5 Investing Rules to Live by

I will explain the major rules for investing that four legendary Investors provide: Warren Buffet, Charlie Munger, Mohnish Pabrai, and Peter Lynch. Warren Buffet is considered the most successful investor with a net worth of over $100 billion. He manages Berkshire Hathaway with Charlie Munger and together they have received average annual returns of 20% from 1965-2020. That means that $1 invested in Berkshire Hathaway in 1965 would have turned into $22,645 in 2020. This doubles the S&P500’s rate of return in the same time frame, wherein that same $1 would only equal $189 in 2020. Compound interest is no joke! Mohnish Pabrai manages the Pabrai Investment Funds which has turned $1 million in 1999 into $400 million today, the equivalent of an average annual return rate of 30.2%. Lastly, Peter Lynch managed Fidelity’s Magellan Fund for 13 years and received an average annual rate of return of 29%. Buffet and Munger are the OG’s of the investing world, and they have been mimicked by both Lynch and Pabrai.

After watching several lectures from each of these legends, it slowly became clear to me how they think because they have recurring thought patterns that appear every time they talk. If you pay close enough attention, you can begin to understand intuitively their innerworkings as well as how they approach investing. Most people will hear the same lectures that I have, but because they listen the wrong way, they do not gain their insight. Mohnish Pabrai was musing to himself in a lecture about listening to a “secret talk” that Warren Buffet gave and how Buffet provided a tremendous wealth of investing knowledge that the other listeners in the same room as Mohnish thought was useless. Pabrai realized that even though the talk expressed valuable alternative ways of thinking, the other listeners were just expecting one and done “hints” or “tricks.” The Legends realize that what made them successful wasn't a handful of rules that they dogmatically stick to, but rather a flexible mindset that encourages deep foundational thinking. They teach people how to invest not by discussing economics or "tricks-of-the-trade", but by trying to explain the mindset you have to have to be a successful investor.

Therefore, enumerating a list of their rules provides an inaccurate way to convey their mindset—but it is the best method of doing so. If you can read the rules and then read “between the lines,” you can see how all of them have a common origin and mindset. This is how you truly listen to them in a way that provides more information than the lay researcher who merely listens to words rather than the person behind the words. After all, the rules are extremely humble and simple, and yet most people fail to implement them.

The way I will present these investors’ mindsets is by (1) enumerating the common rules that these four investors explicitly state. Then I will (2) explain to the best of my ability the mindset that created them, and lastly, I will (3) provide the raw list of points that these investors make themselves.

I. Enumerated Common Rules Explicitly Stated by the Four Legends.

1) Rule 1: “Don’t lose money, Rule 2: Don’t forget rule 1.”

- A loss in 50% of your wealth will take a 100% gain to return back to normal.

1.1 Always think in terms of “How can I lose money?” and then do the opposite (always invert).

1.2 Stay within your small circle of competence and know your boundaries.

- If you know when you don’t know something, then you won’t make a mistake from being overly pompous.

1.3 Be a shameless cloner.

- You can easily look up what the best investors are buying in the US from 13F filings. Learn from those who are good at the game, because you might be able to avoid the same mistakes they have made.

1.4 Listen to facts not speculation or emotions.

- Don’t listen to anybody’s projections unless you trust their character and their rationales are sound.

- In general, the future is uncertain unless you have reason to be certain about an outcome, e.g. If a company owns a contract that provides them the right to sell a well-defined number of units to another company, we have a legally binding contract that can ensure certainty to a reasonable degree.

1.5 Know what you own and know why you own it. You should be able to explain why you own a stock to a two-year-old.

- The “Single greatest principle” according to Peter Lynch is: if you cannot explain what the company does, then don’t buy it.

- You have plenty of time to research, there is no rush to buy a stock. There is no excuse for making a poor investment. There is no ticking clock on whether a company is a good buy now or in a year. A good company should be bought because you think it will always be a good company.

1.6 “Do it right the first time, that’s a really good rule.”

- Dot your i's and cross your t’s before jumping in with both feet. An important skill is knowing when you have messed up so that you can change your decision as early as you can.

2) Cash is not a good investment, buy assets that produce.

- One pound of gold will still be one pound of gold in 50 years. But one stock that produces 3 toys a year will have produced 150 toys in 50 years. Owning a business provides more wealth than a depreciating currency, and certainly more wealth than an inflating currency such as cash.

3) Buy great companies not cheap ones.

- Although you can make money buying mediocre companies selling them later at a discount, more money can be made by buying amazing companies at fair prices.

- Find companies with “moats” or competitive advantages that no one can compete against—such as Apple who can charge a 50% markup on their phones and still customers would not transfer to Android.

4) Play big when an opportunity arises.

4.1 It only takes a few businesses to get rich.

- Buffet and Munger made most of their money from a few “once every 5 year” investments such as Coca-Cola, Geico, See’s Candies, and the Washington Post etc.

4.2 “100 baggers” come from companies you haven’t heard of.

- The more businesses you analyze the more chances you have of finding that one lollapalooza.

4.3 When everything lines up and several models indicate a tremendous opportunity, do not miss it. There are not that many opportunities in life, and it only takes one investment every couple years to be extremely successful. Place a tremendous bet.

5) No one can predict interest rates, the stock market, or the economy.

5.1 Don’t sell because of market Fluctuations.

5.2 You are buying a business so that it can produce wealth which will trickle down to you. You’re a business owner, not a stock owner. You do not buy a business simply to sell it to someone else who is willing to pay more for it than you did. The latter method is a very fickle and unstable way to make money.

5.3 The best investors do not make money by predicting the economy. Most of them did not even go to business school. They look at companies, and the best companies are usually those that will stay afloat even in economic depressions.

- Lynch says that people who wait for a “market crash” before buying have in the past lost more money in opportunities squandered by waiting, than they actually gained from the crash.

II. The Mindset that Created the Rules.

As we can see from above, the legends converge their thinking patterns. It is from these common modes of thought that we can extract foundational advice. None of the rules are overintellectual but all are founded on one simple premise: “Look for truth and avoid background noise.”

Stop messing around with speculation, and only pay attention to what is in front of you. Open your eyes and stop letting your judgements interfere with what the facts are telling you. Find good companies through diligent and meticulous research. Find something real that produces wealth, both in good and in bad economies, that can also produce historical records that match your hypotheses. Think in terms of risk aversion by predicting as many scenarios that can go wrong, and you can’t lose—Pabrai has a list of 80 items that must be checked before buying a company, where each of the 80 items came from a case study of the best investors’ mistakes. Investing is not about “beating the market.” It is about finding good companies run by good people that care more about their businesses than their quarterly results.

Think for yourself and make predictions based off of unbiased rationalizations that are humble and simple, and grounded in facts. Keep learning and keep researching new businesses with your ear to the ground and your eyes blindfolded to what the experts are predicting in regards to the economy or to particular stocks. Make sure you press the “buy” button only after you know so much about the company that you can feel comfortable not looking at the stock price for 20 years.

The above three paragraphs taken together provide no enumerated “tips”, but instead share the mindset and spirit behind these investors’ habits. Buffett famously said that you do not need an IQ above 130 to make it in the financial industry. Munger adds: You only need common sense and an ability to admit when you’re wrong.

III. Raw and Nuanced Advice from the Investors from Various Conversations.

Despite the similarities in their advice, the four legendary investors do have nuanced approaches. Charlie Munger however stands out for his markedly different quality of advice. The points that Charlie Munger provides lean more on the side of life-wisdom rather than financial advice. However, I love learning from Charlie the most since all of his wise remarks translate directly into financial advice because the two ways of thinking aren’t all that distinct. For example, the point of "learning how to destroy your bad ideas" is great life advice that obviously would impact how you invest. It is hard to scrap an investment when you have put 100 hours reading decades worth of annual reports in a company. If you find out in the end that the company is not worth your money, how hard would it be to admit that you wasted 2 weeks of your life and then to move on? Most people may find some tenuous justification to invest into that company, only to their own disappointment. Even the most introspective among us will find this task a challenge.

If you want a flavor of his style of giving advice, here is a short 10 minute YouTube video compilation of Charlie Munger:

https://www.youtube.com/watch?v=YS7j0YrlceE&t=81s

And, here are the legends' enumerated advice in raw form (from my unedited notes):

Warren Buffet of Berkshire Hathaway:

1) Cash is not a good investment, buy assets that produce

2) Stay within your small circle of competence and know you’re boundaries.

3) Play big in bets that are very good.

4) invest in yourself first

5) listen to facts not speculation or emotions

6) Buy what you know

7) buy great companies not cheap ones

8) don’t sell because of fluctuations

9) Buy at a discount

10) 20 punch cards: it only takes a few businesses to get rich.

11) take the high road, its less crowded lol

Peter Lynch of the Magellan Fund:

1) Know what you own, and know why you own it. You should be able to explain why you own the stock to a two-year-old. (“single greatest principle” if you cannot explain what the company does, then don’t buy it)

2) No one can predict interest rates or the stock market or the economy. Economic predictions are a total waste, so look at historical facts. Every 6 years the market goes down 25% historically.

3) You have plenty of time, there is no rush to buy a stock.

4) You need an edge to make money. Buy what you know, if you work in an industry, then you know what is good in that industry. If a business goes bad to mediocre, the stock goes up. If it goes from mediocre to good, it goes up etc.

5) You only need a few stocks in your lifetime.

6) “How much lower can it go” is a horrible way to think. If it keeps going down and you don’t understand the company, you might sell because you get scared.

7) Its very hard to go bankrupt if you don’t have debt.

8) Avoid longshots. I’ve taken 30 and haven’t broken even on even one.

9) Think what companies are going to be doing in the future. If you see something is slowing down, then move on to something else.

10) Find a company that you like, strong fundamentals, strong earnings, competition is doing poorly. Then you can also find out after a market decline, which of these companies are not suffering by the bad economy but yet are selling at a discount.

11) you should be able to give a lecture on 4 to 5 companies, especially if they’re local. You only need one or two stocks. Invest into mutual funds, but everyone in awhile buy a company that you know.

12) High reward to risk ratio

Mohnish Pabrai of the Pabrai Investment funds:

1) Only buy a stocks that you are absolutely certain of. You would have to hit me with a two by four before you would make me buy a stock. You should be able to explain why you’re buying a stock to the village idiot.

2) You would be better off buying a good growth stock company than a cheap company, because you can make more than just the gap between the bargain price and the intrinsic value price. (Great company at fair price over bad companies at cheap price)

3) Know what the growth engine companies, what these are worth. When trying to buy.

4) Selling is more complicated because you have to look at the future, even the insiders have a fizzy picture of the future. Even great companies go high in price, but there are so many times where you sell because it is overpriced and then it goes up more since it is a great company. Don’t’ sell if it is underpriced or overpriced. Sell when it is egregiously priced.

5) Be a shameless cloner, look at the strategies that the best people are doing since in the U.S. you can look them up. 13F filings.

6) “keep your calendar empty”: Warren buffet

7) find the good thing and sleep for 20 years, “that’s it” wake up whenever” {find CRISIL Indian moody’s}

8) only invest if you love investing. To love investing 1) No staff 2) no trading during office hours 3) don’t go to work when market is open=---be a gentleman of leisure [do things because they’re fun]

9) High reward to risk ratio

10) ‘Tando” don’t have downside. Warren Buffet: “Rule 1 don’t lose money; rule number 2 don’t forget rule number 1”

11) business makes a good investor, investing makes a good businessman

12) look for business with business models with little downside.

13) you’ll have your 20-30% a year by buying a stock less than half of what its worth. You can double money in 2-3 years.

14) low risk and high uncertainty = mispriced stocks.

15) replace capital with creative thinking. Non-venture backed startups are forced to think in a high reward low risk way

16) deal with uncertainty by putting floors on max loss. Don’t use spreadsheets or precision thinking. Think about what the CEO’s are thinking about

17) Be patient, 20 stocks in your entire life.

18) Think in terms of “how can I lose money” reason backwards and use a checklist for this.

19) good business for world/society

20) Research a company because its fun. If you research to find out if you invest, then its bad because you lose objectivity and you feel compelled to act since you put so much time into it

21) find out mistakes of other great investors and avoid them

22) Don’t find catalysts, catalysts should be value itself. Don’t be like, “oh, this ratio means a buy” if you see a good ratio, dig in deeper to make sure that the ratio isn’t that way for a reason. [most things are efficiently priced.] catalysts only serve to reduce uncertainty.

23) a great business has a growing earnings, high return on capital, and can absorb its capital.

24) Plan A is great business, Plan B is cigarette butts.

25) golden finds which Pabrai has never found is HUGE earnings with idiot managers. Means a great business.

26) 100 BAGGERS ARE NOT THE NAMES YOU’VE HEARD OF

27) 100 baggers in an efficient market usually comes from uncertainty. That’s when people don’t know what to do.

28) Oil is fun in the us cuz they have a very hard time making new refineries and each state has restrictions on the type of refineries that can be made, so even though it’s a “commodadies” business, its kind of a monopoly with a fun moat.

29) stock market people think “What is happening now will always happen”

Charlie Munger of Berkshire Hathaway:

1) Invert problems.

2) your opportunities are very few, if you see one; by God go all in. Those lalapoluzas are what make people rich.

3) We don’t try to predict the tides.

4) if there is a lolapaluza result, look for a confounding of variables.

5) “Do it right the first time, that’s a really good rule.”

6) you will not succeed in whatever you do if it doesn’t interest you

7) Learning a lifetime is what makes you go far

8) Don’t super specialize

9) Clone great ideas

10) More important to anything is to be reasonable

11) destroy bad ideas

13) think like a business owner, not a careerist

14) If youre wondering what to do with a naughty horse, “Next time your horse is behaving well, sell it.”

15) There is no business so lousy that it cannot get a wonderful “projection”

16) If crooks only knew how profitable it is to be honest…

17) take the high road, its less crowded lol -Buffett

17) Reduce expectations. Easy money attracts excess.

18) Learn how to scramble out of your mistakes without them costing too much.