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How to Build a Portfolio According to Charlie Munger

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GuruFocus.com
·4 min read
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In 2017, Charlie Munger (Trades, Portfolio) famously made the claim that he had just three investments in his personal portfolio. These were Costco (NASDAQ:COST), Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and an investment in Li Lu's partnership.


Munger used this example to justify the idea that most investors do not need to own a highly diversified portfolio of stocks. Instead, he believed that just a handful of companies could help investors get rich, as long as they are good companies that the investor knows and understands.

This is only partly correct. Munger may have only had three investments in his portfolio in 2017, but both Berkshire and Li Lu's investment partnership were investment vehicles.

It's difficult to tell precisely how many companies and stocks these two vehicles owned in 2017 because we don't have all of the data. Still, we do know that Berkshire had over 200 subsidiaries and 50 significant equity positions in 2017. That's more business interests than many mutual funds.

Li Lu follows a concentrated portfolio approach, but it is also likely that he had at least five companies in his portfolio at the time, according to my observations. So, while Munger might have liked to say that an investor only needs to have a few investments, the reality is, his portfolio was much more diversified than it first appeared.

There are a couple of other factors to consider here as well. Munger is in a high-level management position at both Costco and Berkshire. This means he has insights into the businesses that are not available to most ordinary stockholders. Therefore, he can afford to make more substantial investments based on his inside knowledge and understanding of the companies.

Further, the money for Munger's investment in Li Lu's partnership came from a previous deep value investment. At the 2017 annual meeting of Daily Journal (NASDAQ:DJCO) shareholders, Munger explained that he discovered a deep value stock in Barron's one day and decided to invest. "In 50 years, I found one investment opportunity in Barron's, out of which I made about $80 million. For almost no risk," he explained.

The billionaire then went on to add that he took these funds and gave them to Li Lu, "who turned it into $400 million or $500 million."

Of course, there is absolutely nothing wrong with this approach. However, in my opinion, it is misleading to say that investors can do quite well by having a portfolio of just three stocks.

Yes, Munger is indeed a fantastic stock picker, and there are plenty of examples of his success in picking deep value stocks. But, with Berkshire and Li Lu, his success lies not in picking stocks but in picking managers.

Munger found these great managers, and he was also sensible enough to stick with them for the long term. The same goes for Costco. He found a good business that he understood and stuck with it.

In my opinion, that's the real lesson for investors here. It's not that anyone can get rich by a concentrated portfolio of stocks. It is that investors can do well if they find investments they understand and stick with them over the long run.

Munger used Berkshire, Costco and Li Lu, but nothing is stopping the average investor using a simple S&P 500 index tracker fund. If you understand real estate, it might be better to stick with physical property or real estate investment trusts. The correct course of action will vary from investor to investor. Munger had skin in the game at Berkshire and Costco. He was also friendly with Li Lu. That helped him gain the confidence required to make these holdings significant positions in his portfolio.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.