2006: What would Buffett and Munger do if they were starting over again?

AUDIENCE MEMBER: My name is Simon Denison-Smith from the UK.

My question is this: if you were starting out today with a million dollars, with a vision of building a business with 20 percent average growth in value over 40 years, what type of investments and investment strategy would you look to make in the first five years?

WARREN BUFFETT: Well, it’s somewhat interesting that we formed the first partnership 50 years ago last — 2 days ago, Thursday, May 4, 1956, which was 105,000. (Applause) That’s my sister clapping. She was in the partnership. (Laughter)

The — we would — if Charlie and I were starting all over again and we were in this, Charlie would say we shouldn’t be doing this. (Laughter)

But if we were to succumb to Satan and engage in the same kind of activity, we would, I think, be doing something very similarly. If we were investing in securities, we would look around the world, and we would look at a Korea.

And Charlie says you can’t find 20 of them, but you don’t have to find 20 of them; you only have to find one, really. You do not have to have tons of good ideas in this business, you just have a good idea that’s worth a ton, occasionally.

And in securities, we would be doing the same thing, which would probably mean smaller stocks — it would mean smaller stocks — because we would find things that could have an impact on a small portfolio that will have no impact on a portfolio the size of Berkshire.

If we were trying to buy businesses, we’d have a tough time. We would have no reputation, so people would not be coming to us. We’d be too small a player, if you’re talking about a million dollars. So we would not have much success, I don’t think, with small amounts, buying businesses.

Charlie started out, you know, in real estate development because it took very, very little capital, and you could magnify brain power and energy — or, I should say, brain power and energy could magnify small amounts of capital in a huge way that was not true in securities.

You know, my natural inclination was to look at securities and just kind of do it one foot in front of the other over time. But the basic principles wouldn’t be different.

You know, I think if I’d been running a partnership a couple of years ago with a small amount of money, I think I’d have probably been 100 percent in Korea.

And, you know, I would be looking around for something that was very mispriced and which — and that I understood. And every now and then, that’s going to happen.

Charlie?

CHARLIE MUNGER: Well, I agree with that. The concept that you’re likely to find just one thing where it will make 20 percent per annum and you just sit back for the next 40 years, that tends to be dreamland.

And in the real world, you have to find something that you can understand that’s the best you have available. And once you’ve found the best thing, then you measure everything against that because it’s your opportunity cost.

That’s the way small sums of money should be invested. And the trick, of course, is getting enough expertise that your opportunity cost — meaning your default option, which is still pretty good — is very high.

And so, the game hasn’t changed at all in terms of its basic arithmetic. That’s why modern portfolio theory is so asinine. (Laughter)

WARREN BUFFETT: It really is, folks.

CHARLIE MUNGER: Yeah. When Warren said he would have been all in one country, that’s pretty close to right. He wouldn’t have quite done that when he had the partnership, but he would have been way more concentrated than is conventional if you listen to modern portfolio theory.

Most people aren’t going to find thousands of things that are equally good; they’re going to find a few things where one or two of them are way better than anything else they know. And the right way to think about investing is to act thinking about your best opportunity cost.

WARREN BUFFETT: Number 9.

CHARLIE MUNGER: By the way, that’s in the freshman course in economics everywhere in the basic textbook; it just hasn’t made its way into modern portfolio theory.

WARREN BUFFETT: We don’t get asked to do book reviews. (Laughter)