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“You need a different checklist and different mental models for different companies. I can never make it eary by saying, ‘Here are three things.’ You have to derive it yourself to ingrain it in your head for the rest of your life.” —Munger
Today I finished reading the great book Poor Charlie’s Almanack – The Wit and Wisdom of Charles T. Munger.
I have read all of the talks included in the book earlier, but since they’re so great re-reading them is nothing but a true pleasure.
Listening to what Schopenhauer had to say about good books, I think I might pick it up again once or twice.
“Any book, which is at all important, should be reread immediately.” —Arthur Schopenhauer
In the book Charlie talks about the importance of having different checklists and use them properly when making decisions in different situations, this to try to avoid making foolish judgmental mistakes.
Below is an excerpt from the book discussing the use of an investing checklist based on the thinking of Charlie Munger.
“An Investing Principles Checklist
“No wise pilot, no matter how great his talent and experience, fails to use his checklist.”
We have now examined Charlie’s approach to thinking in general and to investing in particular. In keeping with our intent to observe “how he seems to do it,” we will recap his approach by using the “checklist” methodology he advocates. (For Charlie’s own words of wisdom on the value and importance of checklists, see Talk Five and page 320.) Note, however, that the following principles are most certainly not employed by Charlie in a one-by-one or one-time fashion as the checklist format might seem to imply. Nor can they necessarily be prioritized in terms of any apparent or relative importance. Rather, each must be considered as
part of the complex whole or gestalt of the investment analysis process, in much the same way that an individual tile is integral to the larger mosaic in which it appears.
- 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
- 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)
- 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?”
- 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
- 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
- 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
- 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
- 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 does
- Opportunity meeting the prepared mind: that’s the game
- 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
- 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 and boredom
- Don’t overlook the obvious by drowning in minutiae
- 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
Since human beings began investing, they have been searching for a magic formula or easy recipe for instant wealth. As you can see, Charlie’s superior performance doesn’t come from a magic formula or some business-school-inspired system. It comes from what he calls his “constant search for better methods of thought,” a willingness to “prepay” through rigorous preparation, and from the extraordinary outcomes of his multidisciplinary research model. In the the end, it comes down to Charlie’s most basic guiding principles, his fundamental philosophy of life: Preparation. Discipline. Patience. Decisiveness. Each attribute is in turn lost without the other, but together they form the dynamic critical mass for a cascading of positive effects for which Munger is famous (the “lollapalooza” ).
Finally, a word or two on why this overview of Charlie’s investment philosophy has focused so much on the subject of “what to buy” and so litle on “when to sell.” ‘the answer, in Charlie’s own words, serves as a wonderful summation of the “Munger School” of highly-concentrated, focused investing described here: “We’re partial to putting out large amounts of money where we won’t make another decision. If you buy something because it’s undervalued, then you have to think about selling it when it approaches your calculation if its intrinsic value. That’s hard. But, if you can buy a few, great companies, then you can sit on ass. That’s a good thing.”
Like his hero, Benjamin Franklin, Charlie Munger painstakingly developed and perfected unique approaches to personal and business endeavors. Through these methods, and the development and maintenance of sound, lifelong habits, he has achieved extraordinary success.”
“The elementary part of psychology ‑ the psychology of misjudgment, as I call it ‑ is a terribly important thing to learn. There are about 20 little principles. And they interact, so it gets slightly complicated. But the guts of it is unbelievably important. Terribly smart people make totally bonkers mistakes by failing to pay heed to it. In fact, I’ve done it several times during the last two or three years in a very important way. You never get totally over making silly mistakes. There’s another saying that comes from Pascal which I’ve always considered one of the really accurate observations in the history of thought. Pascal said in essence, ‘The mind of man at one and the same time is both the glory and the shame of the universe.'” — Charlie Munger
Charlie Munger’s standard causes of Human Misjudgement is truly great stuff, and something I wish everyone had the privilege to get in touch with.
The audio file below contains the often referred to speech by Charlie Munger on the psychology of human misjudgment given to an audience at Harvard University back in 1995. In his speech, Charlie talks about some of the different kinds of human misjudgments that he has encountered through his life.
The following is a summary of Charlie’s 25 standard causes of human misjudgments (see link in the end of this post), revised by himself in 2005 and included in Poor Charlie’s Almanack – The Wit and Wisdom of Charles T. Munger:
- Reward and Punishment Superresponse Tendency
- Liking/Loving Tendency
- Disliking/Hating Tendency
- Doubt-Avoidance Tendency
- Inconsistency-Avoidance Tendency
- Curiosity Tendency
- Kantian Fairness Tendency
- Envy/Jealousy Tendency
- Reciprocation Tendency
- Influence-from-Mere Association Tendency
- Simple, Pain-Avoiding Psychological Denial
- Excessive Self-Regard Tendency
- Overoptimism Tendency
- Deprival Superreaction Tendency
- Social-Proof Tendency
- Contrast-Misreaction Tendency
- Stress-Influence Tendency
- Availability-Misweighing Tendency
- Use-It-or-Lose-It Tendency
- Drug-Misinfluence Tendency
- Senescence-Misinfluence Tendency
- Authority-Misinfluence Tendency
- Twaddle Tendency
- Reason-Respecting Tendency
- Lollapalooza Tendency – The Tendency to Get Extreme Confluences of Psychological Tendencies Acting in Favor of a Particular Outcome
See here for full text in PDF.
See here for audio file.
When analyzing a business as a possible future investment an investor needs to form an opinion about corporate governance, i.e. whether the business is run in the interest of shareholders or not.
In his shareholder letter for fiscal year 2007 Warren Buffett wrote about what kind of businesses that turn him and Charlie, and summarized it as follows.
“Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag.”
Today I read a paper titled Corporate Governance According to Charles T. Munger. The paper discusses corporate governance and “How […] an organization [should] be structured to encourage ethical behavior among organizational participants and motivate decision-making in the best interest of shareholders?”
A good start to widen your circle of competence in getting a better understanding about the area of corporate governance, is to read the paper and listen carefully to what Charlie has to say.
The paper can be found here.