Charlie Munger on Poor Charlie’s Almanack

http://www.valuewalk.com/charlie-munger-page/

Without a doubt, the best resource you can get on Charlie Munger is the book, Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger .

Poor Charlie’s Almanack was constructed by Peter D. Kaufman (the production team also included Travis Gallup, Carl Foote, Scott Rule, Dwight Tompkins, Michael Broggie, Steve Mull, Pamela Koch, Eric Hartman-Birge, Paul Hartman, Charles Belser, Ed Wexler, Whitney Tilson, Marcus Kaufman, Peter Kaufman, Carol Loomis, Debbie Bosanek, and Doerthe Obert) and groups together a broad selection of Charlie Munger’s essays, memoirs, interviews, and speeches. The book is based on Benjamin Franklin's Poor Richard's Almanack, a popular collection of calendars, weather-related and astrological material that was published from 1733 to 1758.

Poor Charlie's breakdown

The first chapter of the book includes a biography of Munger, a short version of which you can find here -- the start of this series. Poor Charlie's Almanack then goes on to discuss "the Munger approach to life, learning, decision-making, and investing". This part of the book is just as important as any other. Poor Charlie’s Almanack was one of the first publications to draw attention to Munger's ‘multiple mental models’ approach to evaluating businesses. Key to this approach is Charlie’s investing checklist, which I covered in part five of this series.

Also introduced alongside Charlie Munger’s metal models, is his "Lollapalooza Effect".

The "Lollapalooza Effect" is, in Charlie’s words, the “multiple biases, tendencies or mental models all acting at the same time in the same direction to produce extreme outcomes and investor misjudgement”. Or in other words, the "Lollapalooza Effect" describes the mentality of short-term investors, who chase wild market gyrations in an attempt to profit.

Charlie’s essays

Chapter three of Poor Charlie’s Almanack covers material from Berkshire Hathaway and WescoFinancial meetings. The rest of the book is devoted to ten stand-out talks from Munger given over his 20-year career.

Poor Charlie's Almanack is essential reading for all value investors. Not only does it provide essential investing advice, but it also guides on the psychological side of investing and life in general.

Below are just two excerpts from the book. These two short lessons are taken from Charlie Munger’s lecture to the students of Professor Guilford Babcock, at the University of Southern California Marshall School of Business. The lecture was tilted, "A Lesson On Elementary, Worldly Wisdom As It Relates To Investment Management & Business."

If you’re interested in more of Charlie Munger’s musings, but don't have access to Poor Charlie's Almanack, here's a PDF compilation of documents.

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'RE GIVING A HUGE ADVANTAGE TO OTHERS IF YOU DON'T LEARN THIS SIMPLE TECHNIQUE.

...Obviously, you've got to be able to handle numbers and quantities - basic arithmetic.

And the great useful model, after compound interest, is the elementary math of permutations and combinations. And that was taught in my day in the sophomore year in high school. I suppose by now in great private schools, it's probably down to the eighth grade or so.

It's very simple algebra. And it was all worked out in the course of about one year in correspondence between Pascal and Fermat. They worked it out casually in a series of letters.

Your brain isn't designed to figure it out spontaneously.

Munger: It's not that hard to learn. What is hard is to get so you use it routinely almost everyday of your life. The Fermat/Pascal system is dramatically consonant with the way that the world works. And it's fundamental truth. So you simply have to have the technique.

Many educational institutions - although not nearly enough - have realized this. At Harvard Business School, the great quantitative thing that bonds the first-year class together is what they call decision tree theory. All they do is take high school algebra and apply it to real life problems. And the students love it. They're amazed to find that high school algebra works in life....

By and large, as it works out, people can't naturally and automatically do this. If you understand elementary psychology, the reason they can't is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution. And it's not Fermat/Pascal. It uses a very crude, shortcut-type of approximation. It's got elements of Fermat/Pascal in it. However, it's not good.

Without it, you're giving a huge advantage to others....

Munger: So you have to learn in a very usable way this very elementary math and use it routinely in life - just the way if you want to become a golfer, you can't use the natural swing that broad evolution gave you. You have to learn to have a certain grip and swing in a different way to realize your full potential as a golfer.

If you don't get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest. You're giving a huge advantage to everybody else. One of the advantages of a fellow like Buffett, whom I've worked with all these years, is that he automatically thinks in terms of decision trees and the elementary math of permutations and combinations....

YOU HAVE TO KNOW ACCOUNTING - ALONG WITH ITS LIMITATIONS.

Double-entry bookkeeping was a hell of an invention.

Munger: Obviously, you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization. I've heard it came to civilization through Venice which of course was once the great commercial power in the Mediterranean. However, double entry bookkeeping was a hell of an invention.

And it's not that hard to understand. But you have to know accounting's limitations....

Munger: But you have to know enough about it to understand its limitations - because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know.

In terms of the limitations of accounting, one of my favorite stories involves a very great businessman named Carl Braun who created the CF Braun Engineering Company. It designed and built oil refineries - which is very hard to do. And Braun would get them to come in on time and not blow up and have efficiencies and so forth. This is a major art.

And Braun, being the thorough Teutonic type that he was, had a number of quirks. And one of them was that he took a look at standard accounting and the way it was applied to building oil refineries and he said, "This is asinine."

So he threw all of his accountants out and he took his engineers and said "Now, we'll devise our own system of accounting to handle this process." And in due time, accounting adopted a lot of Carl Braun's notions. So he was a formidably willful and talented man who demonstrated both the importance of accounting and the importance of knowing its limitations.