Buying Shares---My 2016 Summary from Charlie Munger
Sit on Your Ass Investing
The concept of sit on your ass investing was introduced at the 2000 Berkshire Hathaway Annual meeting. The essence of this new school of investment theory; find a few outstanding companies, buy them, and hold them forever.
In many ways this style of investment management can be traced back to Berkshire Hathaway’s early days. See’s Candies, Coca-Cola and American Express were all quality business brought at an attractive price with the intention of holding them forever. According to Charlie Munger --- a view that’s also affected Warren Buffett’s style --- you should only buy a stock if you are willing to hold for ten years, and if you are willing to commit a substantial portion of your money to it.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.
So you do get an occasional opportunity to get into a wonderful business that's being run by a wonderful manager. And, of course, that's hog heaven day. If you don't load up when you get those opportunities, it's a big mistake.
Big opportunities in life have to be seized. We don’t do very many things, but when we get the chance to do something that’s right and big, we’ve got to do it. And even to do it in a small scale is just as big a mistake almost as not doing it at all. You’ve really got to grab them when they come, because you’re not going to get 500 great opportunities. You would be off if when you got out of school here you got a punch card with 20 punches on it, and every financial decision you made you used up a punch. You’d get very rich because you’d think through very hard each one. ----Buffett
”There are two types of mistakes: 1) doing nothing [We saw it, but didn’t act on it]; what Warren calls “sucking my thumb” and 2) buying with an eyedropper things we should be buying a lot of.”
Up until the late 1980’s, even Warren Buffett didn’t follow this school of thought. He traded in and out of undervalued stocks, selling them when they reached full value and positions were rarely held for more than a year or two.
The success of sit on your ass investing is driven by a company’s ability to successfully compound shareholder equity at an attractive rate over the long-term --- if this isn’t possible, the strategy won’t work and it’s easier to buy low and sell high.
”Understanding both the power of compound return and the difficulty of getting it is the heart and soul of understanding a lot of things.”
“Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.”
Similarly, here’s what Warren Buffett said about Coca-Cola, See's Candies, and Buffalo News at the 2003 Berkshire Hathaway meeting:
“The ideal business is one that generates very high returns on capital and can invest that capital back into the business at equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the next year earns 20% of $120 million and so forth. But there are very very few businesses like this. Coke has high returns on capital, but incremental capital doesn't earn anything like its current returns. We love businesses that can earn high rates on even more capital than it earns.
Most of our businesses generate lots of money, but can't generate high returns on incremental capital --- for example, See's and Buffalo News.. We look for them [areas to wisely reinvest capital], but they don't exist.
So, what we do is take money and move it around into other businesses. The newspaper business earned great returns but not on incremental capital. But the people in the industry only knew how to reinvest it [so they squandered a lot of capital]. But our structure allows us to take excess capital and invest it elsewhere, wherever it makes the most sense. It's an enormous advantage.”
Attractive investment opportunities tend to be ephemeral
The dates stick in my mind: July 23rd and October 9th last year and March 11th this year --- all days in which the market bottomed amidst panicked selling, when bargains abounded. But if you weren’t ready to buy, stocks snapped back quickly. Munger noted that “a lot of opportunities in life tend to last a short while, due to some temporary inefficiency... For each of us, really good investment opportunities aren’t going to come along too often and won’t last too long, so you’ve got to be ready to act and have a prepared mind.”
“Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind that loves diagnosis involving multiple variables. Then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available because of prudence and patience in the past.”
“In addition, the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time they don't. It is just that simple.”
A lot of opportunities in life tend to last a short while, due to some temporary inefficiency. If you’re Berkshire, you can get a few billion dollars out, but most institutions would miss it --- they would have to meet with trustees, lawyers, etc. By the time they were done, they’d have missed it. In this environment, you have to be present and ready to act. Look at some of our recent acquisitions. They faced default and needed money by Monday, and it was Friday afternoon. It was an ephemeral opportunity. For each of us, really good investment opportunities aren’t going to come along too often and won’t last too long, so you’ve got to be ready to act and have a prepared mind.
”Using [a stock’s] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns – for example, See’s [a candy company owned by Berkshire] usually loses money in two quarters of each year---and some terrible businesses can have steady results.”
Buying into stock declines
"Over many decades, our usual practice is that if [the stock of] something we like goes down, we buy more and more. Sometimes something happens, you realize you're wrong, and you get out. But if you develop correct confidence in your judgment, buy more and take advantage of stock prices."
Even with a 10% per annum investment, paying a 35% tax at the end gives you 8.3% after taxes as an annual compounded result after 30 years. In contrast, if you pay the 35% each year instead of at the end, your annual result goes down to 6.5%. So you add nearly 2% of after-tax return per annum if you only achieve an average return by historical standards from common stock investments in companies with tiny dividend payout ratios.
There are huge advantages for an individual to get into a position where you make a few great investments and just sit back and wait: You're paying less to brokers. You're listening to less nonsense. And if it works, the governmental tax system gives you an extra 1, 2 or 3 percentage points per annum compounded.
10 checklists by Charlie Munger
1. Risk --- All investment evaluations should begin by measuring risk, especially reputational
· Incorporate an appropriate margin of safety
· Avoid dealing with people of questionable character
· Insist upon proper compensation for risk assumed
· Always beware of inflation and interest rate exposures
· Avoid big mistakes; shun permanent capital loss
2. Allocation — Proper allocation of capital is an investor’s number one job
· Remember that highest and best use is always measured by the next best use (opportunity cost)
· Good ideas are rare – when the odds are greatly in your favor, bet (allocate) heavily
· Don’t “fall in love” with an investment – be situation-dependent and opportunity-driven
3. Patience — Resist the natural human bias to act
· “Compound interest is the eighth wonder of the world” (Einstein); never interrupt it unnecessarily
· Avoid unnecessary transactional taxes and frictional costs; never take action for its own sake
· Be alert for the arrival of luck
· Enjoy the process along with the proceeds, because the process is where you live
4. Independence -- “Only in fairy tales are emperors told they are naked”
· Objectivity and rationality require independence of thought
· Remember that just because other people agree or disagree with you doesn’t make you right or wrong – the only thing that matters is the correctness of your analysis and judgment
· Mimicking the herd invites regression to the mean (merely average performance)
5. Decisiveness — When proper circumstances present themselves, act with decisiveness and conviction
· Be fearful when others are greedy, and greedy when others are fearful
· Opportunity doesn’t come often, so seize it when it comes
· Opportunity meeting the prepared mind; that’s the game
6. Preparation -- “The only way to win is to work, work, work, work, and hope to have a few insights”
· Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day
· More important than the will to win is the will to prepare
· Develop fluency in mental models from the major academic disciplines
· If you want to get smart, the question you have to keep asking is “why, why, why?”
7. Analytic rigor -- Use of the scientific method and effective checklists minimizes errors and omissions
· Determine value apart from price; progress apart from activity; wealth apart from size
· It is better to remember the obvious than to grasp the esoteric
· Be a business analyst, not a market, macroeconomic, or security analyst
· Consider totality of risk and effect; look always at potential second order and higher level impacts
· Think forwards and backwards – Invert, always invert
8. Change — Live with change and accept unremovable complexity
· Recognize and adapt to the true nature of the world around you; don’t expect it to adapt to you
· Continually challenge and willingly amend your “best-loved ideas”
· Recognize reality even when you don’t like it – especially when you don’t like it
9. Intellectual humility -- Acknowledging what you don’t know is the dawning of wisdom
· Stay within a well-defined circle of competence
· Identify and reconcile disconfirming evidence
· Resist the craving for false precision, false certainties, etc.
· Above all, never fool yourself, and remember that you are the easiest person to fool
10. Focus – Keep things simple and remember what you set out to do
· Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat
· Guard against the effects of hubris (arrogance) and boredom
· Don’t overlook the obvious by drowning in minutiae (the small details)
· Be careful to exclude unneeded information or slop: “A small leak can sink a great ship”
· Face your big troubles; don’t sweep them under the rug
The takeaway is that there are all kinds of problems that are better solved by going through a checklist. This works well in primary medicine and piloting too.
HOW CAN SMART PEOPLE BE SO DUMB? NO CHECKLIST. AND WITHOUT ONE, YOU WILL SCREW UP TIME AFTER TIME.
How do you get to be one of those who is a winner---in a relative sense---instead of a loser?
Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They're sending money out net after the full handle a lot of it to Las Vegas, by the way to people who are actually winning slightly, net, after paying the full handle. They're that shrewd about something with as much unpredictability as horse racing.
And the one thing that all those winning betters in the whole history of people who've beaten the pari-mutuel system have is quite simple. They bet very seldom.
It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it---who look and sift the world for a mispriced bet that they can occasionally find one.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple.
That is a very simple concept. And to me it's obviously right based on experience not only from the pari-mutuel system, but everywhere else.
And yet, in investment management, practically nobody operates that way. We operate that way---I'm talking about Buffett and Munger. And we're not alone in the world. But a huge majority of people have some other crazy construct in their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they'll come to know everything about everything all the time.
To me, that's totally insane. The way to win is to work, work, work, work and hope to have a few insights.
How many insights do you need? Well, I'd argue: that you don't need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that's with a very brilliant man. Warren's a lot more able than I am and very disciplined devoting his lifetime to it. I don't mean to say that he's only had ten insights. I'm just saying, that most of the money came from ten insights.
So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you're probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It's just that simple.
"Playing poker in the Army and as a young lawyer honed my business skills. What you have to learn is to fold early when the odds are against you, or if you have a big edge, back it heavily because you don't get a big edge often. Opportunity comes, but it doesn't come often, so seize it when it does come."
“Warren talks about these discounted cash flows. I’ve never seen him do one.” “It’s true,” replied Buffett. “If the value of a company doesn’t just scream out at you, it’s too close.”
The idea of a margin of safety, a Graham precept, will never be obsolete. The idea of making the market your servant will never be obsolete. The idea of being objective and dispassionate will never be obsolete. So Graham had a lot of wonderful ideas. Warren worshipped Graham. He got rich, starting essentially from zero, following in the footsteps of Graham.
I liked Graham, and he always interested and amused me. But I never had the worship for buying the stocks he did. So I don’t have the worship for what Warren does. I picked up the ideas, but discarded the practices that didn’t suit me. I don’t want to own bad businesses run by people I don’t like and say, “no matter how horrible this is to watch, it [the stock] will bounce by 25%.” I’m not temperamentally attracted to it.
At any rate, the trouble with what I call the classic Ben Graham concept is that gradually the world wised up and those real obvious bargains disappeared. You could run your Geiger counter over the rubble and it wouldn't click.
And so having started out as Grahamites which, by the way, worked fine we gradually got what I would call better insights. And we realized that some company that was selling at 2 or 3 times book value could still be a hell of a bargain because of momentums implicit in its position, sometimes combined with an unusual managerial skill plainly present in some individual or other, or some system or other.
History of Buffett's investing philosophy
"Warren Buffett came to investing at the knee of Ben Graham, who ran a Geiger counter over the detritus of the 1930s. Stocks were ridiculously cheap. Graham bought companies that were quite mediocre on average, but made 20% when their stock bounced."
"Warren trained under this system and made money, so he was slower to come to the idea I learned that the best way to make money is to buy great businesses that earn high returns on capital over long periods of time."
"We're applying Graham's basic ideas, but now we're trying to find undervalued GREAT companies. That concept was foreign to Ben Graham."
"Warren would have morphed into a great investor without Ben Graham. He is a greater investor than Graham was. Warren would have been great had he never met anyone else. He would have excelled at any field that required a high IQ, quantitative skills and risk taking. He wouldn't have done well at ballet though."
And, by the way, the bulk of the billions in Berkshire Hathaway have come from the better businesses. Much of the first $200 or $300 million came from scrambling around with our Geiger counter. But the great bulk of the money has come from the great businesses.
And even some of the early money was made by being temporarily present in great businesses. Buffett Partnership, for example, owned American Express and Disney when they got pounded down.
”If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That’s hard. But if you buy a few great companies, then you can sit on your ass. That’s a good thing.”
In investment management today, everybody wants not only to win, but to have a yearly outcome path that never diverges very much from a standard path except on the upside. Well, that is a very artificial, crazy construct. That's the equivalent in investment management to the custom of binding the feet of Chinese women. It's the equivalent of what Nietzsche meant when he criticized the man who had a lame leg and was proud of it.
Most investment managers are in a game where the clients expect them to know a lot about a lot of things. We didn't have any clients who could fire us at Berkshire Hathaway. So we didn't have to be governed by any such construct. And we came to this notion of finding a mispriced bet and loading up when we were very confident that we were right. So we're way less diversified. And I think our system is miles better.
I'd say that Berkshire Hathaway's system is adapting to the nature of the investment problem as it really is.
We've really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses.
”The number one idea, is to view a stock as an ownership of the business [and] to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash flow than you’re paying for. Move only when you have an advantage. It’s very basic. You have to understand the odds and have the discipline to bet only when the odds are in your favor.”
In fact, any time anybody offers you anything with a big commission and a 200-page prospectus, don't buy it. Occasionally, you'll be wrong if you adopt "Munger's Rule". However, over a lifetime, you'll be a long way ahead---and you will miss a lot of unhappy experiences that might otherwise reduce your love for your fellow man.
The bubble in America was from a combination of megalomania, insanity and evil on the part of a lot of people in banking---both mortgage and investment banking. Greenspan was a smart man but he overdosed on Ayn Rand at a young age. You can’t have total freedom to create gambling games. Much of what crept into investment banking was a gambling game in drag---it was not capital raising. Now, the banks have developed an advantage in derivatives and do not want to give it up. A casino would never give up slots to keep roulette and blackjack. Similarly, the banks don’t want to give up their best businesses to save the rest of us from risk. It makes sense that banks don’t want to give it up.
”Failure to handle psychological denial is a common way for people to go broke. You’ve made an enormous commitment to something. You’ve poured effort and money in. And the more you put in, the more that the whole consistency principle makes you think,” Now it has to work. If I put in just a little more, then it ’all work…. People go broke that way —because they can’t stop, rethink, and say,’ I can afford to write this one off and live to fight again. I don’t have to pursue this thing as an obsession —in a way that will break me.’ “
Betting on a stock index is like betting on a bucket shop. The banks brought back bucket shops with the derivatives markets. With casinos you have to have parking, bars, restaurants and entertainers. But the banks have a casino with no overhead. The government then allows them to operate with leverage through the repo system. Conservative investment banks went to 30-50x leverage, making small returns on each transaction but making a lot of money in aggregate.
The banking industry has been a gold mine. I think Warren and I blew it --- we should have invested a lot of money in banks. While we did well in it, we should have been heavier in it. The amount of money made in banking has been awesome. And [this despite the fact that] the people who made the money --- how shall I say it --- have been moderately skillful. [Laughter] [I think he said something here about one being able to make a lot of money in banking even if one is “a perfect ass.”] [Bankers have been like] a duck sitting on a pond and they raised the pond. By borrowing short and lending long, one can make a lot of money. It’s so easy that people are tempted to do more and more.
Can it go on forever? A wise economist once said, “If a thing can’t go on forever, it will eventually stop.” My guess is that the extremes are over. Banking has been a marvelous business, but I wouldn’t think it would continue to get better and better and it might even get a lot worse.
There was also great excess in highly leveraged speculation of all kinds. Perhaps real estate speculation did the most damage. But the new trading in derivative contracts involving corporate bonds took the prize. This system, in which completely unrelated entities bet trillions with virtually no regulation, created two things: a gambling facility that mimicked the 1920s "bucket shops" wherein bookie-customer types could bet on security prices, instead of horse races, with almost no one owning any securities, and, second, a large group of entities that had an intense desire that certain companies should fail. Croupier types pushed this system, assisted by academics who should have known better. Unfortunately, they convinced regulators that denizens of our financial system would use the new speculative opportunities without causing more harm than benefit.
Many contributors to our over-the-top boom, which led to the gross bust, are known. They include insufficient controls over morality and prudence in banks and investment banks; undesirable conduct among investment banks; greatly expanded financial leverage, aided by direct or implied use of government credit; and extreme excess, sometimes amounting to fraud, in the promotion of consumer credit. Unsound accounting was widespread.
Then there’s the chasing of the investment return rabbit. What if you had an investment that you were confident would return 12% per annum. A lot of you wouldn’t like that -- especially if you’ve done better -- but many would say, “I don’t care if someone else makes money faster.” The idea of caring that someone is making money faster [than you are] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. [Laughter] There’s a lot of pain and no fun. Why would you want to get on that trolley? [Laughter]
How to Get Rich
We get these questions a lot from the enterprising young. It’s a very intelligent question: you look at some old guy who’s rich and you ask, “how can I become like you, except faster?” [Laugher] My answer is that I did it slowly, inch by inch, taking losses mentally when they occurred. If you want to do it with fast rapidity, then you’re talking to the wrong man, but I know my way works.
If you don’t just want to play tiddlywinks, I say welcome to the pool. Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts. You may not need Zsa Zsa Gabor or a Lamborghini or a lot of other things you think you need now. Slug it out one inch at a time, day by day, at the end of the day --- if you live long enough---most peoplle get what they deserve.
Common stocks are valued in 2 ways: 1) rational estimates based on future use value [e.g., as Buffett has said in the past: future cash flows that the underlying businesses will generate from now until kingdom come, discounted back to the present at an appropriate rate]; 2) in the hopes that they will go up because people want to buy them. Like bonds and Rembrandts. Once you have government buying stocks every year like [they are] Rembrandts, God knows what would happen. This doesn’t appeal to me at all. I’m afraid of it, afraid of the politics, and I don’t believe the numbers of those projecting them. By the way, the numbers of those proposing this idea three years ago now look silly. What would happen to the morale of this country if [we invested Social Security into stocks and then what’s happened over the past 20+ years in Japan happened here? Imagine that the] government of Japan had put [their] Social Security into common stocks. For a while, stock prices went up and everyone felt good, consumers and politicians spent more, etc., and then stocks declined by 80%. I think they’d be in even worse shape. The more anything sounds like easy free money, the less I tend to believe it.
"It's natural that you'd have more brains going into money management. There are so many huge incomes in money management and investment banking --- it's like ants to sugar. There are huge incentives for a man to take up money management as opposed to, say, physics, and it's a lot easier."
"I think it's inevitable but terrible --- a disaster for the wider civilization. I'm somewhat ashamed… That I've profited from being shrewd with money is not by itself satisfying to me. To atone, I teach and try to set an example. I would hate it if the example of my life caused people to pursue the passive ownership of pieces of paper. I think lives so spent are disastrous lives. I think it's a better career if you help build something. I wish I'd built more, but I was cursed at being so good at stock picking. 'The man is the prisoner of his talents.' You can laugh, but I'll bet this room is full of people who are prisoners of their talents. It tends to be the human condition."
One idea is that whenever you think something or some person is ruining your life, it's you. A victimization mentality is so debilitating. I love spreading this stuff around. Just because it's trite doesn't mean it isn't right. In fact, I like to say, 'If it's trite, it's right.'"
Becoming a good investor
“If you’re going to be an investor, you’re going to make some investments where you don’t have all the experience you need. But if you keep trying to get a little better over time, you’ll start to make investments that are virtually certain to have a good outcome. The keys are discipline, hard work, and practice. It’s like playing golf --- you have to work on it.”
Investing mental models
“You need a different checklist and different mental models for different companies. I can never make it easy by saying, ‘Here are three things.’ You have to derive it yourself to ingrain it in your head for the rest of your life.”
"Generally speaking, you need to have appropriate mental models and a checklist to go through each of them. If 2-3 items are not on the checklist, and you're a pilot, you might crash."
Well, there is one mental trick that is unbelievably useful. And that is, as you think through reality using these models, think it through forward and also think it through backward. In other words, follow the injunction of the great algebraist, Carl Jacobi, who said, “Invert". Always invert.”
When it gets complicated, it is very helpful to think it through forward and backward.
Always try to disprove your own assumptions.
And, of course, the mental habit of thinking backward forces objectivity—because one of the ways you think a thing through backward is you take your initial assumption and say, “Let’s try to disprove it.”
That is not what most people do with their initial assumption. They try to confirm it. It is an automatic tendency in psychology—often called “first-conclusion bias.” But it is only a tendency. You can train yourself away from the tendency to a substantial degree. You just constantly take your own assumptions and try to disprove them. That is part of the winning game of thinking both forward and backward.
Circle of competence
“There are a lot of things we pass on. We have three baskets: in, out, and too tough...We have to have a special insight, or we’ll put it in the ‘too tough’ basket. All of you have to look for a special area of competency and focus on that.”
“Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.”
“Intense interest in any subject is indispensable if you are really going to excel in it.”
“Never, ever, think about something else when you should be thinking about the power of incentives.”
“In my whole life, I have known no wise people who did not read all the time---none, zero. You would be amazed at how much Warren reads---and at how much I read. My children laugh at me, they think I’m a book with a couple of legs sticking out.”
It is perfectly clear…that if Warren Buffett had never learned anything new after graduating from the Columbia Business School, Berkshire would be a pale shadow of its present self. Warren would have gotten rich—because what he learned from Ben Graham at Columbia was enough to make anybody rich. But he wouldn’t have the kind of enterprise Berkshire Hathaway is if he hadn’t kept learning.
YOU'LL FAIL IN BUSINESS AND IN LIFE.
Without a latticework of models, you'll fail in school and life.
Munger: What is elementary, worldly wisdom? Well, the first rule is that you can't really know anything if you just remember isolated facts and try and bang 'em back. If the facts don't hang together on a latticework of theory, you don't have them in a usable form.
You've got to have models in your head. And you've got to array your experience--- both vicarious and direct---on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and fail in life. You've got to hang experience on a latticework of models in your head.
Absent enough models, your brain will torture reality.
Munger: What are the models? Well, the first rule is that you've got to have multiple models---because if you just have one or two that you're using, the nature of human psychology is such that you'll torture reality so that it fits your models, or at least you'll think it does. You become the equivalent of a chiropractor who, of course, is the great boob in medicine.
It's like the old saying, "To the man with only a hammer, every problem looks like a nail." And of course, that's the way the chiropractor goes about practicing medicine. But that's a perfectly disastrous way to think and a perfectly disastrous way to operate in the world. So you've got to have multiple models.
And the models have to come from multiple disciplines---because all the wisdom of the world is not to be found in one little academic department. That's why poetry professors, by and large, are so unwise in a worldly sense. They don't have enough models in their heads. So you've got to have models across a fair array of disciplines.
Fortunately, it isn't all that tough....
Munger: You may say, "My God, this is already getting way too tough." But, fortunately, it isn't that tough---because 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person. And, of those, only a mere handful really carry very heavy freight.
You don’t have to know it all. Just take in the best, big ideas from all these disciplines. And it is not that hard to do….
When it gets complicated, it is very helpful to think it through forward and backward.
One can quickly see the pattern of excesses followed by financial destruction throughout history. John Kenneth Galbraith, a Harvard Economics professor, wrote a fascinating book in 1990 entitled "A Short History of Financial Euphoria" detailing many of these phenomena. I would like to end this long-winded post with several quotes from this book that are deadly relevant to the current debt crisis.
"Warren and I get nervous with vast amounts of leverage unless we're 100% confident that risk-taking won't creep into the culture."
Risks of financial institutions
"The beauty of a financial institution is that there are a lot of ways to go to hell in a bucket. You can push credit too far, do a dumb acquisition, leverage yourself excessively --- it's not just derivatives [that can bring about your downfall]."
One of the tricks in life is to get so you can handle mistakes.
Part of what you must learn is how to handle mistakes and new facts that change the odds. Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand.
I think it's dangerous to rely on special talents --- it's better to own lots of monopolistic businesses with unregulated prices.
"We have to have a special insight, or we'll put it in the 'too tough' basket. All of you have to look for a special area of competency and focus on that."
"What's interesting in Japan is that every life insurance company is essentially insolvent because they promised to pay 3%. Who'd have thought that this could lead to insolvency, but interest rates went to zero and stayed there for years. They tried to invest in equities, but got negative returns. Can you imagine 13 years with negative equity returns and interest rates below 1%?"
"Originally, there were interest rate swaps. If you did them naked, you could lose or make an enormous amount. But there wasn't enough money for traders, so they adopted mark-to-market accounting. Everyone caved, adopted loose [accounting] standards and created exotic derivatives linked to theoretical models. As a result, all kinds of earnings, blessed by accountants, are not really being earned. When you reach for the money, it melts away. It was never there."
Darwin is a great model in terms of objectivity. And the reason why I especially like Darwin is that his example provides reasonable hope of mental improvement to a great many people. If Darwin could take the modest intellectual endowments and end up next to Newton in Westminster Abbey, we can all learn something from him.
And one of the great things to learn from Darwin is the value of extreme objectivity. He tried to disconfirm his ideas as soon as he got’em. He quickly put down in his notebook anything that disconfirmed a much-loved idea. He especially sought out such things. Well, if you keep doing that over time, you get to be a perfectly marvellous thinker instead of one more klutz repeatedly demonstrating first-conclusion bias”
Investment should be approached in the same way. When you find a company or idea you like…try and break it down and prove yourself wrong. If you can’t (and as long as you’re somewhat competent), you have a good investment.
Look for disconfirming evidence – killing your own ideas
Emphasize factors that don’t produce lots of easily available numbers.
Under-weigh extra vivid experience and overweigh less vivid experience. Same with recent events i.e cool off
Remember the lesson: 1 idea or a fact is not worth more merely because it is easily available to you.
There’s no logical answer in some cases except to wring the money out and go elsewhere
Poor Charlie’s Almanack
I don’t want you to think we have any way of learning or behaving so you won’t make mistakes. I’m just saying that you can learn to make fewer mistakes than other people – and how to fix mistakes faster when you do make them…
But there’s no way you can live any adequate life without making many mistakes. In fact, one trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke.
Learn how to ignore the examples from others when they are wrong, because few skills are worth more having.
Our experience tends to confirm a long held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of the lifetime.
A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables.
And then all that is required is a willingness to bet heavily when the odds are extremely favourable, using resources available as a result of prudence and patience in the past.
Opportunity comes, but it doesn’t come often so seize it when it does come.
People calculate too much and think too little
If you want to rise in the world above others you just must use the mental model. Framework in a checklist style fashion – otherwise it will be an unequal contest like that of a one-legged man in an ass kicking contest…
There’s always going to be somebody who is making money faster, running the mile faster or what have you…Once you get something that works ﬁne in your life, the idea of caring terribly that somebody else is making money faster strikes me as insane.
There’s one big truth that the typical investment counselor will have difficulty recognizing but the guy who’s investing his own money ought to have no trouble recognizing…If you’re comfortably rich and you’ve got a way of investing your money that is overwhelmingly likely to keep you comfortably rich and someone else ﬁnds some rapidly growing something-or-other and is getting richer a lot faster than you are, that is not a big tragedy.
How crazy it would be to be made miserable by the fact that someone else is doing better because someone else is always going to be doing better at any human activity you can name… Even Tiger Woods loses a lot of the time.
If you want to get smart, the question you’ve got to ask is why? why? why? And you relate the answers to a structure of deep theory (Mental Models).
To acquire general wisdom, you also need: Full attribution ethos; and extreme reductionism (like in algebra) to understand lollapalooza outcomes
A great business at a fair price is superior to a fair business at a great price
Stocks are never cheap when the news is good.
"Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with managers of the highest integrity and ability. Then you own those shares forever." - Warren Buffett
”Finding a single investment that will return 20% per year for 40 years tends to happen only in dreamland. In the real world, you uncover an opportunity, and then you compare other opportunities with that. And you only invest in the most attractive opportunities. That’s your opportunity cost. That’s what you learn in freshman economics. The game hasn’t changed at all. That’s why Modern Portfolio Theory is so asinine.”
”It’s dangerous to short stocks.”
”…the cost of being a publicly traded stock has gone way, way up. It doesn’t make sense for a little company to be public anymore. A lot of little companies are going private to be rid of these burdensome requirements….”
If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along, you pounce on them with vigor.”
”Experience tends to confirm a long-held notion that being prepared, on a few occasions in a lifetime, to act promptly in scale, in doing some simple and logical thing, will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind that loves diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.”
Our investment style has been given a name---focus investing---which implies ten holdings, not one hundred or four hundred. The idea that it is hard to find good investments, so concentrate in a few, seems to me to be an obvious idea. But 98% of the investment world does not think this way. It’s been good for us.”
”We’re guessing at our future opportunity cost. Warren is guessing that he’ll have the opportunity to put capital out at high rates of return, so he’s not willing to put it out at less than 10% now. But if we knew interest rates would stay at 1%, we’d change. Our hurdles reflect our estimate of future opportunity costs.”
”A lot of share-buying, not bargain-seeking, is designed to prop stock prices up. Thirty to 40 years ago, it was very profitable to look at companies that were aggressively buying their own shares. They were motivated simply to buy below what it was worth.”
There are a lot of things we pass on. We have three baskets: in, out, and too tough…We have to have a special insight, or we’ll put it in the ‘too tough’ basket. All of you have to look for a special area of competency and focus on that.
”It is entirely possible that you could use our mental models to find good IPOs to buy. There are countless IPOs every year, and I’m sure that there are a few cinches that you could jump on. But the average person is going to get creamed. So if you’re talented, good luck. IPOs are too small for us, or too high tech, so we won’t understand them. So, if Warren’s looking at them, I don’t know about it.”
A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. And that is why we say that having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success.”
”I always like it when someone attractive to me agrees with me, so I have fond memories of Phil Fisher. The idea that it was hard to find good investments, so concentrate in a few, seems to me to be an obviously good idea. But 98% of the investment world doesn’t think this way. “
”The investment game always involves considering both quality and price, and the trick is to get more quality than you pay for in price. It’s just that simple.”
”…by regularly reading business newspaper and magazines I am exposed to an enormous amount of material at the micro level.. . I find that what I see going on there pretty much informs me about what’s happening at the macro level.”
We didn’t know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no one cared. Learning this changed Berkshire. It was really important.”
“You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own Circle of Competence.”
“If you have competence, you pretty much know its boundaries already. To ask the question [of whether you are past the boundary] is to answer it.”
“The game of investing is one of making better predictions about the future than other people. How are you going to do that? One way is to limit your tries to areas of competence. If you try to predict the future of everything, you attempt too much.”
“Proper allocation of capital is an investor’s number one job”
“By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”
25 of Munger’s Human Tendencies
To cope with information and computation overload, humans have developed simple “rules of thumb” called “heuristics” which allow them to make decisions. Decision making heuristics are sometimes beneficial and sometimes not. Catching a fly ball in a baseball games involves a heuristic which works very well. Really skillful people who know their limitations well can sometimes use heuristics to their advantage. The reason for this mixed or nuanced answer is namely heuristics act faster than rational deliberation, but precisely because of their speed, heuristics can mislead us into systematic errors in making decisions.
Charlie Munger advises us to avoid or minimize them as the brain can be a .
1. Reward and Punishment Super-response Tendency
2. Liking/Loving Tendency
3. Disliking/Hating Tendency
4. Doubt-Avoidance Tendency
5. Inconsistency-Avoidance Tendency
6. Curiosity Tendency
7. Kantian Fairness Tendency
8. Envy/Jealousy Tendency
9. Reciprocation Tendency
10. Influence-from-Mere Association Tendency
11. Simple, Pain-Avoiding Psychological Denial
12. Excessive Self-Regard Tendency
13. Overoptimism Tendency
14. Deprival Superreaction Tendency
15. Social-Proof Tendency
16. Stress-Influence Tendency
17. Use-It-or-Lose-It Tendency
18. Drug-Misinfluence Tendency
19. Senescence-Misinfluence Tendency
20. Authority-Misinfluence Tendency
21. Contrast-Mis-reaction Tendency
22. Availability-Misweighing Tendency
23. Twaddle Tendency
24. Reason-Respecting Tendency
25. Lollapalooza Tendency