I would know much more than others.
Me: As if that was so simple! There are thousands of listed companies. Where do I start?
Buffett: Start with the A’s!
Me: Is that so simple? Do I read annual reports of all companies?
Buffett: Stick to your own circle of competence…if you don’t know enough to know about the business instantly, you won’t know enough in a month or in two months. You have to have sort of the background of understanding and knowing what you do or don’t understand. That is the key. It is defining your circle of competence.
Me: But I am just a layman. I don’t anyways understand a lot of businesses.
Buffett: The important thing is not how big the circle is, the important thing is the size of the circle; the important thing is staying inside the circle. And if that circle only has 30 companies in it out of 1000s on the big board, as long as you know which 30 they are, you will be OK. And you should know those businesses well enough so you don’t need to read lots of work.
What do you say Peter?
Peter Lynch: Well, I too have a simple philosophy. It is – Never invest in any idea you cannot illustrate with a crayon.
Me: Oh Peter, are you kidding? I mean, if my kid can draw a company’s business with a crayon, is she ready to invest in it?
Lynch: Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.
Me: So is a fifth grader capable enough to invest in stocks? That sounds incredible!
Lynch: I am not saying so! What I am saying is – Behind every stock is a company. Find out what it’s doing.
Me: This is getting too tough now! Who has time to work hard and do the research, and then buy stocks that may prove to be duds? I think I’ll be better in the company of bonds.
Lynch: If you hope to have more money tomorrow than you have today, you’ve got to put a chunk of your assets into stocks. Sooner or later, a portfolio of stocks or stock mutual funds will turn out to be a lot more valuable than a portfolio of bonds or CDs or money-market funds.
Me: But Andrew Mellon said, “Gentlemen prefer bonds.” So why should one own stocks?
Lynch: Gentlemen who prefer bonds don’t know what they’re missing.
Me: Maybe! But is investing in stocks really so important? I mean I am already making enough from my job.
Lynch: In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.
Haven’t you read what Einstein wrote? The most powerful force in the universe is compound interest.
Me: Yes, I read that somewhere and understand the concept of compounding. But is that a good enough reason why I must invest in stocks?
Munger: Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.
Ben Franklin once said, “Money can beget money, and its offspring can beget more.” Never interrupt it unnecessarily.
Me: Yeah fine. But doesn’t compounding only work in the long term?
Buffett: No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.
Me: That’s right! But Keynes said, “In the long run we are all dead.” So why should I worry about what will happen to my money 30 years from now? I may not be alive then!
Buffett: Someone’s sitting in the shade today because someone planted a tree a long time ago.
Charlie, you have something to say on this?
Munger: I have nothing to add.
“Wake up Vishal!” I heard as I rubbed my eyes. My wife was standing in front of me. “Now you also dream investing? Oh God!”
Well, my dream ended there. But since I’m not yet satisfied with what I heard, I will try and meet these legends (and some more) in my future dreams – to pick their brains on how to go about identifying good stocks, how to develop the right investment behaviour, and broadly, how to become a successful investor.
Wish me good luck!