Charlie Munger, former vice chairman of Berkshire Hathaway Inc. (BRK.A, BRK.B) and long-time right-hand man of Warren Buffett, argued that investors must be prepared for a brutal reality: If you can’t withstand a 50% drop in your portfolio, you will never achieve exceptional results.
While many expect an easy path to wealth, Munger’s rule remains one of the simplest and most challenging tests for anyone serious about long-term stock investing.
The 50% drop test that separates the winners from the losers
“It can be argued that if you are not prepared to react with equanimity to a 50% drop in market prices two or three times a century, you are not fit to be an ordinary shareholder and you deserve the mediocre result that you are going to get,” Munger told the BBC in 2009. Facing such a huge drop isn’t just theoretical: During the 2008 financial crisis, Berkshire Hathaway’s stock lost more than half its value, as did many other high-quality companies.
“A 50% drop isn’t fun, but it’s part of investing,” said Taylor Kovar, certified financial planner and CEO of 11 Financial. Investopedia. “If you’re going to stick with this long enough to see real growth, you need to be able to hang in there when the going gets tough.” The rule is simple, but it forces investors to confront their true risk tolerance, especially during panicked markets.
Why Many Investors Don’t Meet Munger’s Brutal Standard
Historically, even the best market performers have faced deep declines. As Kovar explained, “Berkshire Hathaway, Amazon (AMZN), Apple (APPL), all of them, have had drops of 50% at some point. That doesn’t mean they were bad investments. It means the market goes through cycles.”
However, most investors sell during these dips, locking in losses and missing out on the eventual rally. Munger’s view: Great investing means surviving temporary pain, trusting fundamentals and not getting carried away by volatility.
Preparation is everything. “We focused on some basics,” Kovar said. “Make sure no investment can ruin the entire plan. Maintain some liquidity so there is no pressure to sell at a bad time. And always have a plan in place before the market starts swinging.”
Advising on insights from behavioral finance can help investors maintain perspective when the headlines become scary, Kovard said. He also noted that knowing when to ride out a dip and when to cut losses comes down to fundamentals. “If the company still has strong leadership, a healthy balance sheet and long-term potential, a dip could be a buying opportunity. But if something fundamental has changed… it could be time to move on,” Kovar said.
The cost of playing too safe
Many investors, wary of volatility, opt for safer assets instead of stocks. However, over time, excessive caution can undermine wealth creation. Munger highlighted his arguments because those who cannot withstand declines tend to earn returns that fail to beat inflation or generate significant long-term wealth.
Playing it safe may protect you from short-term pain, but it could also often mean settling for mediocrity and missing out on the biggest market rallies.
Munger’s 50% drop rule is not just market wisdom; It’s a gut test that separates emotional investors from disciplined wealth creators. Historically, even the best companies have faced massive declines, and those that held out were rewarded with more profits.
Investors who prepare for market turmoil and develop emotional resilience can better weather inevitable downturns and capitalize on improved long-term growth prospects.
