What is Charlie Munger's stance on using standard deviation as a measure of risk?
Charlie Munger's View on Standard Deviation as a Risk Measure
Hey there! I'm a huge fan of Munger and have read many of his speeches and books, like Poor Charlie's Almanack. Let me break down his thoughts on "standard deviation" in plain language—no jargon, I promise.
What Standard Deviation Is (Simplified)
In investing, standard deviation is often used to measure "risk." It quantifies how much a stock or asset’s price fluctuates—the bigger the swings, the higher the standard deviation, and the "riskier" it’s considered. This approach is popular in finance textbooks and models (like Modern Portfolio Theory) because it mathematically captures uncertainty.
Munger’s Critique: It’s Flawed
Munger dismisses this idea entirely. He calls standard deviation as a risk benchmark "nonsense" peddled by academics and Wall Street. Why? To him, real risk isn’t short-term price volatility—it’s the possibility of permanent loss of capital. For example, if you buy shares of a strong company and the price drops 20% short-term, standard deviation screams "risk!" But if the business fundamentals are sound and it’ll recover long-term, that’s not risk—it’s a buying opportunity!
Munger often cites Coca-Cola: its stock might swing wildly, but the company’s earnings are rock-solid, making it low-risk. Conversely, a stagnant "junk stock" that barely moves until the company goes bankrupt overnight? That’s real risk—your money vanishes forever.
Why Munger Thinks This Way (His Logic)
- Behavioral Psychology Lens: Munger emphasizes psychology. He believes people overreact to short-term volatility (thanks to "loss aversion" bias), leading to poor decisions like selling low and buying high. Standard deviation fuels this fear, distracting investors from long-term value.
- Value Investing Perspective: Like Buffett, Munger champions value investing. They focus on a company’s intrinsic value and margin of safety—not mathematical models. As Munger famously said, risk comes from "not knowing what you’re doing," not from volatility.
- Real-World Proof: At Berkshire Hathaway, they never sweat standard deviation. Munger mocks fund managers who use it to "manage risk," calling them "fools with the wrong tools."
My Two Cents
If you’re new to investing, don’t blindly trust standard deviation. Embrace Munger’s "multidisciplinary mindset"—combine psychology, economics, and history to assess risk. True risk management means buying wisely and holding patiently, not dancing to squiggles on a chart.
Got more questions about Munger’s ideas? Ask away! 😊