Charlie Munger: The Complete Investor (Columbia Business School Publishing)

by Tren Griffin

Daniel Kahneman considers doubt-avoidance tendency to be a System 1 activity, which Michael Mauboussin described as follows: “System 1 is your experiential system. It’s fast. It’s quick. It’s automatic and really difficult to control. System 2 is your analytical system: slow, purposeful, deliberate, but malleable.”

Nassim Taleb put it this way: “Most of you will fail, disrespected, impoverished, but we are grateful for the risks you’re taking and the sacrifices you’re making for the sake of the economic growth of the planet and pulling others out of poverty. You’re the source of our antifragility. Our nation thanks you.”

Inconsistency-Avoidance Tendency The brain of man conserves programming spaces by being reluctant to change. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995 People are reluctant to change even when they have been given new information that conflicts with what they already believe. Inconsistency-avoidance tendency is another often-useful heuristic because starting each day with a fresh mind about everything requires too much processing power. Unfortunately, as is the case with every heuristic, what is mostly helpful can sometimes be harmful. The adverse effects of this tendency can be made worse when it appears in combination with the previously discussed

doubt-avoiding tendency. The desire to resist any change in a given conclusion or belief is particularly strong if a person has invested a lot of effort in reaching that conclusion or belief and/or if the change will result in something that is unpleasant. This is a major reason why progress in many professions tends to advance “one funeral at a time.” An example of this phenomenon can be found in the many companies which refused to recognize that personal computers or mobile phones were a threat to their business. Absence of the inconsistency-avoidance tendency among some people operates to benefit society. For example, company founders who are not wedded to old ideas can sometimes create innovative new businesses more easily. As another example, an executive may cling to an idea he or she has publicly advocated, even after facts come to light proving the idea false. One way to avoid this problem is to be very careful about what you say in public. Also, be aware that once you say something in public, you may be blind to disconfirming evidence. Mark Twain’s statement comes to mind on this tendency: “All you need in this life is ignorance and confidence; then success is sure.”7 Some entrepreneurs often don’t know enough to think that something can’t be done, so once in a while they actually do something that is completely unexpected. As the old saying goes, even a blind squirrel finds a nut once in a while.

Curiosity Tendency Curiosity can provide both fun and wisdom, and occasionally trouble. —CHARLIE MUNGER,...

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. —CHARLIE MUNGER, WESCO ANNUAL MEETING, 1996

7. Kantian Fairness Tendency

Tolerating a little unfairness to some to get a greater fairness for all is a model I recommend to all of you.

CHARLIE MUNGER, UCSB, 2003

some people would rather lose money in an investment than see another person benefit from unfairness.

Envy/Jealousy Tendency A member of a species designed through evolutionary process to want often scarce food is going to be driven strongly toward getting food when it first sees food. And this is going to occur often and tend to create some conflict when the food is seen in the possession of another member of the same species. This is probably the evolutionary origin of the envy/jealousy tendency that lies so deep in human nature. —CHARLIE MUNGER, UNIVERSITY OF SOUTHERN CALIFORNIA (USC), 1994

The idea of caring that someone is making money faster [than you] 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. There’s a lot of pain and no fun. Why would you want to get on that trolley? —CHARLIE MUNGER, WESCO ANNUAL MEETING, 2003

Munger’s point on envy is simple: nothing good comes from envy. He believes that envy is a completely wasted emotion that a person should work hard to avoid.

Professor Robert Cialdini has pointed out that, “People will help if they owe you for something you did in the past to advance their goals. That’s the rule of reciprocity.”

The urge to reciprocate favors and disfavors is so strong that even someone smiling at you is hard not to reciprocate.

10. Influence-from-Mere-Association Tendency

Think how association, pure association, works. Take Coca-Cola Company (we’re the biggest shareholder). They want to be associated with every wonderful image: heroics in the Olympics, wonderful music, you name it.

They don’t want to be associated with presidents’ funerals and so forth. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995

Because compliance professionals know this human weakness, advertisers spend huge amounts of money to associate their products and services with favorable images.

Influence from association can also work in reverse, such as when a person is unfairly connected to something unfavorable they did not cause. An example of this is the Persian messenger syndrome (also known as “shoot the messenger”). There is significant danger inherent in this syndrome because people, often executives or politicians, may surround themselves with people who only tell them what they want to hear. Munger pointed to Bill Paley of CBS as an example of someone who put himself in a cocoon of unreality and suffered a major business failure as a result.

11. Simple, Pain-Avoiding Psychological Denial One should recognize reality even when one doesn’t like it. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2000

12. Excessive Self-regard Tendency We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. —CHARLIE MUNGER, SEEKING WISDOM, 2003

Investor over-optimism—and its evil twin, over-pessimism—are what make Mr. Market bipolar. The good news for people who can keep their level of optimism at rational levels is that the unpredictable but inevitable gyrations between these two states create opportunities for Graham value investors. Staying rationally optimistic as the market gyrates is very difficult. Only a small number of people can do it successfully. Even experts who spend their lives studying behavioral economics can fall prey to the over-optimism and over-pessimism tendencies. For example, Nobel Prize winner Daniel Kahneman wrote this:

14. Deprival Super-Reaction Tendency

The deprival super-reaction syndrome of man helps cause much ruin as people’s cognition is distorted as a result of their suffering losses and near misses. —CHARLIE MUNGER, STANFORD LAW SCHOOL, 1998 Your brain doesn’t naturally know how to think the way Zeckhauser knows how to play bridge. For example, people do not react symmetrically to loss and gain. Well, maybe a great bridge player like Zeckhauser does, but that’s a trained response. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995 I mean people are really crazy about minor decrements down. … Huge insanities can come from just subconsciously overweighing the importance of what you’re losing or almost getting and not getting.

The deprival super-reaction tendency is more commonly called loss aversion, and it can cause investors to irrationally avoid risk when they face potential for gain, but irrationally seek risk when there is a potential for loss. In other words, people tend to be too conservative in seeking gains and too aggressive in seeking to avoid losses. The most important point to remember about this tendency is that it causes investors to do things like sell stocks too early and hold on to them for too long. It is very common for investors to hold on to losing stocks in the hope that somehow the price will rise and they will somehow break even. As another example of this tendency at work, many investors were so traumatized by stock losses after the 2007 financial crisis that they completely missed the subsequent rally in the markets. One of prospect theory’s most important contributions to finance is loss aversion, the idea that, for most people, losses loom larger than corresponding gains. The empirical evidence suggests we feel losses about two to two-and-a-half times more than we feel gains. —MICHAEL MAUBOUSSIN, AVER AND AVERSION, 2005

15. Social-Proof Tendency Big-shot businessmen get into these waves of social proof. Do you remember some years ago when an oil company bought a fertilizer company, and every other major oil company practically ran out and bought a fertilizer company? And there was no more damned reason for all these oil companies to buy fertilizer companies, but they didn’t know exactly what to do, and if Exxon was doing it, it was good enough for Mobil, and vice versa. I think they’re all gone now, but it was a total disaster. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995

paradoxical

Humans have a natural tendency to follow a herd of other humans. In other words, because humans do not have unlimited time and complete information, they tend to copy the behavior of other humans. Cialdini put it this way: “One means we use to determine what is correct is to find out what other people think is correct.

Learning to ignore the crowd and think independently is a trained response.

Munger is a big proponent of independent thinking in investing. In thinking independently, it’s wise to remember Seth Klarman’s view that a Graham value investor is a marriage between a contrarian and a calculator. Falling in with the crowd due to social proof means it is mathematically impossible to outperform the market. Independent thinking can be an opportunity to arbitrage the tendency of people to follow the crowd. Profit can be made by sometimes zigging when the crowd zags if you see a wager in which the odds are substantially in your favor. It is not enough to be contrarian; you must also be sufficiently right in terms of the magnitude of the positive outcome that you outperform the markets.

For example, the fact that Y is a better stock than X is not enough information to make an investing decision. Is Y the best investment of all the investments you could possibly make anywhere? Thinking about the world through an opportunity-cost lens is a simple but often-ignored idea.

Investors have a tendency to make decisions based on what they can easily recall. The more vivid and memorable the event, fact, or phenomenon may be, the more likely it will be used by the investor in making a decision—even if what is being recalled is not the best data on which to make a decision. For example, if stocks have recently dramatically fallen in a market crash, investors tend to be afraid to buy, even though it may be the very best time to buy. The year 2002 was an excellent time to buy stocks, but the memory of the crash of the stock market after the collapse of the Internet bubble was so vivid that only people who, like Munger, had trained themselves to overcome this tendency were able to use that opportunity to reap big investing rewards.

19. Use-It-or-Lose-It Tendency

We all know talented people who have ruined their lives abusing either alcohol or drugs—and often both. —CHARLIE MUNGER, HARVARD-WESTLAKE SCHOOL, 1986

21. Senescence-Misinfluence Tendency Some people remain pretty good in maintaining intensely practiced old skills until late in life, as one can notice in many a bridge tournament. … Continuous thinking and learning, done with joy, can somewhat help delay what is inevitable. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995

22. Authority-Misinfluence Tendency

You get a pilot and a co-pilot. The pilot is the authority figure. They don’t do this in airplanes, but they’ve done it in simulators. They have the pilot do something where the co-pilot, who’s been trained in simulators a long time—he knows he’s not to allow the plane to crash—they have the pilot do something where an idiot co-pilot would know the plane was going to crash, but the pilot’s doing it, and the co-pilot is sitting there, and the pilot is the authority figure. 25 percent of the time, the plane crashes. I mean, this is a very powerful psychological tendency. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995 People tend to follow people who they believe are authorities, especially when they face risk, uncertainty, or ignorance. Professor Cialdini described the authority tendency this way: “When people are uncertain … they don’t look inside themselves for answers—all they see is ambiguity and their own lack of confidence. Instead, they look outside for sources of information that can reduce their uncertainty. The first thing they look to is authority.”

24. Reason-Respecting Tendency

Reason-Respecting Tendency is so strong that even a person’s giving of meaningless or incorrect reasons will increase compliance with his orders and requests. This has been demonstrated in psychology experiments wherein “compliance practitioners” successfully jump to the head of the lines in front of copying machines by explaining their reason: “I have to make some copies.” This sort of unfortunate byproduct of Reason-Respecting Tendency is a conditioned reflex, based on a widespread appreciation of the importance of reasons. And, naturally, the practice of laying out various claptrap reasons is much used by commercial and cult “compliance practitioners” to help them get what they don’t deserve. —CHARLIE MUNGER, HARVARD UNIVERSITY, 1995

IN HIS BIOGRAPHY of Warren Buffett, Roger Lowenstein pointed out that Buffett’s “genius was largely a genius of character—of patience, discipline and rationality. … His talent sprang from his unrivaled independence of mind and ability to focus on his work and shut out the world.”

You can improve your ability to read, think, learn, avoid mistakes, and pay attention to the personal attributes that drive success.

1. Patient

Success means being very patient but aggressive when it’s time. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2004

2. Disciplined

We both insist on a lot of time being available almost every day to just sit and think. That is very uncommon in American business. We read and think. So Warren and I do more reading and thinking and less doing than most people in business. —CHARLIE MUNGER, KIPLINGER, 2005

3. Calm but Courageous and Decisive

I think there’s something to be said for developing the disposition to own stocks without fretting. —CHARLIE MUNGER, BERKSHIRE ANNUAL MEETING, 2003 We fret way earlier than other people. We left a lot of money on the table through early fretting. It’s the way we are—you’ll just have to live with it. —CHARLIE MUNGER, WESCO ANNUAL MEETING, 2001 If you’re not willing to react with equanimity to a market price decline of 50 percent two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations. —CHARLIE MUNGER, BBC INTERVIEW, 2010 If you want to get rich, you’ll need a few decent ideas where you really know what you’re doing. Then you’ve got to have the courage to stick with them and take the ups and downs. Not very complicated, and it’s very old-fashioned. —CHARLIE MUNGER, DAILY JOURNAL MEETING, 2013 You will get a few opportunities to profit from finding underpricing. There are actually people out there who don’t price everything as high as the market will easily stand. And once you figure that out, it’s like finding money in the street—if you have the courage of your convictions.

It’s amazing how fast Berkshire acts when we find opportunity. You can’t be timid—and that applies to all of life. —CHARLIE MUNGER, WESCO ANNUAL MEETING, 2011

If you are a Graham value investor, the best times for you are the worst times for other investors and speculators. John Templeton put it this way: “To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage but provides the greatest profit.”