Charlie Munger says investors should get comfortable with lower returns in the current environment

• Investing legend Charlie Munger says investors should get comfortable with lower returns in the current environment
• His friend Mohnish Pabrai disagrees, sharing a strategy called "circling the wagons" to make money in recessions
• This involves finding and holding onto 5-6 great compounders for life that can drive portfolio returns
• Many legendary investors like Buffett, Graham, Sleep have used this approach with just a few key investments
• The lesson is to avoid overtrading, buy great compounders when cheap, and never sell them

Riding Out the Storm: How to Invest Through Recessions

As we move through 2023, the investing environment remains challenging. Inflation has cooled but high interest rates continue to slow growth. Many businesses face lower profits and falling share prices. Amidst this gloom, investing legend Charlie Munger recently suggested investors resign themselves to lower returns. However, his close friend Mohnish Pabrai disagrees. In a recent talk, Pabrai laid out a strategy to overcome recessions and make money. He calls it “circling the wagons.”

As Pabrai explains, “When the Native Americans attacked, the best defensive posture was to put the wagons in a circle.” Similarly, when market conditions attack our investments, we should circle our portfolio wagons – the compounders that can best weather the storm. As Pabrai describes:

"As an investor what you're looking for are the five or six big wagons that provide you the best defense AKA what he's talking about is finding the five or six businesses that you can hold on to for life that continue to compound through the decades and ultimately protect your portfolio from literally all the other mediocre trades you make."

Ride Out Volatile Markets by Circling Your Portfolio's Wagons

This approach focuses on identifying and holding a handful of high-quality businesses for the very long run rather than trading in and out of positions.

Evidence suggests most investors take the opposite approach. As renowned value investor Nick Sleep observes, “You could have been wrong 80% of the time and it didn’t matter, it still worked out very well." In other words, a few key winners can outweigh numerous poor investment decisions.

Even Warren Buffett attributes Berkshire Hathaway's success to just a handful of investments. In his recent letter, he wrote, “Most of my capital allocation decisions have been no better than so-so and our satisfactory results have been the product of about a dozen truly great decisions.”

Legendary value investor Benjamin Graham, despite pioneering deep value and diversification, also saw his portfolio driven by one long-term winner.

Finally, even in the disastrous markets of the 1970s, an approach called the “Nifty Fifty” – buying 50 blue chip compounders without regard to valuation – managed to match the S&P 500 despite companies like Xerox and Polaroid falling over 70%. The key was sticking with the investments rather than selling after price drops. For today's investors, the lessons are clear. Use market weakness to identify strong long-term compounders trading at reasonable valuations. Buy them knowing you will hold them forever, allowing their growth to drive returns. Avoid overtrading on short-term news or events.

As Pabrai concludes, “It goes to show that in this recession environment while it seems so hard to make money right now we shouldn't be trying to do any sort of fancy footwork.”

Investing Proposition

• Identify 5-6 high-quality companies with durable competitive advantages and long growth runways
• Target businesses with talented management teams focused on delivering high returns on capital
• Buy when valuations become reasonable during market downturns
• Commit to holding forever regardless of short-term price volatility
• Avoid market timing by trading around positions
• Let the long-term compounding power of great businesses drive portfolio returns

Rather than resigning themselves to lower returns, investors can overcome recessions through a “circling the wagons” approach – identifying a handful of excellent compounders trading at reasonable prices and holding them for the long run. Numerous legendary investors have used this strategy to drive outsized returns with just a few key investments, letting these winners outweigh other mediocre decisions. The lesson for today’s volatile markets is to take advantage of lower prices to secure stakes in elite businesses, and then sticker with them to allow their compounding engines to work their magic.