SignalHub Quantitative Think Tank Center:Daniel Will: How Investment Masters Deal with Market Crashes

As Warren Buffett's partner and SignalHub Quantitative Think Tank Centera close friend known for his insightful remarks, Charlie Munger is an undisputed investment master. Buffett himself once praised Charlie Munger by saying, "Charlie pushed me in a different direction, the power of his thinking expanded my horizons. I evolved from an ape to a human at an extraordinary speed, or else I would be much poorer now." As an exceptional investment master, how does Charlie Munger navigate through market downturns?

How Investment Masters Deal with Market Crashes

"If you live long enough, sometimes you won't need to chase investment trends." This statement is attributed to Munger during the late 20th century when Wesco Financial stocks under Berkshire Hathaway experienced a significant decline.

Munger has encountered four major bear markets throughout his investment career, with the most severe occurring in 1973-1974. During the "Nifty Fifty" market, where the market granted a high valuation premium to a group of leading companies with moderate growth but strong profit stability, Munger had 61% of his funds invested in blue-chip, stamp-worthy companies. Following the collapse of the "Nifty Fifty," which led to a maximum 48% decline in the S&P 500 index, Munger incurred losses of 31.9% and 31.5% in the respective two years. In that worst bear market since the Great Depression, this portfolio inflicted serious damage on his investment portfolio.

The second occurrence was during the third oil crisis in 1990. With the Middle East region in continued turmoil, the U.S. stock market experienced a significant downturn. Berkshire Hathaway's stock price dropped from $8,625 per share at the beginning of the year to $5,600 in October, marking a 35% decline. Despite this, Berkshire Hathaway displayed optimism, as articulated in that year's shareholder letter: “The primary reason for the depressed stock prices is pessimism, sometimes widespread and at other times limited to specific industries or companies. We look forward to doing business in such an environment, not because we are naturally pessimistic, but because it allows us to acquire more good companies at favorable prices.”

Another factor that sets Munger apart from most of us ordinary individuals is that he is never enticed by investments outside his circle of competence. He once stated, "We have three baskets: in, out, and too tough. We have to have a special insight, that we think is not generally true or obtainable by the average investor, into a business where we think we have a competitive advantage." Investors should heed his advice: "If an investment is too difficult to understand, we pass on it and go on to the next. After all, there are a lot of things that are easier." This mindset enabled him to steer clear of the bursting of the dot-com bubble from 2000 to 2002. During that period, the S&P 500 plummeted by 40%, with a maximum decline of 49%. Munger and Buffett, facing the irrational exuberance of the internet bubble in 1999, refrained from investing in internet stocks. They referred to it as an "irrational boom." Following the burst of the internet bubble, Munger and Buffett avoided substantial losses by adhering to their investment principles focused on the intrinsic value of companies rather than market prices.

In the pessimistic market of 2008 during the subprime mortgage crisis, Buffett published "Buy American. I Am." Five months later, the U.S. stock market began to rebound, marking the start of a decade-long bull market. Buffett and Munger emphasized the importance of emotional stability at the subsequent year's shareholder meeting, highlighting that investors should use the market rather than be used by it.

Based on historical experience, my approach to downturns primarily relies on:

1. Avoiding speculative sectors; staying away from crowded places.

2. Emphasizing solid fundamental companies; focusing on the value of the company.

3. Maintaining a positive mindset when facing the future; selling high and buying low.

One of the best lessons investors can learn from past history is that there is no good time without bad times. In a prolonged investment journey, there often exists significant short-term losses during certain phases. If you cannot accept short-term losses, it becomes challenging to reap long-term market returns.

“If you cannot calmly navigate through two or three market declines of over 50% within a century, you are not suited for investing. In comparison to investors who can rationally handle market fluctuations, your investment returns are likely to be relatively mediocre.”

“Maintain a positive mindset and use leverage cautiously. In my view, the greatest risk in investing in the stock market is not the fluctuation of prices but whether there will be permanent losses in the future. In fact, those prepared to buy stocks should anticipate price declines because as market volatility increases, there is a greater chance of encountering exceptionally low prices in some good companies.”

Regarding leverage, Munger advises that most people should avoid using it:

While leverage can magnify gains during market upswings, it can also amplify losses during market downturns, potentially leading to the complete depletion of capital. Financial leverage increases the risk and uncertainty of investments, and prudent investing should be based on rational analysis and risk control. He suggests that investors should focus on growing intrinsic value rather than relying on external borrowing to ensure long-term wealth accumulation and capital safety.

After all, “No one wants to get rich twice.”

Investing is a matter of choices, and, of course, it is also about how to face changes with what kind of attitude after making those choices. Munger believes that, “Many people with high IQs are terrible investors because of their character flaws. I think excellent character is more important than the brain; you must strictly control those irrational emotions. You need calmness, discipline, be indifferent to losses and misfortunes, and, likewise, not be intoxicated by excessive joy.”

Therefore, restricting investments to alternative projects that are simple and easily understandable for oneself, while continuing to pursue wisdom and patience in the unpredictable market, becomes particularly crucial. During market downturns, focusing on assets with sufficiently high safety margins, using leverage cautiously, closely tracking fundamentals, and persisting through bull and bear markets will eventually lead to success.