Warren Buffett's right-hand man offers 3 tips for investors to boost long-term returns

"I think it must end badly, but I don't know when."

Charlie Munger, Berkshire Hathaway
Lacy O’ Toole | CNBC

Every spring, tens of thousands of investing obsessives gather in Omaha for the annual Berkshire Hathaway shareholder meeting, affectionately nicknamed "Woodstock for Capitalists." The main attraction: the Oracle of Omaha himself, Berkshire chairman and CEO Warren Buffett, who sits for hours behind a microphone answering questions from shareholders eager to glean some of the great man's investing wisdom.

Seated next to him, usually, is his longtime business partner and Berkshire vice chairman Charlie Munger — a multibillionaire in his own right who, at 97, is one of the few men who has lived through more market ups and downs than Buffett himself.

Last week Munger staged a mini-Woodstock of his own in the form of the shareholder meeting for The Daily Journal, where Munger is chairman of the board. The market sage answered two hours of questions over live stream, offering perspective on everything from GameStop to Netflix's Golden Globe-winning show "The Queen's Gambit." The entire talk is worth a listen, and three points stood out as especially salient for everyday investors.

Don't get caught up in trading frenzies: 'Ride them out'

Early on in the talk, a shareholder asked Munger how investors can cope with periodic investor frenzies, like the sky-high runups in so-called "meme stocks" in recent months.

"There are these periods in capitalism," Munger said. "I've been around for a long time and my policy has always been to just ride them out. And I think that's what shareholders do."

What's the behavior Munger hopes investors should avoid? "What a lot of shareholders actually do is crowd in buying stocks on frenzy — frequently on credit — because they see that they're going up," he said. "And, of course, that's a very dangerous way to invest."

Munger went on to compare such investing behavior to gambling. He isn't wrong to do so, says Sam Huszczo, a certified financial planner and founder of SGH Wealth Management in Southfield, Michigan. "Every investment should have a purpose. If you can't come up with a purpose for why you're investing that money, you're a rudderless ship," he says. "Then you're approaching it like gambling. You're just hoping you get lucky."

Lately, those investors have gotten lucky, points out Christine Benz, director of personal finance at Morningstar. "Over the past year, if you invested in stocks that had gone up a bunch, that's been a decent strategy," she says. "But we know from the data that historically, past performance hasn't been indicative of future performance."

The best way to ignore the frenzy, she says: Stick to the plan. "Investing toward your specific goals should be the starting point," she says. "Think about the thing you're saving toward and invest appropriately."

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Beware of bubbles

Several investors asked Munger about perceived froth in the market, comparing the ascendant trading of new companies going public to the conditions of the dot-com bubble of the late 1990s.

"I think this kind of crazy speculation in enterprises not even found or picked out yet is a sign of an irritating bubble," Munger said.

When asked if he believes things would end badly, he offered: "I think it must end badly, but I don't know when." The S&P 500 sank by more than 49% when the dot-com bubble popped in March of 2000, and surrendered nearly 57% from 2007 to 2009 after the housing market collapsed.  

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Regardless, though, don't panic and sell all of your stocks. Instead, stay diversified, says Benz. She suggests holding a core portfolio of broad market mutual funds or exchange-traded funds, which hold a mix of stocks that will behave differently depending on the market conditions. "That's one of the key concepts everyone should know," she says. "You want some of these very sexy companies, but also some of the boring ones."

Right now, she concedes, the sexy ones are very sexy, offering eye-popping returns that seem to make holders rich over the course of just a few days. But if you're determined to experiment with individual stocks, whose performance will be more volatile than a broad basket of stocks, use a small allocation of your portfolio to branch out, she says.

"As a very basic rule of thumb, 5% to 10% of your portfolio is probably an OK threshold for individual stocks," she says. "The rest of your portfolio should be in something more broadly diversified."

Own stocks you 'know something about'

Another big believer in taking a diversified approach through broad-market index funds: Warren Buffett. Over and over, the Oracle has urged retail investors to "buy a cross-section of America" in the form of a fund that tracks, say, the S&P 500.

Munger may agree with him when it comes to the everyday investor. But when it comes to the pros that want to invest on your behalf, Munger doesn't see the point of spreading one's bets. "A lot of people think that if they have a hundred stocks they're investing more professionally than they are if they have four or five. I regard this as insanity. Absolute insanity," he says.

"I call it di-worse-ification, which I copied from somebody," he continued. "I'm way more comfortable owning two or three stocks which I think I know something about and where I think I have an advantage."

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So should you dump your index funds in favor of a few choice stocks? Probably not, unless you've made a multibillion-dollar career in the stock market, says Benz. "If you're Warren Buffett or Charlie Munger, that's legitimate," she says. "If you're just learning about stocks, not so much."

But Munger's thoughts do apply to the small portion of your portfolio you can use to augment your diversified core holding, says Huszczo. "That 5% to 10% of your portfolio can be those really high-conviction picks," he says. "Just don't put more at risk on one or two names than you're willing to lose."

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