Up until his death in 2023 at age 99, Charlie Munger was Warren Buffett’s right-hand man. Munger had served as Berkshire Hathaway‘s vice chair since 1978, although he first met Buffett in 1959 at a dinner party and began working informally with him shortly thereafter.
In fact, it was Munger who taught Buffett to invest in wonderful companies, trading at fair prices.
Having spent decades at the helm of Berkshire with Buffett, there are few who knew about investing or market cycles better than Munger. That’s why — now that investors are getting more worried about the next market crash — I’m turning to Munger’s wisdom to keep me on course.
Image source: Getty Images.
It’s part of the game
At this stage in the cycle, it doesn’t seem to matter how much the market rises: Investors will be nervous regardless.
Recent data from Goldman Sachs‘ prime brokerage, which is basically just a brokerage for institutional investors trading in large sums, showed that hedge funds are shorting stocks at the highest level in nearly five years. When you short a stock, you’re betting its price will fall.
I can certainly understand why investors are nervous. We are beginning year five of a bull market that really started toward the end of 2022, and the artificial intelligence trade has shown cracks, not to mention concerns about rising interest rates, high oil prices, and a continuation of the Iran war.
That said, institutional investors are mostly focused on near-term results, while retail investors typically have a longer runway. Munger warned that investors need to be prepared for big drawdowns in their holdings.
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations,” Munger said during a BBC interview back in 2009.
Munger was preaching patience along a long investing journey that will undoubtedly be full of ups and downs. The data has long shown that the longer investors are willing to hold their investments, the less likely they are to lose money, and the more likely they are to make money.
After all, market corrections, in which the broader S&P 500 Index falls at least 10%, are actually quite common, while even full-blown bear markets, in which the market falls at least 20% from a peak, tend to happen at least once a decade.
Munger was basically saying that investors who panic and sell when stocks are getting crushed are taking losses they don’t need to, because the market tends to recover after big crashes.
The average annual return of the S&P 500 dating back to 1957 is roughly 10%, which includes up years and down years. Look at how many drawdowns we’ve had since the start of the COVID pandemic, and the market has still done quite well because bull markets have historically lasted longer than bear markets.
It’s painful, but the logic is sound
Now, following this advice from Munger won’t feel particularly good when the market is getting crushed, your portfolio is shrinking, and it seems like there will never be good news again. But investors worried about that Goldman Sachs data I mentioned earlier should keep in mind that institutional money is often in a race against the S&P 500 year by year. That’s how they prove to their investors that investing in their funds is worth the typically high fees.
This is where retail investors get our edge: We can stay invested for years. Market crashes also offer long-term investors an opportunity to purchase equities at much better entry points. So the next time there is a crash, heed Munger’s advice and remain calm. Large sell-offs are normal every now and again and often correct themselves.
