Munger's Leverage Lesson to Compounding | Generated by AI
Question: How did Munger stop using borrowed money and instead rely on compound returns (复利) over time?
Answer:
This is the core of Munger’s evolution—and it was forced, not chosen.
Early career (1960s-early 70s): The leverage gambler
Munger used leverage aggressively in his partnership. His most notable example was a British Columbia Power arbitrage where he “put not just his whole partnership but all the money he had and all that he could borrow into an arbitrage on this single stock—but only because there was almost no chance that this deal would fall apart.” Before joining Berkshire, Munger was “more than happy to borrow money to buy stocks if he thought the risk was worth the reward.”
This worked until 1973-74.
The 1973-74 crucible: Leverage backfires
The brutal bear market of 1973-74 served as a crucible. The borrowed money that had amplified gains during good times became an unforgiving liability when markets turned, mercilessly magnifying losses and nearly wiping out his investment partnership. This firsthand experience with the double-edged sword of debt left an indelible mark, leading to his famous analogy comparing leverage to “drinking alcohol – a little might be fine, but too much will kill you.”
Post-1976: Zero leverage, infinite compounding
When Munger and Buffett took control of Berkshire, they were “very cautious” in handling shareholders’ money. Munger even said Berkshire “could easily be worth twice what it is now” if they had used leverage.
Why did he refuse to leverage if it would double Berkshire’s returns?
Buffett explained the psychology: “There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”
The math of patience:
Here’s what Munger discovered: With a 20%+ annual compound return and a 50+ year time horizon (he was in his 50s when he joined Berkshire, lived to 99), you don’t need leverage. The numbers work:
- $1M compounded at 20% for 50 years = ~$91 billion
- $1M leveraged 2x at 10% (net after debt costs) for 50 years = ~$117 million
But the levered portfolio gets wiped out in the next 1973-74 crash. The unlevered portfolio survives and keeps compounding.
The key insight: Munger realized leverage isn’t about maximizing mathematical returns—it’s about controlling the psychological and organizational risk of forced liquidations. His aphorism on leverage has long guided Berkshire’s conservative stance on borrowings. He and Buffett prioritized being able to hold through any crash, which paradoxically made them richer over 50 years than any leveraged strategy could.
The shift from “I’ll borrow to triple my returns next quarter” to “I’ll wait 40 years for compound returns to do the work” required living through 1973-74. After that, the choice was obvious.
References:
- Using Leverage to Boost Returns With Munger, Buffett and Dalio
- Charlie Munger’s Borrowing Binge
- Charlie Munger said Berkshire would be worth double if he and Buffett used leverage
- Charlie Munger’s Wealth: Investment Secrets & Key Lessons